vtu supply chain ppt

© Prof. Prasad Kulkarni, MBA department GIT Belgaum.Change to change otherwise change will change you

Supply Chain Management

By

Prof. Prasad Kulkarni


Module 1


Introduction to supply Chain Management

• Supply chain – objectives – importance – decision phases – process view – competitive and supply chain strategies – achieving strategic fit – supply chain drivers – obstacles – framework – facilities – inventory – transportation – information – sourcing – pricing.


definition

• A supply chain consists of all parties involved directly or indirectly in fulfilling a customer request.

• It includes manufacturer supplier, transporters, warehouses, retailers and customers.


Supply chain management in HUL


Objectives

• Objective 1: enhance the supply chain value

Supply chain value is the difference between final worth of product to customer minus costs supply chain incurs in filling the customers request.


• Objective 2: Increase the supply chain profitability.

Supply chain profitability is the difference between the revenue generated from the customer and the overall cost across the value chain.


• Objective 3: Maximize the customer satisfaction

• Objective 4: Have product replenishment at right time.


Importance of supply chain

• Transportation and information infrastructure facilitates effective flow of goods and information.

• Proper management of product, information and fund flows increases the profitability.

• Involving customers in supply chain improves the effectiveness.

• Zero inventory system and JIT reduces the cost of manufacturing.


[Decision Phases of a Supply Chain ]

• Supply chain strategy or design• Supply chain planning• Supply chain operation


Supply Chain Strategy or Design

• Decisions about the structure of the supply chain and what processes each stage will perform

• Strategic supply chain decisions– Locations and capacities of facilities– Products to be made or stored at various locations– Modes of transportation– Information systems

• Supply chain design must support strategic objectives• Supply chain design decisions are long-term and

expensive to reverse – must take into account market uncertainty


Supply Chain Planning

• Definition of a set of policies that govern short-term operations

• Fixed by the supply configuration from previous phase

• Starts with a forecast of demand in the coming year


Supply Chain Planning

• Planning decisions:– Which markets will be supplied from which

locations– Planned buildup of inventories– Subcontracting, backup locations– Inventory policies– Timing and size of market promotions

• Must consider in planning decisions demand uncertainty, exchange rates, competition over the time horizon


Supply Chain Operation

• Time horizon is weekly or daily• Decisions regarding individual customer orders• Supply chain configuration is fixed and operating policies

are determined• Goal is to implement the operating policies as effectively

as possible• Allocate orders to inventory or production, set order due

dates, generate pick lists at a warehouse, allocate an order to a particular shipment, set delivery schedules, place replenishment orders

• Much less uncertainty (short time horizon)


Process View of a Supply Chain

• Cycle view: processes in a supply chain are divided into a series of cycles, each performed at the interfaces between two successive supply chain stages

• Push/pull view: processes in a supply chain are divided into two categories depending on whether they are executed in response to a customer order (pull) or in anticipation of a customer order (push)


Cycle View of Supply Chains

Customer Order Cycle

Replenishment Cycle

Manufacturing Cycle

Procurement Cycle

Customer

Retailer

Distributor

Manufacturer

Supplier


Cycle View of a Supply Chain

• Each cycle occurs at the interface between two successive stages

• Customer order cycle (customer-retailer)• Replenishment cycle (retailer-distributor)• Manufacturing cycle (distributor-manufacturer)• Procurement cycle (manufacturer-supplier)• Cycle view clearly defines processes involved and the

owners of each process. Specifies the roles and responsibilities of each member and the desired outcome of each process.


Push/Pull View of Supply Chains

Procurement,Manufacturing andReplenishment cycles

Customer OrderCycle

CustomerOrder Arrives

PUSH PROCESSES PULL PROCESSES


Push/Pull View of Supply Chain Processes

• Supply chain processes fall into one of two categories depending on the timing of their execution relative to customer demand

• Pull: execution is initiated in response to a customer order (reactive)

• Push: execution is initiated in anticipation of customer orders (speculative)

• Push/pull boundary separates push processes from pull processes


Push/Pull View of Supply Chain Processes

• Useful in considering strategic decisions relating to supply chain design – more global view of how supply chain processes relate to customer orders

• Can combine the push/pull and cycle views

– Big Bazaar– Hindustan Unilever.

• The relative proportion of push and pull processes can have an impact on supply chain performance


Supply Chain Macro Processes in a Firm • Supply chain processes discussed in the

two views can be classified into:– Customer Relationship Management (CRM)– Internal Supply Chain Management (ISCM)– Supplier Relationship Management (SRM)

• Integration among the above three macro processes is critical for effective and successful supply chain management


Competitive and Supply Chain Strategies• Competitive strategy: defines the set of customer needs

a firm seeks to satisfy through its products and services• Product development strategy: specifies the portfolio of

new products that the company will try to develop


• Marketing and sales strategy: specifies how the market will be segmented and product positioned, priced, and promoted

• Supply chain strategy: – determines the nature of material procurement, transportation of

materials, manufacture of product or creation of service, distribution of product

– Consistency and support between supply chain strategy, competitive strategy, and other functional strategies is important


NewProduct

Development

Marketingand

SalesOperations Distribution Service

Finance, Accounting, Information Technology, Human Resources

The Value Chain: Linking Supply Chain and Business

Strategy


Achieving Strategic Fit

• Strategic fit: – Consistency between customer priorities of competitive strategy

and supply chain capabilities specified by the supply chain strategy

– Competitive and supply chain strategies have the same goals• A company may fail because of a lack of strategic fit or because its

processes and resources do not provide the capabilities to execute the desired strategy


How is Strategic Fit Achieved?

• Step 1: Understanding the customer and supply chain uncertainty

• Step 2: Understanding the supply chain• Step 3: Achieving strategic fit


Step 1: Understanding the Customer and Supply Chain

Uncertainty• Identify the needs of the customer

segment being served• Quantity of product needed in each lot• Response time customers will tolerate• Variety of products needed• Service level required• Price of the product• Desired rate of innovation in the product


Step 1: Understanding the Customer and Supply Chain

Uncertainty• Overall attribute of customer demand• Demand uncertainty: uncertainty of

customer demand for a product• Implied demand uncertainty: resulting

uncertainty for the supply chain given the portion of the demand the supply chain must handle and attributes the customer desires


Step 1: Understanding the Customer and Supply Chain Uncertainty

• Implied demand uncertainty also related to customer needs and product attributes

• First step to strategic fit is to understand customers by mapping their demand on the implied uncertainty spectrum


Achieving Strategic Fit

• Understanding the Customer– Lot size– Response time– Service level– Product variety– Price– Innovation

ImpliedDemand

Uncertainty


Impact of Customer Needs on Implied Demand Uncertainty

Customer Need Causes implied demand uncertainty to increase because …

Range of quantity increases Wider range of quantity implies greater variance in demand

Lead time decreases Less time to react to orders

Variety of products required increases

Demand per product becomes more disaggregated

Number of channels increases Total customer demand is now disaggregated over more channels

Rate of innovation increases New products tend to have more uncertain demand

Required service level increases Firm now has to handle unusual surges in demand


Levels of Implied Demand Uncertainty

Predictable supply and

demand

Salt at a supermarket

A new communication

device

Highly uncertain supply and demand

Figure 2.2: The Implied Uncertainty (Demand and Supply) Spectrum

Predictable supply and uncertain demand or uncertain supply and predictable demand or somewhat

uncertain supply and demand

An existing automobile

model


Correlation Between Implied Demand Uncertainty and Other

Attribute Low Implied Uncertainty

High Implied Uncertainty

Product margin Low High

Avg. forecast error 10% 40%-100%

Avg. stockout rate 1%-2% 10%-40%

Avg. forced season-end markdown

0% 10%-25%


Step 2: Understanding the Supply Chain

• How does the firm best meet demand?• Dimension describing the supply chain is supply chain

responsiveness• Supply chain responsiveness -- ability to

– respond to wide ranges of quantities demanded– meet short lead times– handle a large variety of products– build highly innovative products– meet a very high service level


Step 2: Understanding the Supply Chain

• There is a cost to achieving responsiveness• Supply chain efficiency: cost of making and delivering the product to

the customer• Increasing responsiveness results in higher costs that lower

efficiency• Second step to achieving strategic fit is to map the supply chain on

the responsiveness spectrum


Understanding the Supply Chain: Cost-Responsiveness Efficient Frontier

High Low

Low

High

Responsiveness

Cost


Step 3: Achieving Strategic Fit

• Step is to ensure that what the supply chain does well is consistent with target customer’s needs


Responsiveness Spectrum

Integratedsteel mill

Dell

Highlyefficient

Highlyresponsive

Somewhatefficient

Somewhatresponsive

Hanesapparel

Mostautomotiveproduction


Achieving Strategic Fit Shown on the Uncertainty/Responsiveness Map

Implied uncertainty spectrum

Responsive supply chain

Efficient supply chain

Certain demand

Uncertain demand

Responsiveness spectrum Zone of

Strategic Fit


Step 3: Achieving Strategic Fit

• All functions in the value chain must support the competitive strategy to achieve strategic fit

• Two key points– there is no right supply chain strategy

independent of competitive strategy– there is a right supply chain strategy for a

given competitive strategy


Comparison of Efficient and Responsive Supply Chains

Efficient Responsive

Primary goal Lowest cost Quick response

Product design strategy Min product cost Modularity to allow postponement

Pricing strategy Lower margins Higher margins

Mfg strategy High utilization Capacity flexibility

Inventory strategy Minimize inventory Buffer inventory

Lead time strategy Reduce but not at expense of greater cost

Aggressively reduce even if costs are significant

Supplier selection strategy Cost and low quality Speed, flexibility, quality

Transportation strategy Greater reliance on low cost modes

Greater reliance on responsive (fast) modes


Other Issues Affecting Strategic Fit

• Multiple products and customer segments• Product life cycle• Competitive changes over time


Multiple Products and Customer Segments

• Firms sell different products to different customer segments (with different implied demand uncertainty)

• The supply chain has to be able to balance efficiency and responsiveness given its portfolio of products and customer segments

• Two approaches:– Different supply chains– Tailor supply chain to best meet the needs of each product’s

demand


Product Life Cycle

• The demand characteristics of a product and the needs of a customer segment change as a product goes through its life cycle

• Supply chain strategy must evolve throughout the life cycle• Early: uncertain demand, high margins (time is important), product

availability is most important, cost is secondary• Late: predictable demand, lower margins, price is important


Product Life Cycle

• Examples: pharmaceutical firms, Intel• As the product goes through the life cycle,

the supply chain changes from one emphasizing responsiveness to one emphasizing efficiency


Competitive Changes Over Time

• Competitive pressures can change over time

• More competitors may result in an increased emphasis on variety at a reasonable price

• The Internet makes it easier to offer a wide variety of products

• The supply chain must change to meet these changing competitive conditions


Expanding Strategic Scope

• Scope of strategic fit – The functions and stages within a supply chain that devise

an integrated strategy with a shared objective– One extreme: each function at each stage develops its

own strategy– Other extreme: all functions in all stages devise a strategy

jointly• Five categories:

– Intracompany intraoperation scope– Intracompany intrafunctional scope– Intracompany interfunctional scope– Intercompany interfunctional scope– Flexible interfunctional scope


Drivers of Supply Chain Performance

• Facilities– places where inventory is stored, assembled, or fabricated– production sites and storage sites

• Inventory– raw materials, WIP, finished goods within a supply chain– inventory policies

• Transportation– moving inventory from point to point in a supply chain– combinations of transportation modes and routes


• Information– data and analysis regarding inventory, transportation, facilities

throughout the supply chain– potentially the biggest driver of supply chain performance

• Sourcing– functions a firm performs and functions that are outsourced

• Pricing– Price associated with goods and services provided by a firm to the

supply chain


A Framework for Structuring Drivers

Competitive Strategy

Supply Chain Strategy

Efficiency Responsiveness

Facilities Inventory Transportation

Information

Supply chain structure

Cross Functional Drivers

Sourcing Pricing

Logistical Drivers


Facilities

• Role in the supply chain– the “where” of the supply chain– manufacturing or storage (warehouses)

• Role in the competitive strategy– economies of scale (efficiency priority)– larger number of smaller facilities

(responsiveness priority)• Components of facilities decisions


Components of Facilities Decisions

• Location– centralization (efficiency) vs. decentralization (responsiveness)– other factors to consider (e.g., proximity to customers)

• Capacity (flexibility versus efficiency)• Manufacturing methodology (product focused versus process focused)• Warehousing methodology (SKU storage, job lot storage, cross-docking)• Overall trade-off: Responsiveness versus efficiency


Inventory

• Role in the supply chain• Role in the competitive strategy• Components of inventory decisions


Inventory: Role in the Supply Chain

• Inventory exists because of a mismatch between supply and demand

• Source of cost and influence on responsiveness

• Inventory and throughput are “synonymous” in a supply chain


Inventory: Role in Competitive Strategy

• If responsiveness is a strategic competitive priority, a firm can locate larger amounts of inventory closer to customers

• If cost is more important, inventory can be reduced to make the firm more efficient

• Trade-off


Components of Inventory Decisions

• Cycle inventory– Average amount of inventory used to satisfy demand between

shipments– Depends on lot size

• Safety inventory– inventory held in case demand exceeds expectations– costs of carrying too much inventory versus cost of losing sales


• Seasonal inventory– inventory built up to counter predictable variability in demand– cost of carrying additional inventory versus cost of flexible

production

• Overall trade-off: Responsiveness versus efficiency– more inventory: greater responsiveness but greater cost– less inventory: lower cost but lower responsiveness


Transportation

• Role in the supply chain• Role in the competitive strategy• Components of transportation decisions


Transportation: Role in the Supply Chain

• Moves the product between stages in the supply chain

• Impact on responsiveness and efficiency• Faster transportation allows greater

responsiveness but lower efficiency• Also affects inventory and facilities


Transportation: Role in the Competitive Strategy

• If responsiveness is a strategic competitive priority, then faster transportation modes can provide greater responsiveness to customers who are willing to pay for it

• Can also use slower transportation modes for customers whose priority is price (cost)

• Can also consider both inventory and transportation to find the right balance


Components of Transportation Decisions

• Mode of transportation: – air, truck, rail, ship, pipeline, electronic

transportation– vary in cost, speed, size of shipment, flexibility

• Route and network selection– route: path along which a product is shipped– network: collection of locations and routes

• In-house or outsource• Overall trade-off: Responsiveness versus

efficiency


Information

• Role in the supply chain• Role in the competitive strategy• Components of information decisions


Information: Role in the Supply Chain

• The connection between the various stages in the supply chain – allows coordination between stages

• Crucial to daily operation of each stage in a supply chain – e.g., production scheduling, inventory levels


Information: Role in the Competitive Strategy• Allows supply chain to become more

efficient and more responsive at the same time (reduces the need for a trade-off)

• Information technology• What information is most valuable?


Components of Information Decisions

• Push (MRP) versus pull (demand information transmitted quickly throughout the supply chain)

• Coordination and information sharing• Forecasting and aggregate planning• Enabling technologies

– EDI, Internet, ERP systems– Supply Chain Management software

• Overall trade-off: Responsiveness versus efficiency


Sourcing

• Role in the supply chain• Role in the competitive strategy• Components of sourcing decisions


Sourcing: Role in the Supply Chain

• Set of business processes required to purchase goods and services in a supply chain

• Supplier selection, single vs. multiple suppliers, contract negotiation


Sourcing: Role in the Competitive Strategy• Sourcing decisions are crucial because

they affect the level of efficiency and responsiveness in a supply chain

• In-house vs. outsource decisions- improving efficiency and responsiveness


Components of Sourcing Decisions

• In-house versus outsource decisions• Supplier evaluation and selection• Procurement process• Overall trade-off: Increase the supply

chain profits


Pricing

• Role in the supply chain• Role in the competitive strategy• Components of pricing decisions


Pricing: Role in the Supply Chain

• Pricing determines the amount to charge customers in a supply chain

• Pricing strategies can be used to match demand and supply


Sourcing: Role in the Competitive Strategy• Firms can utilize optimal pricing strategies

to improve efficiency and responsiveness• Low price and low product availability; vary

prices by response times• Example 3.7: Amazon


Components of Pricing Decisions

• Pricing and economies of scale• Everyday low pricing versus high-low

pricing• Fixed price versus menu pricing• Overall trade-off: Increase the firm profits


Obstacles to Achieving Strategic Fit

• Increasing variety of products• Decreasing product life cycles• Increasingly demanding customers• Fragmentation of supply chain ownership• Globalization• Difficulty executing new strategies


• MODULE 2• Designing the supply chain network • Designing the distribution network – role of

distribution – factors influencing distribution – design options – e-business and its impact – distribution networks in practice – network design in the supply chain – role of network – factors affecting the network design decisions – modeling for supply chain.


The Role of Distributionin the Supply Chain

• Distribution: the steps taken to move and store a product from the supplier stage to the customer stage in a supply chain

• Distribution directly affects cost and the customer experience and therefore drives profitability

• Choice of distribution network can achieve supply chain objectives from low cost to high responsiveness


Factors InfluencingDistribution Network Design

• Distribution network performance evaluated along two dimensions at the highest level:– Customer needs that are met– Cost of meeting customer needs

• Distribution network design options must therefore be compared according to their impact on customer service and the cost to provide this level of service


Factors InfluencingDistribution Network Design

• Elements of customer service influenced by network structure:– Response time– Product variety– Product availability– Customer experience– Order visibility– Returnability

• Supply chain costs affected by network structure:– Inventories and Transportation– Facilities and handling– Information


Service and Number of Facilities

Number of Facilities

Response Time


The Cost-Response Time Frontier

Local FG

Mix

Regional FG

Local WIP

Central FG

Central WIP

Central Raw Material and Custom production

Custom production with raw material at suppliers

Cost

Response Time HiLow

Low

Hi


Inventory Costs and Numberof Facilities

Inventory Costs

Number of facilities


Transportation Costs and Number of Facilities

TransportationCosts



Facility Costs and Numberof Facilities

FacilityCosts



Transportation

Total Costs Related to Number of Facilities

To

tal

Co

sts


Inventory

Facilities

Total Costs


Response Time

Variation in Logistics Costs and Response Time with Number of Facilities


Total Logistics Costs


Design Options for a Distribution Network

• Manufacturer Storage with Direct Shipping• Manufacturer Storage with Direct Shipping

and In-Transit Merge• Distributor Storage with Carrier Delivery• Distributor Storage with Last Mile Delivery• Manufacturer or Distributor Storage with

Consumer Pickup• Retail Storage with Consumer Pickup• Selecting a Distribution Network Design


Manufacturer Storage withDirect Shipping

Manufacturer

Retailer

Customers

Product FlowInformation Flow


In-Transit Merge NetworkFactories

Retailer


In-Transit Merge by Carrier

Customers


Distributor Storage withCarrier Delivery

Factories

Customers


Warehouse Storage by Distributor/Retailer


Distributor Storage with Last Mile Delivery

Factories

Customers

Product Flow

Information flow

Distributor/Retailer Warehouse


Manufacturer or Distributor Storage with Customer Pickup (Fig. 4.10)

Factories

Retailer

Pickup Sites

Cross Dock DC

Customers


E-Business and the Distribution Network

• Impact of E-Business on Customer Service

• Impact of E-Business on Cost• Using E-Business: Dell, Amazon, Peapod,

Grainger


Distribution Networks in Practice

• The ownership structure of the distribution network can have as big as an impact as the type of distribution network

• The choice of a distribution network has very long-term consequences

• Consider whether an exclusive distribution strategy is advantageous

• Product, price, commoditization, and criticality have an impact on the type of distribution system preferred by customers


Network Design Decisions

• Facility role• Facility location• Capacity allocation• Market and supply allocation


Factors InfluencingNetwork Design Decisions

• Strategic • Technological• Macroeconomic• Political• Infrastructure• Competitive• Logistics and facility costs


A Framework forGlobal Site Location

PHASE ISupply Chain

Strategy

PHASE IIRegional Facility

Configuration

PHASE IIIDesirable Sites

PHASE IVLocation Choices

Competitive STRATEGY

INTERNAL CONSTRAINTSCapital, growth strategy,existing network

PRODUCTION TECHNOLOGIESCost, Scale/Scope impact, supportrequired, flexibility

COMPETITIVEENVIRONMENT

PRODUCTION METHODSSkill needs, response time

FACTOR COSTSLabor, materials, site specific

GLOBAL COMPETITION

TARIFFS AND TAXINCENTIVES

REGIONAL DEMANDSize, growth, homogeneity,local specifications

POLITICAL, EXCHANGERATE AND DEMAND RISK

AVAILABLEINFRASTRUCTURE

LOGISTICS COSTSTransport, inventory, coordination


Conventional Network

CustomerStore

MaterialsDC

ComponentManufacturin

g

VendorDC

Final Assembly

FinishedGoods DC

ComponentsDC

VendorDC Plant

Warehouse

FinishedGoods DC

CustomerDC

CustomerDC

CustomerDC

CustomerStore

CustomerStore

CustomerStore

CustomerStore

VendorDC


Tailored Network: Multi-Echelon Finished Goods Network

RegionalFinished

Goods DC

RegionalFinished

Goods DC

Customer 1DC

Store 1

NationalFinished

Goods DC

Local DCCross-Dock

Local DC Cross-Dock

Local DCCross-Dock

Customer 2DC

Store 1

Store 2

Store 2

Store 3

Store 3


Gravity Methods for Location

• Ton Mile-Center Solution– x,y: Warehouse Coordinates

– xn, yn : Coordinates of

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– dn : Distance to delivery

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– Fn : Annual tonnage to

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Network Optimization Models

• Allocating demand to production facilities

• Locating facilities and allocating capacity

Which plants to establish? How to configure the network?

Key Costs:

• Fixed facility cost• Transportation cost• Production cost• Inventory cost• Coordination cost


Demand Allocation Model

• Which market is served by which plant?

• Which supply sources are used by a plant?

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Plant Location with Multiple Sourcing

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Plant Location with Single Sourcing

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• MODULE 3 (5 Hours) • Designing and Planning

Transportation Networks. • Role of transportation - modes and their

performance - transportation infrastructure and policies - design options and their trade-offs - Tailored transportation


Factors AffectingTransportation Decisions

• Carrier (party that moves or transports the product)– Vehicle-related cost– Fixed operating cost– Trip-related cost

• Shipper (party that requires the movement of the product between two points in the supply chain)– Transportation cost– Inventory cost– Facility cost


Transportation Modes• Trucks

– TL– LTL

• Rail• Air• Package Carriers• Water• Pipeline


Truckload (TL)

• Average revenue per ton mile (1996) = 9.13 cents

• Average haul = 274 miles• Average Capacity = 42,000 - 50,000 lb.• Low fixed and variable costs• Major Issues

– Utilization– Consistent service– Backhauls


Less Than Truckload (LTL)

• Average revenue per ton-mile (1996) = 25.08 cents• Average haul = 646 miles• Higher fixed costs (terminals) and low variable costs• Major issues:

– Location of consolidation facilities– Utilization– Vehicle routing– Customer service


Rail

• Average revenue / ton-mile (1996) = 2.5 cents• Average haul = 720 miles• Average load = 80 tons• Key issues:

– Scheduling to minimize delays / improve service– Off-track delays (at pickup and delivery end) – Yard operations– Variability of delivery times


Air

• Key issues:– Location/number of hubs– Location of fleet bases/crew bases– Schedule optimization– Fleet assignment– Crew scheduling– Yield management


Package Carriers• Companies like FedEx, UPS,, that carry small

packages ranging from letters to shipments of about 150 pounds

• Expensive• Rapid and reliable delivery• Small and time-sensitive shipments• Preferred mode for e-businesses• Consolidation of shipments (especially important for

package carriers that use air as a primary method of transport)


Water

• Limited to certain geographic areas• Ocean, inland waterway system, coastal

waters• Very large loads at very low cost• Slowest• Dominant in global


Pipeline

• High fixed cost• Primarily for crude petroleum, refined

petroleum products, natural gas• Best for large and predictable demand• Would be used for getting crude oil to a

port or refinery, but not for getting refined gasoline to a gasoline station (why?)


Intermodal• Use of more than one mode of transportation to move a

shipment to its destination• Most common example: rail/truck• Also water/rail/truck or water/truck• Grown considerably with increased use of containers• Increased global trade has also increased use of intermodal

transportation• More convenient for shippers (one entity provides the

complete service)• Key issue involves the exchange of information to facilitate

transfer between different transport modes


Design Options for aTransportation Network

• What are the transportation options? Which one to select? On what basis?

• Direct shipping network• Direct shipping with milk runs• All shipments via central DC• Shipping via DC using milk runs• Tailored network


Trade-offs in Transportation Design

• Transportation and inventory cost trade-off– Choice of transportation mode– Inventory aggregation

• Transportation cost and responsiveness trade-off


Choice of Transportation Mode

• A manager must account for inventory costs when selecting a mode of transportation

• A mode with higher transportation costs can be justified if it results in significantly lower inventories


Inventory Aggregation: Inventory vs. Transportation

Cost• As a result of physical aggregation

– Inventory costs decrease– Inbound transportation cost decreases– Outbound transportation cost increases

• Inventory aggregation decreases supply chain costs if the product has a high value to weight ratio, high demand uncertainty, or customer orders are large

• Inventory aggregation may increase supply chain costs if the product has a low value to weight ratio, low demand uncertainty, or customer orders are small


Trade-offs Between Transportation Cost and Customer Responsiveness

• Temporal aggregation is the process of combining orders across time

• Temporal aggregation reduces transportation cost because it results in larger shipments and reduces variation in shipment sizes

• However, temporal aggregation reduces customer responsiveness


Tailored Transportation

• The use of different transportation networks and modes based on customer and product characteristics

• Factors affecting tailoring:– Customer distance and density– Customer size– Product demand and value


Role of IT in Transportation

• The complexity of transportation decisions demands to use of IT systems

• IT software can assist in:– Identification of optimal routes by minimizing

costs subject to delivery constraints– Optimal fleet utilization– GPS applications


Risk Management in Transportation

• Three main risks to be considered in transportation are:– Risk that the shipment is delayed– Risk of disruptions– Risk of hazardous material

• Risk mitigation strategies:– Decrease the probability of disruptions– Alternative routings– In case of hazardous materials the use of

modified containers, low-risk transportation models, modification of physical and chemical properties can prove to be effective


• MODULE 4 (6 Hours) • Sourcing and Pricing. • Sourcing – In-house or Outsource – 3rd and 4th PLs –

supplier scoring and assessment, selection – design collaboration – procurement process – sourcing planning and analysis.

• Pricing and revenue management for multiple customers, perishable products, seasonal demand, bulk and spot contracts.


The Role of Sourcingin a Supply Chain

• Sourcing is the set of business processes required to purchase goods and services

• Sourcing processes include:– Supplier scoring and assessment– Supplier selection and contract negotiation– Design collaboration– Procurement– Sourcing planning and analysis


Benefits of EffectiveSourcing Decisions

• Better economies of scale can be achieved if orders are aggregated

• More efficient procurement transactions can significantly reduce the overall cost of purchasing

• Design collaboration can result in products that are easier to manufacture and distribute, resulting in lower overall costs

• Good procurement processes can facilitate coordination with suppliers

• Appropriate supplier contracts can allow for the sharing of risk

• Firms can achieve a lower purchase price by increasing competition through the use of auctions


Supplier Scoring and Assessment

• Supplier performance should be compared on the basis of the supplier’s impact on total cost

• There are several other factors besides purchase price that influence total cost


Supplier Assessment Factors

• Replenishment Lead Time• On-Time Performance• Supply Flexibility• Delivery Frequency /

Minimum Lot Size• Supply Quality• Inbound Transportation

Cost

• Pricing Terms• Information

Coordination Capability• Design Collaboration

Capability• Exchange Rates,

Taxes, Duties• Supplier Viability


Supplier Selection- Auctions and Negotiations

• Supplier selection can be performed through competitive bids, reverse auctions, and direct negotiations

• Supplier evaluation is based on total cost of using a supplier

• Auctions:– Sealed-bid first-price auctions– English auctions– Dutch auctions– Second-price (Vickery) auctions


Contracts and Supply Chain Performance

• Contracts for Product Availability and Supply Chain Profits– Buyback Contracts– Revenue-Sharing Contracts– Quantity Flexibility Contracts

• Contracts to Coordinate Supply Chain Costs

• Contracts to Increase Agent Effort• Contracts to Induce Performance

Improvement


Contracts for Product Availability and Supply Chain

Profits• Many shortcomings in supply chain performance occur because the buyer and supplier are separate organizations and each tries to optimize its own profit

• Total supply chain profits might therefore be lower than if the supply chain coordinated actions to have a common objective of maximizing total supply chain profits

• Recall Chapter 10: double marginalization results in suboptimal order quantity

• An approach to dealing with this problem is to design a contract that encourages a buyer to purchase more and increase the level of product availability

• The supplier must share in some of the buyer’s demand uncertainty, however


Contracts for Product Availability and Supply Chain Profits: Buyback Contracts

• Allows a retailer to return unsold inventory up to a specified amount at an agreed upon price

• Increases the optimal order quantity for the retailer, resulting in higher product availability and higher profits for both the retailer and the supplier

• Most effective for products with low variable cost, such as music, software, books, magazines, and newspapers

• Downside is that buyback contract results in surplus inventory that must be disposed of, which increases supply chain costs

• Can also increase information distortion through the supply chain because the supply chain reacts to retail orders, not actual customer demand


Contracts for Product Availability and Supply Chain Profits: Revenue Sharing Contracts

• The buyer pays a minimal amount for each unit purchased from the supplier but shares a fraction of the revenue for each unit sold

• Decreases the cost per unit charged to the retailer, which effectively decreases the cost of overstocking

• Can result in supply chain information distortion, however, just as in the case of buyback contracts


Contracts for Product Availability and Supply Chain Profits: Quantity Flexibility Contracts

• Allows the buyer to modify the order (within limits) as demand visibility increases closer to the point of sale

• Better matching of supply and demand• Increased overall supply chain profits if the

supplier has flexible capacity• Lower levels of information distortion than

either buyback contracts or revenue sharing contracts


Contracts to CoordinateSupply Chain Costs

• Differences in costs at the buyer and supplier can lead to decisions that increase total supply chain costs

• Example: Replenishment order size placed by the buyer. The buyer’s EOQ does not take into account the supplier’s costs.

• A quantity discount contract may encourage the buyer to purchase a larger quantity (which would be lower costs for the supplier), which would result in lower total supply chain costs

• Quantity discounts lead to information distortion because of order batching


Contracts to Increase Agent Effort

• There are many instances in a supply chain where an agent acts on the behalf of a principal and the agent’s actions affect the reward for the principal

• Example: A car dealer who sells the cars of a manufacturer, as well as those of other manufacturers

• Examples of contracts to increase agent effort include two-part tariffs and threshold contracts

• Threshold contracts increase information distortion, however


Contracts to InducePerformance Improvement

• A buyer may want performance improvement from a supplier who otherwise would have little incentive to do so

• A shared savings contract provides the supplier with a fraction of the savings that result from the performance improvement

• Particularly effective where the benefit from improvement accrues primarily to the buyer, but where the effort for the improvement comes primarily from the supplier


Design Collaboration• 50-70 percent of spending at a manufacturer is through procurement• 80 percent of the cost of a purchased part is fixed in the design

phase• Design collaboration with suppliers can result in reduced cost,

improved quality, and decreased time to market• Important to employ design for logistics, design for manufacturability• Manufacturers must become effective design coordinators

throughout the supply chain


The Procurement Process

• The process in which the supplier sends product in response to orders placed by the buyer

• Goal is to enable orders to be placed and delivered on schedule at the lowest possible overall cost

• Two main categories of purchased goods:– Direct materials: components used to make finished goods– Indirect materials: goods used to support the operations of a firm

• Focus for direct materials should be on improving coordination and visibility with supplier

• Focus for indirect materials should be on decreasing the transaction cost for each order

• Procurement for both should consolidate orders where possible to take advantage of economies of scale and quantity discounts


Product Categorization by Value and Criticality

Critical Items Strategic Items

General Items Bulk Purchase Items

Low

Low

High

High

Value/Cost

Crit

ical

ity


Sourcing Planning and Analysis

• A firm should periodically analyze its procurement spending and supplier performance and use this analysis as an input for future sourcing decisions

• Procurement spending should be analyzed by part and supplier to ensure appropriate economies of scale

• Supplier performance analysis should be used to build a portfolio of suppliers with complementary strengths– Cheaper but lower performing suppliers

should be used to supply base demand– Higher performing but more expensive

suppliers should be used to buffer against variation in demand and supply from the other source


Making SourcingDecisions in Practice

• Use multifunction teams• Ensure appropriate coordination across

regions and business units• Always evaluate the total cost of

ownership• Build long-term relationships with key

suppliers


The Role of Revenue Management in the Supply

Chain• Revenue management is the use of pricing to increase the profit generated from a limited supply of supply chain assets

• Supply assets exist in two forms: capacity and inventory• Revenue management may also be defined as the use of differential

pricing based on customer segment, time of use, and product or capacity availability to increase supply chain profits

• Most common example is probably in airline pricing


Conditions Under Which Revenue Management Has the Greatest

Effect• The value of the product varies in different market

segments (Example: airline seats)• The product is highly perishable or product waste occurs

(Example: fashion and seasonal apparel)• Demand has seasonal and other peaks (Example:

products ordered at Amazon.com)• The product is sold both in bulk and on the spot market

(Example: owner of warehouse who can decide whether to lease the entire warehouse through long-term contracts or save a portion of the warehouse for use in the spot market)


Revenue Management forMultiple Customer Segments

• If a supplier serves multiple customer segments with a fixed asset, the supplier can improve revenues by setting different prices for each segment

• Prices must be set with barriers such that the segment willing to pay more is not able to pay the lower price

• The amount of the asset reserved for the higher price segment is such that the expected marginal revenue from the higher priced segment equals the price of the lower price segment


Revenue Management forMultiple Customer Segments

pL = the price charged to the lower price segment

pH = the price charged to the higher price segment

DH = mean demand for the higher price segment

sH = standard deviation of demand for the higher price segment

CH = capacity reserved for the higher price segment

RH(CH) = expected marginal revenue from reserving more capacity

= Probability(demand from higher price segment > CH) x pH

RH(CH) = pL

Probability(demand from higher price segment > CH) = pL / pH

CH = F-1(1- pL/pH, DH,sH) = NORMINV(1- pL/pH, DH,sH)


Example : ToFrom Trucking

Revenue from segment A = pA = $3.50 per cubic ft

Revenue from segment B = pB = $3.50 per cubic ft

Mean demand for segment A = DA = 3,000 cubic ft

Std dev of segment A demand = sA = 1,000 cubic ft

CA = NORMINV(1- pB/pA, DA,sA)= NORMINV(1- (2.00/3.50), 3000, 1000)= 2,820 cubic ft

If pA increases to $5.00 per cubic foot, then

CA = NORMINV(1- pB/pA, DA,sA)= NORMINV(1- (2.00/5.00), 3000, 1000)= 3,253 cubic ft


Revenue Managementfor Perishable Assets

• Any asset that loses value over time is perishable• Examples: high-tech products such as computers and

cell phones, high fashion apparel, underutilized capacity, fruits and vegetables

• Two basic approaches:– Vary price over time to maximize expected revenue– Overbook sales of the asset to account for

cancellations



• Overbooking or overselling of a supply chain asset is valuable if order cancellations occur and the asset is perishable

• The level of overbooking is based on the trade-off between the cost of wasting the asset if too many cancellations lead to unused assets and the cost of arranging a backup if too few cancellations lead to committed orders being larger than the available capacity



p = price at which each unit of the asset is sold

c = cost of using or producing each unit of the asset

b = cost per unit at which a backup can be used in the case of asset shortage

Cw = p – c = marginal cost of wasted capacity

Cs = b – c = marginal cost of a capacity shortage

O* = optimal overbooking level

s* = Probability(cancellations < O*) = Cw / (Cw + Cs)



If the distribution of cancellations is known to be normal with mean mc and standard deviation sc then

O* = F-1(s*, mc, sc) = NORMINV(s*, mc, sc)If the distribution of cancellations is known only as a function

of the booking level (capacity L + overbooking O) to have a mean of m(L+O) and std deviation of s(L+O), the optimal overbooking level is the solution to the following equation:

O = F-1(s*, (m L+O),s(L+O)) = NORMINV(s*, (m L+O),s(L+O))


Example Cost of wasted capacity = Cw = $10 per dress

Cost of capacity shortage = Cs = $5 per dress

s* = Cw / (Cw + Cs) = 10/(10+5) = 0.667

mc = 800; sc = 400

O* = NORMINV(s*, mc,sc)

= NORMINV(0.667,800,400) = 973

If the mean is 15% of the booking level and the coefficient of variation is 0.5, then the optimal overbooking level is the solution of the following equation:

O = NORMINV(0.667,0.15(5000+O),0.075(5000+O))

Using Excel Solver, O* = 1,115


Revenue Managementfor Seasonal Demand

• Seasonal peaks of demand are common in many supply chains

• Examples: Most retailers achieve a large portion of total annual demand in December (Amazon.com)

• Off-peak discounting can shift demand from peak to non-peak periods

• Charge higher price during peak periods and a lower price during off-peak periods


Revenue Management forBulk and Spot Customers

• Most consumers of production, warehousing, and transportation assets in a supply chain face the problem of constructing a portfolio of long-term bulk contracts and short-term spot market contracts

• The basic decision is the size of the bulk contract• The fundamental trade-off is between wasting a

portion of the low-cost bulk contract and paying more for the asset on the spot market

• Given that both the spot market price and the purchaser’s need for the asset are uncertain, a decision tree approach as discussed in Chapter 6 should be used to evaluate the amount of long-term bulk contract to sign



For the simple case where the spot market price is known but demand is uncertain, a formula can be used

cB = bulk rate

cS = spot market priceQ* = optimal amount of the asset to be purchased in bulkp* = probability that the demand for the asset does not

exceed Q*

Marginal cost of purchasing another unit in bulk is cB. The expected marginal cost of not purchasing another unit in bulk and then purchasing it in the spot market is (1-p*)cS.



If the optimal amount of the asset is purchased in bulk, the marginal cost of the bulk purchase should equal the expected marginal cost of the spot market purchase, or cB = (1-p*)cS

Solving for p* yields p* = (cS – cB) / cS

If demand is normal with mean m and std deviation s, the optimal amount Q* to be purchased in bulk is

Q* = F-1(p*,m,s) = NORMINV(p*,m,s)


Example 15.6

Bulk contract cost = cB = $10,000 per million units

Spot market cost = cS = $12,500 per million units

m = 10 million units

s = 4 million units

p* = (cS – cB) / cS = (12,500 – 10,000) / 12,500 = 0.2

Q* = NORMINV(p*,m,s) = NORMINV(0.2,10,4) = 6.63

The manufacturer should sign a long-term bulk contract for 6.63 million units per month and purchase any transportation capacity beyond that on the spot market


Using Revenue Managementin Practice

• Evaluate your market carefully• Quantify the benefits of revenue management• Implement a forecasting process• Apply optimization to obtain the revenue

management decision• Involve both sales and operations• Understand and inform the customer• Integrate supply planning with revenue management


Role of Information Technologyin a Supply Chain

• Information is the driver that serves as the “glue” to create a coordinated supply chain

• Information must have the following characteristics to be useful:– Accurate– Accessible in a timely manner– Information must be of the right kind

• Information provides the basis for supply chain management decisions– Inventory– Transportation– Facility


Characteristics of UsefulSupply Chain Information

• Accurate• Accessible in a timely manner• The right kind• Provides supply chain visibility


Use of Information in a Supply Chain

• Information used at all phases of decision making: strategic, planning, operational

• Examples:– Strategic: location decisions– Operational: what products will be

produced during today’s production run


Use of Information in a Supply Chain

• Inventory: demand patterns, carrying costs, stockout costs, ordering costs

• Transportation: costs, customer locations, shipment sizes

• Facility: location, capacity, schedules of a facility; need information about trade-offs between flexibility and efficiency, demand, exchange rates, taxes, etc.


Role of Information Technologyin a Supply Chain

• Information technology (IT)– Hardware and software used throughout

the supply chain to gather and analyze information

– Captures and delivers information needed to make good decisions

• Effective use of IT in the supply chain can have a significant impact on supply chain performance


The Importance of Informationin a Supply Chain

• Relevant information available throughout the supply chain allows managers to make decisions that take into account all stages of the supply chain

• Allows performance to be optimized for the entire supply chain, not just for one stage – leads to higher performance for each individual firm in the supply chain


The Supply Chain IT Framework

• The Supply Chain Macro Processes– Customer Relationship Management (CRM)– Internal Supply Chain Management (ISCM)– Supplier Relationship Management (SRM)– Plus: Transaction Management Foundation

• Why Focus on the Macro Processes?• Macro Processes Applied to the Evolution

of Software


Macro Processes in a Supply Chain

(Figure 16.1)

Supplier Relationshi

p Managemen

t (SRM)

Internal Supply Chain

Management (ISCM)

Customer Relationshi

p Managemen

t (CRM)

Transaction Management Foundation (TFM)


Customer Relationship Management

• The processes that take place between an enterprise and its customers downstream in the supply chain

• Key processes:– Marketing– Selling– Order management– Call/Service center


Internal Supply Chain Management

• Includes all processes involved in planning for and fulfilling a customer order

• ISCM processes:– Strategic Planning– Demand Planning– Supply Planning– Fulfillment– Field Service

• There must be strong integration between the ISCM and CRM macro processes


Supplier Relationship Management

• Those processes focused on the interaction between the enterprise and suppliers that are upstream in the supply chain

• Key processes:– Design Collaboration– Source– Negotiate– Buy– Supply Collaboration

• There is a natural fit between ISCM and SRM processes


The Transaction Management Foundation

• Enterprise software systems (ERP)• Earlier systems focused on automation of

simple transactions and the creation of an integrated method of storing and viewing data across the enterprise

• Real value of the TMF exists only if decision making is improved

• The extent to which the TMF enables integration across the three macro processes determines its value


The Future of IT in the Supply Chain

• At the highest level, the three SCM macro processes will continue to drive the evolution of enterprise software

• Software focused on the macro processes will become a larger share of the total enterprise software market and the firms producing this software will become more successful

• Functionality, the ability to integrate across macro processes, and the strength of their ecosystems, will be keys to success


Supply Chain Information Technology in Practice

• Select an IT system that addresses the company’s key success factors

• Take incremental steps and measure value

• Align the level of sophistication with the need for sophistication

• Use IT systems to support decision making, not to make decisions

• Think about the future


Lack of SC Coordination and the Bullwhip Effect

• Supply chain coordination – all stages in the supply chain take actions together (usually results in greater total supply chain profits)

• SC coordination requires that each stage take into account the effects of its actions on the other stages

• Lack of coordination results when: – Objectives of different stages conflict or– Information moving between stages is distorted


Bullwhip Effect

• Fluctuations in orders increase as they move up the supply chain from retailers to wholesalers to manufacturers to suppliers

• Distorts demand information within the supply chain, where different stages have very different estimates of what demand looks like

• Results in a loss of supply chain coordination

• Examples: Proctor & Gamble (Pampers); HP (printers); Barilla (pasta)


The Effect of Lack ofCoordination on Performance

• Manufacturing cost (increases)• Inventory cost (increases)• Replenishment lead time (increases)• Transportation cost (increases)• Labor cost for shipping and receiving (increases)• Level of product availability (decreases)• Relationships across the supply chain (worsens)• Profitability (decreases)• The bullwhip effect reduces supply chain profitability by

making it more expensive to provide a given level of product availability


Obstacles to Coordination in a Supply Chain

• Incentive Obstacles• Information Processing Obstacles• Operational Obstacles• Pricing Obstacles• Behavioral Obstacles


Incentive Obstacles

• When incentives offered to different stages or participants in a supply chain lead to actions that increase variability and reduce total supply chain profits – misalignment of total supply chain objectives and individual objectives

• Local optimization within functions or stages of a supply chain

• Sales force incentives


Information Processing Obstacles

• When demand information is distorted as it moves between different stages of the supply chain, leading to increased variability in orders within the supply chain

• Forecasting based on orders, not customer demand– Forecasting demand based on orders magnifies

demand fluctuations moving up the supply chain from retailer to manufacturer

• Lack of information sharing


Operational Obstacles

• Actions taken in the course of placing and filling orders that lead to an increase in variability

• Ordering in large lots (much larger than dictated by demand) –

• Large replenishment lead times• Rationing and shortage gaming (common in the

computer industry because of periodic cycles of component shortages and surpluses)


Pricing Obstacles

• When pricing policies for a product lead to an increase in variability of orders placed

• Lot-size based quantity decisions• Price fluctuations (resulting in forward

buying) – Figure 17.3


Behavioral Obstacles• Problems in learning, often related to communication in

the supply chain and how the supply chain is structured• Each stage of the supply chain views its actions locally

and is unable to see the impact of its actions on other stages

• Different stages react to the current local situation rather than trying to identify the root causes

• Based on local analysis, different stages blame each other for the fluctuations, with successive stages becoming enemies rather than partners

• No stage learns from its actions over time because the most significant consequences of the actions of any one stage occur elsewhere, resulting in a vicious cycle of actions and blame

• Lack of trust results in opportunism, duplication of effort, and lack of information sharing


Managerial Levers to Achieve Coordination

• Aligning Goals and Incentives• Improving Information Accuracy• Improving Operational Performance• Designing Pricing Strategies to Stabilize

Orders• Building Strategic Partnerships and

Trust


Aligning Goals and Incentives

• Align incentives so that each participant has an incentive to do the things that will maximize total supply chain profits

• Align incentives across functions• Pricing for coordination• Alter sales force incentives from sell-in

(to the retailer) to sell-through (by the retailer)


Improving Information Accuracy

• Sharing point of sale data• Collaborative forecasting and planning• Single stage control of replenishment

– Continuous replenishment programs (CRP)

– Vendor managed inventory (VMI)


Improving Operational Performance

• Reducing replenishment lead time– Reduces uncertainty in demand– EDI is useful

• Reducing lot sizes– Computer-assisted ordering, B2B exchanges– Shipping in LTL sizes by combining shipments– Technology and other methods to simplify receiving– Changing customer ordering behavior

• Rationing based on past sales and sharing information to limit gaming– “Turn-and-earn”– Information sharing


Designing Pricing Strategiesto Stabilize Orders

• Encouraging retailers to order in smaller lots and reduce forward buying

• Moving from lot size-based to volume-based quantity discounts (consider total purchases over a specified time period)

• Stabilizing pricing– Eliminate promotions (everyday low pricing, EDLP)– Limit quantity purchased during a promotion– Tie promotion payments to sell-through rather than

amount purchased• Building strategic partnerships and trust – easier to

implement these approaches if there is trust


Building Strategic Partnerships and Trust in a Supply Chain• Background• Designing a Relationship with

Cooperation and Trust• Managing Supply Chain Relationships

for Cooperation and Trust


Building Strategic Partnerships and Trust in a Supply Chain

• Trust-based relationship– Dependability– Leap of faith

• Cooperation and trust work because:– Alignment of incentives and goals– Actions to achieve coordination are easier

to implement– Supply chain productivity improves by

reducing duplication or allocation of effort to appropriate stage

– Greater information sharing results


Trust in the Supply Chain

• Table 17.2 shows benefits• Historically, supply chain relationships are based on

power or trust• Disadvantages of power-based relationship:

– Results in one stage maximizing profits, often at the expense of other stages

– Can hurt a company when balance of power changes

– Less powerful stages have sought ways to resist


Building Trust into aSupply Chain Relationship

• Deterrence-based view– Use formal contracts– Parties behave in trusting manner out of self-

interest• Process-based view

– Trust and cooperation are built up over time as a result of a series of interactions

– Positive interactions strengthen the belief in cooperation of other party

• Neither view holds exclusively in all situations


Building Trust into aSupply Chain Relationship

• Initially more reliance on deterrence-based view, then evolves to a process-based view

• Co-identification: ideal goal• Two phases to a supply chain

relationship– Design phase– Management phase


Designing a Relationshipwith Cooperation and Trust

• Assessing the value of the relationship and its contributions

• Identifying operational roles and decision rights for each party

• Creating effective contracts• Designing effective conflict resolution

mechanisms


Assessing the Value of the Relationship and its

Contributions• Identify the mutual benefit provided• Identify the criteria used to evaluate the

relationship (equity is important)• Important to share benefits equitably• Clarify contribution of each party and

the benefits each party will receive


Identifying Operational Roles and Decision Rights for Each

Party• Recognize interdependence between parties

– Sequential interdependence: activities of one partner precede the other

– Reciprocal interdependence: the parties come together, exchange information and inputs in both directions

• Sequential interdependence is the traditional supply chain form

• Reciprocal interdependence is more difficult but can result in more benefits


Effects of Interdependence on Supply Chain Relationships

Org

an

iza

tio

n’s

D

ep

end

en

ce

High

Low

Partner’s Dependence

Low High

Partner Relatively Powerful

Organization Relatively Powerful

High Level of Interdependence

Effective Relationship

Low Level of Interdependenc

e


Creating Effective Contracts

• Create contracts that encourage negotiation when unplanned contingencies arise

• It is impossible to define and plan for every possible occurrence

• Informal relationships and agreements can fill in the “gaps” in contracts

• Informal arrangements may eventually be formalized in later contracts


Designing Effective Conflict Resolution Mechanisms

• Initial formal specification of rules and guidelines for procedures and transactions

• Regular, frequent meetings to promote communication

• Courts or other intermediaries


Managing Supply Chain Relationships for Cooperation and

Trust• Effective management of a relationship

is important for its success• Top management is often involved in

the design but not management of a relationship

• -- process of alliance evolution• Perceptions of reduced benefits or

opportunistic actions can significantly impair a supply chain partnership


Achieving Coordination in Practice

• Quantify the bullwhip effect• Get top management commitment for coordination• Devote resources to coordination• Focus on communication with other stages• Try to achieve coordination in the entire supply chain

network• Use technology to improve connectivity in the supply

chain• Share the benefits of coordination equitably


Role of Forecasting in a Supply Chain

• The basis for all strategic and planning decisions in a supply chain

• Used for both push and pull processes• Examples:

– Production: scheduling, inventory, aggregate planning

– Marketing: sales force allocation, promotions, new production introduction

– Finance: plant/equipment investment, budgetary planning

– Personnel: workforce planning, hiring, layoffs• All of these decisions are interrelated


Characteristics of Forecasts

• Forecasts are always wrong. Should include expected value and measure of error.

• Long-term forecasts are less accurate than short-term forecasts (forecast horizon is important)

• Aggregate forecasts are more accurate than disaggregate forecasts


Forecasting Methods

• Qualitative: primarily subjective; rely on judgment and opinion

• Time Series: use historical demand only– Static – Adaptive

• Causal: use the relationship between demand and some other factor to develop forecast

• Simulation– Imitate consumer choices that give rise to demand– Can combine time series and causal methods


Components of an ObservationObserved demand (O) =

Systematic component (S) + Random component (R)

Level (current deseasonalized demand)

Trend (growth or decline in demand)

Seasonality (predictable seasonal fluctuation)

• Systematic component: Expected value of demand• Random component: The part of the forecast that deviates from the systematic component• Forecast error: difference between forecast and actual demand


Time Series ForecastingQuarter Demand Dt

II, 1998 8000III, 1998 13000IV, 1998 23000I, 1999 34000II, 1999 10000III, 1999 18000IV, 1999 23000I, 2000 38000II, 2000 12000III, 2000 13000IV, 2000 32000I, 2001 41000

Forecast demand for thenext four quarters.


Time Series Forecasting

0

10,000

20,000

30,000

40,000

50,000

97,2

97,3

97,4

98,1

98,2

98,3

98,4

99,1

99,2

99,3

99,4

00,1


Forecasting Methods

• Static • Adaptive

– Moving average– Simple exponential smoothing– Holt’s model (with trend)– Winter’s model (with trend and

seasonality)


Basic Approach toDemand Forecasting

• Understand the objectives of forecasting• Integrate demand planning and forecasting• Identify major factors that influence the demand

forecast• Understand and identify customer segments• Determine the appropriate forecasting technique• Establish performance and error measures for the

forecast


Time Series Forecasting Methods

• Goal is to predict systematic component of demand– Multiplicative: (level)(trend)(seasonal factor)– Additive: level + trend + seasonal factor– Mixed: (level + trend)(seasonal factor)

• Static methods• Adaptive forecasting


Static Methods

• Assume a mixed model:

Systematic component = (level + trend)(seasonal factor)

Ft+l = [L + (t + l)T]St+l

= forecast in period t for demand in period t + l

L = estimate of level for period 0

T = estimate of trend

St = estimate of seasonal factor for period t

Dt = actual demand in period t

Ft = forecast of demand in period t


Static Methods

• Estimating level and trend• Estimating seasonal factors


Estimating Level and Trend

• Before estimating level and trend, demand data must be deseasonalized

• Deseasonalized demand = demand that would have been observed in the absence of seasonal fluctuations

• Periodicity (p) – the number of periods after which the

seasonal cycle repeats itself– for demand at Tahoe Salt (Table 7.1,

Figure 7.1) p = 4


Time Series Forecasting (Table 7.1)

Quarter Demand Dt

II, 1998 8000III, 1998 13000IV, 1998 23000I, 1999 34000II, 1999 10000III, 1999 18000IV, 1999 23000I, 2000 38000II, 2000 12000III, 2000 13000IV, 2000 32000I, 2001 41000

Forecast demand for thenext four quarters.


Time Series Forecasting(Figure 7.1)

0

10,000

20,000

30,000

40,000

50,000

97,2

97,3

97,4

98,1

98,2

98,3

98,4

99,1

99,2

99,3

99,4

00,1


Estimating Level and Trend

• Before estimating level and trend, demand data must be deseasonalized

• Deseasonalized demand = demand that would have been observed in the absence of seasonal fluctuations

• Periodicity (p) – the number of periods after which the

seasonal cycle repeats itself– for demand at Tahoe Salt (Table 7.1,

Figure 7.1) p = 4


Deseasonalizing Demand

[Dt-(p/2) + Dt+(p/2) + S 2Di] / 2p for p even

Dt = (sum is from i = t+1-(p/2) to t+1+(p/2))

S Di / p for p odd

(sum is from i = t-(p/2) to t+(p/2)), p/2 truncated to lower integer


Deseasonalizing Demand

For the example, p = 4 is even

For t = 3:

D3 = {D1 + D5 + Sum(i=2 to 4) [2Di]}/8

= {8000+10000+[(2)(13000)+(2)(23000)+(2)(34000)]}/8

= 19750

D4 = {D2 + D6 + Sum(i=3 to 5) [2Di]}/8

= {13000+18000+[(2)(23000)+(2)(34000)+(2)(10000)]/8

= 20625


Deseasonalizing DemandThen include trend

Dt = L + tT

where Dt = deseasonalized demand in period t

L = level (deseasonalized demand at period 0)

T = trend (rate of growth of deseasonalized demand)

Trend is determined by linear regression using deseasonalized demand as the dependent variable and period as the independent variable (can be done in Excel)

In the example, L = 18,439 and T = 524


Time Series of Demand(Figure 7.3)

0

10000

20000

30000

40000

50000

1 2 3 4 5 6 7 8 9 10 11 12

Period

Dem

an

d

Dt

Dt-bar


Estimating Seasonal Factors

Use the previous equation to calculate deseasonalized demand for each period

St = Dt / Dt = seasonal factor for period t

In the example,

D2 = 18439 + (524)(2) = 19487 D2 = 13000

S2 = 13000/19487 = 0.67

The seasonal factors for the other periods are calculated in the same manner


Estimating Seasonal Factors (Fig. 7.4)

t Dt Dt-bar S-bar1 8000 18963 0.42 = 8000/189632 13000 19487 0.67 = 13000/194873 23000 20011 1.15 = 23000/200114 34000 20535 1.66 = 34000/205355 10000 21059 0.47 = 10000/210596 18000 21583 0.83 = 18000/215837 23000 22107 1.04 = 23000/221078 38000 22631 1.68 = 38000/226319 12000 23155 0.52 = 12000/23155

10 13000 23679 0.55 = 13000/2367911 32000 24203 1.32 = 32000/2420312 41000 24727 1.66 = 41000/24727


Estimating Seasonal FactorsThe overall seasonal factor for a “season” is then

obtained by averaging all of the factors for a “season”

If there are r seasonal cycles, for all periods of the form pt+i, 1<i<p, the seasonal factor for season i is

Si = [Sum(j=0 to r-1) Sjp+i]/r

In the example, there are 3 seasonal cycles in the data and p=4, so

S1 = (0.42+0.47+0.52)/3 = 0.47

S2 = (0.67+0.83+0.55)/3 = 0.68

S3 = (1.15+1.04+1.32)/3 = 1.17

S4 = (1.66+1.68+1.66)/3 = 1.67


Estimating the Forecast

Using the original equation, we can forecast the next four periods of demand:

F13 = (L+13T)S1 = [18439+(13)(524)](0.47) = 11868

F14 = (L+14T)S2 = [18439+(14)(524)](0.68) = 17527

F15 = (L+15T)S3 = [18439+(15)(524)](1.17) = 30770

F16 = (L+16T)S4 = [18439+(16)(524)](1.67) = 44794


Adaptive Forecasting

• The estimates of level, trend, and seasonality are adjusted after each demand observation

• General steps in adaptive forecasting• Moving average• Simple exponential smoothing• Trend-corrected exponential smoothing (Holt’s

model)• Trend- and seasonality-corrected exponential

smoothing (Winter’s model)


Basic Formula forAdaptive Forecasting

Ft+1 = (Lt + lT)St+1 = forecast for period t+l in period t

Lt = Estimate of level at the end of period t

Tt = Estimate of trend at the end of period t

St = Estimate of seasonal factor for period t

Ft = Forecast of demand for period t (made period t-1 or earlier)

Dt = Actual demand observed in period t

Et = Forecast error in period t

At = Absolute deviation for period t = |Et|

MAD = Mean Absolute Deviation = average value of At


General Steps inAdaptive Forecasting

• Initialize: Compute initial estimates of level (L0), trend (T0), and seasonal factors (S1,…,Sp). This is done as in static forecasting.

• Forecast: Forecast demand for period t+1 using the general equation

• Estimate error: Compute error Et+1 = Ft+1- Dt+1

• Modify estimates: Modify the estimates of level (Lt+1), trend (Tt+1), and seasonal factor (St+p+1), given the error Et+1 in the forecast

• Repeat steps 2, 3, and 4 for each subsequent period


Moving Average• Used when demand has no observable trend or

seasonality• Systematic component of demand = level• The level in period t is the average demand over the last

N periods (the N-period moving average)• Current forecast for all future periods is the same and is

based on the current estimate of the level

Lt = (Dt + Dt-1 + … + Dt-N+1) / N

Ft+1 = Lt and Ft+n = Lt

After observing the demand for period t+1, revise the estimates as follows:

Lt+1 = (Dt+1 + Dt + … + Dt-N+2) / N

Ft+2 = Lt+1


Moving Average Example

From Tahoe Salt example (Table 7.1)

At the end of period 4, what is the forecast demand for periods 5 through 8 using a 4-period moving average?

L4 = (D4+D3+D2+D1)/4 = (34000+23000+13000+8000)/4 = 19500

F5 = 19500 = F6 = F7 = F8

Observe demand in period 5 to be D5 = 10000

Forecast error in period 5, E5 = F5 - D5 = 19500 - 10000 = 9500

Revise estimate of level in period 5:

L5 = (D5+D4+D3+D2)/4 = (10000+34000+23000+13000)/4 = 20000

F6 = L5 = 20000


Simple Exponential Smoothing

• Used when demand has no observable trend or seasonality• Systematic component of demand = level• Initial estimate of level, L0, assumed to be the average of all historical

data

L0 = [Sum(i=1 to n)Di]/n

Current forecast for all future periods is equal to the current estimate of the level and is given as follows:

Ft+1 = Lt and Ft+n = Lt

After observing demand Dt+1, revise the estimate of the level:

Lt+1 = aDt+1 + (1-a)Lt

Lt+1 = Sum(n=0 to t+1)[a(1-a)nDt+1-n ]


Simple Exponential Smoothing Example

From Tahoe Salt data, forecast demand for period 1 using exponential smoothing

L0 = average of all 12 periods of data

= Sum(i=1 to 12)[Di]/12 = 22083

F1 = L0 = 22083

Observed demand for period 1 = D1 = 8000

Forecast error for period 1, E1, is as follows:

E1 = F1 - D1 = 22083 - 8000 = 14083

Assuming a = 0.1, revised estimate of level for period 1:

L1 = aD1 + (1-a)L0 = (0.1)(8000) + (0.9)(22083) = 20675

F2 = L1 = 20675

Note that the estimate of level for period 1 is lower than in period 0


Trend-Corrected Exponential Smoothing (Holt’s Model)

• Appropriate when the demand is assumed to have a level and trend in the systematic component of demand but no seasonality

• Obtain initial estimate of level and trend by running a linear regression of the following form:

Dt = at + b

T0 = a

L0 = b

In period t, the forecast for future periods is expressed as follows:

Ft+1 = Lt + Tt

Ft+n = Lt + nTt


Trend-Corrected Exponential Smoothing (Holt’s Model)

After observing demand for period t, revise the estimates for level and trend as follows:

Lt+1 = aDt+1 + (1-a)(Lt + Tt)

Tt+1 = b(Lt+1 - Lt) + (1-b)Tt

a = smoothing constant for level

b = smoothing constant for trend

Example: Tahoe Salt demand data. Forecast demand for period 1 using Holt’s model (trend corrected exponential smoothing)

Using linear regression,

L0 = 12015 (linear intercept)

T0 = 1549 (linear slope)


Holt’s Model Example (continued)

Forecast for period 1:F1 = L0 + T0 = 12015 + 1549 = 13564Observed demand for period 1 = D1 = 8000E1 = F1 - D1 = 13564 - 8000 = 5564Assume a = 0.1, b = 0.2L1 = aD1 + (1-a)(L0+T0) = (0.1)(8000) + (0.9)(13564) =

13008T1 = b(L1 - L0) + (1-b)T0 = (0.2)(13008 - 12015) + (0.8)

(1549) = 1438F2 = L1 + T1 = 13008 + 1438 = 14446F5 = L1 + 4T1 = 13008 + (4)(1438) = 18760


Trend- and Seasonality-Corrected Exponential Smoothing

• Appropriate when the systematic component of demand is assumed to have a level, trend, and seasonal factor

• Systematic component = (level+trend)(seasonal factor)• Assume periodicity p• Obtain initial estimates of level (L0), trend (T0), seasonal

factors (S1,…,Sp) using procedure for static forecasting

• In period t, the forecast for future periods is given by:

Ft+1 = (Lt+Tt)(St+1) and Ft+n = (Lt + nTt)St+n


Trend- and Seasonality-Corrected Exponential Smoothing (continued)

After observing demand for period t+1, revise estimates for level, trend, and seasonal factors as follows:

Lt+1 = a(Dt+1/St+1) + (1-a)(Lt+Tt)

Tt+1 = b(Lt+1 - Lt) + (1-b)Tt

St+p+1 = g(Dt+1/Lt+1) + (1-g)St+1

a = smoothing constant for level

b = smoothing constant for trend

g = smoothing constant for seasonal factor

Example: Tahoe Salt data. Forecast demand for period 1 using Winter’s model.

Initial estimates of level, trend, and seasonal factors are obtained as in the static forecasting case


Trend- and Seasonality-Corrected Exponential Smoothing Example (continued)

L0 = 18439 T0 = 524 S1=0.47, S2=0.68, S3=1.17, S4=1.67

F1 = (L0 + T0)S1 = (18439+524)(0.47) = 8913

The observed demand for period 1 = D1 = 8000

Forecast error for period 1 = E1 = F1-D1 = 8913 - 8000 = 913

Assume a = 0.1, b=0.2, g=0.1; revise estimates for level and trend for period 1 and for seasonal factor for period 5

L1 = a(D1/S1)+(1-a)(L0+T0) = (0.1)(8000/0.47)+(0.9)(18439+524)=18769

T1 = b(L1-L0)+(1-b)T0 = (0.2)(18769-18439)+(0.8)(524) = 485

S5 = g(D1/L1)+(1-g)S1 = (0.1)(8000/18769)+(0.9)(0.47) = 0.47

F2 = (L1+T1)S2 = (18769 + 485)(0.68) = 13093


Measures of Forecast Error

• Forecast error = Et = Ft - Dt

• Mean squared error (MSE)

MSEn = (Sum(t=1 to n)[Et2])/n

• Absolute deviation = At = |Et|

• Mean absolute deviation (MAD)

MADn = (Sum(t=1 to n)[At])/n

s = 1.25MAD


Measures of Forecast Error

• Mean absolute percentage error (MAPE)

MAPEn = (Sum(t=1 to n)[|Et/ Dt|100])/n

• Bias• Shows whether the forecast consistently under- or

overestimates demand; should fluctuate around 0

biasn = Sum(t=1 to n)[Et]

• Tracking signal• Should be within the range of +6• Otherwise, possibly use a new forecasting method

TSt = bias / MADt


Forecasting Demand at Tahoe Salt

• Moving average• Simple exponential smoothing• Trend-corrected exponential smoothing• Trend- and seasonality-corrected

exponential smoothing


Forecasting in Practice

• Collaborate in building forecasts• The value of data depends on where you

are in the supply chain• Be sure to distinguish between demand

and sales


Collaborative Planning, Forecasting And Replenishment (CPFR)

• Initiatives that have attempted to create efficiency and effectiveness through integration of supply chain activities and processes have been identified as quick response, electronic data interchange (EDI), short cycle manufacturing, vendor managed inventory (VMI), continuous replenishment planning (CRP) and efficient consumer response (ECR).

• CPFR has become recognized as a breakthrough business model for planning, forecasting and replenishment. Using this approach, retailers, transport providers, distributors and manufacturers can utilize available internet-based technologies to collaborate from operational planning through execution. CPFR simplifies and streamlines overall demand planning.


CPFR Business Model


• Development of CPFR came from an effort by Wal Mart and one of its suppliers, Warner-Lambert Company, particularly with regard to its Listerine brand product. In addition to rationalizing inventories of specific line items and addressing out-of-stock occurrences, these two companies collaborated to increase their forecasting accuracy, so as to have just the right amount of inventory where it was needed, when it was needed.

• CPFR emphasizes a sharing of consumer purchasing data among and between trading partners for the purpose of helping to govern supply chain activities. In this manner, CPFR creates a significant, direct link between the consumer and the supply chain.


• The CPFR initiative begins with the sharing of marketing plans between trading partners. Once an agreement is reached on the timing and planned sales of specific products, and a commitment is made to follow that plan closely, the plan is then used to create a forecast, by stock-keeping unit, by week, and by quantity. The planning can be for thirteen, twenty-six, or fifty two weeks.


Order Fulfillment and Order Management • Three critical elements of collaborative planning are

collaborative demand planning, joint capacity planning, and synchronized order fulfillment. This type of planning improves quality of the demand signal for the entire supply chain through a constant exchange of information from one end to the other that goes well beyond traditional practices.

• The Order-Management system represents the principal means by which buyers and sellers communicate information relating to individual orders of product. Effective order management is a key to operational efficiency and customer satisfaction.


Collaborative PlanningCollaborative demand planning

Joint Capacity planning

Synchronized Order fulfillment


Order Management Functions• Receive order• Enter order – manual/electronic• Verify and check order for accuracy • Check credit• Check inventory availability• Process back order• Acknowledge order• Modify order• Suspend order• Check pricing and promotion• Identify shipping point• Generate picking documents• Originate shipment• Inquire order status• Deliver order• Measure service level• Measure quality of service


Order and Replenishment Cycles

• When referring to outbound-to-customer shipments, we typically use the term order cycle. The term replenishment cycle is used more frequently when referring to the acquisition of additional inventory, as in materials management. Basically one firm’s order cycle is another’s replenishment cycle.

Major components of Order Cycle

Order placement

Order processing

Order preparation

Order shipment


• Order Placement – Order-placement time can vary significantly, from taking days or weeks to being instantaneous. Company experiences indicate that improvements in order-placement systems and processes offer some of the greatest opportunities for significantly reducing the length and variability of the overall order. Significant increases were projected for Internet facilitated resources such as E-marketplace, Extranets and E-mail.

• Order Processing – The order-processing function usually involves checking customer credit, transferring information to sales records, sending the order to the inventory and shipping areas, and preparing shipping documents.

• Order Preparation – Depending on the commodity being handled and other factors, the order-preparation process sometimes may be very simple and performed manually or, perhaps, may be relatively complex and highly automated.

• Order Shipment – Shipment time extends from the moment an order is placed upon the transport vehicle for movement, until the moment it is received and unloaded at the buyer’s location.


Customer Service• Having the right product, at the right time, in

the right quantity, without damage or loss, to the right customer is an underlying principle of logistics systems that recognizes the importance of customer service.

• Another aspect of customer service that deserves mention is the growing consumer awareness of the price/quality ratio and the special needs of today’s consumers, who are time conscious and who demand flexibility.


The Traditional Logistics/Marketing Interface

Product

Price

Place/Customer service levels

Promotion

Inventory carrying costs

Lot quantity costs

Order processing and information

costs

Warehousing costs

Transportation costs


Defining Customer Service• Customer service is a process for providing competitive

advantage and adding benefits to the supply chain in order to maximize the total value to the ultimate customer.

• According to marketers, there are three levels of product:

1. The core benefit or service, which constitutes what the buyer is really buying.

2. The tangible product, or the physical product or service itself;

3. The augmented product, which includes benefits that are secondary to, but an integral enhancement to, the tangible product the customer is purchasing. Logistical customer service, installation warranties and after-sale service are examples of augmented product features.


Examples of the various forms that customer service may take include the following:

1. Revamping a billing procedure to accommodate a customer’s request.

2. Providing financial and credit terms.

3. Guaranteeing delivery within specified time periods.

4. Providing prompt and congenial sales representatives.

5. Extending the option to sell on consignment.

6. Providing material to aid in a customer’s sales presentation.

7. Installing the product.

8. Maintaining satisfactory repair parts inventories.


Levels of Customer Service• Customer service as an activity – This level treats

customer service as a particular task that a firm must accomplish to satisfy the customer’s needs. Order processing, billing and invoicing, product returns and claims handling are all typical examples of this level of customer service.

• Customer service as performance measures – This level emphasizes customer service in terms of specific performance measures, such as the percentage of orders delivered on time and complete and the number of orders processed within acceptable time limits.

• Customer service as a philosophy – This level elevates customer service to a firm-wide commitment to providing customer satisfaction through superior customer service by laying emphasis on quality and quality management.


Elements of Customer ServiceCustomer service has multifunctional interest for a

company; but, from the point of view of the logistics function, we can view customer service as having four traditional dimensions:

• Time – The time factor is usually order cycle time, particularly from the perspective of the seller looking at customer service. On the other hand, the buyer usually refers to the time dimension as the lead time, or replenishment time.

• Dependability – Dependability can be more important than lead time. The customer can minimize its inventory level if lead time is fixed.


1. Cycle time – A seller who can assure the customer of a given level of lead time, plus some tolerance, distinctly differentiates its product from that of its competitor. The seller that provides a dependable lead time permits the buyer to minimize the total cost of inventory, stockouts, order processing and production scheduling.

2. Safe delivery – If goods arrive damaged or are lost, the customer cannot use the goods as intended. A shipment containing damaged goods aggravates several customer cost centers – inventory, production and marketing.

3. Correct orders – An improperly filled order forces the customer to reorder, if the customer is not angry enough to buy from another supplier. If a customer who is an intermediary in the marketing channel experiences a stockout, the stockout cost also directly affects the seller.


• Communications – The two logistics activities vital to order-filling are the communication of customer order information to the order-filling area and the actual process of picking out of inventory the items ordered. In the order information stage, the use of EDI or Internet-enabled communications can reduce errors in transferring order information from the order to the warehouse receipt.

• Convenience – Convenience is another way of saying that the logistics service level must be flexible. Basically, logistics requirements differ with regard to packaging, the mode and carrier the customer requires, routing and delivery times.


Performance Measures for Customer Service

Element Brief Description

Typical Measurement UnitProduct

availability

Order cycle time

Distribution system flexibility

Usually defined as percent in stock (target performance level) in some base unit (i.e. order, product, dollars)

Elapsed time from order placement to order receipt. Usually measured in time units and variation from standard or target order cycle

% availability in base units

Speed and consistency

Ability of system to respond to special and/or unexpected needs of customer.

Response time to special requests


Distribution system information

Ability of firm’s information system to respond in timely and accurate manner to customer’s requests for information

Speed, accuracy and message detail of response

Distribution system malfunction

Efficiency of procedures and time required to recover from distribution system malfunction (i.e. errors in billing, shipping, damage , claims).

Response and recovery time requirements

Postsale product support

Efficiency in providing product support after delivery, including technical, information, spare parts, or equipment modification, as appropriate.

Response time, quality of response


Expected cost of stockoutsA principal benefit of inventory availability and,

hence of customer service is to reduce the incidence of stockouts. Once we develop a convenient way to calculate the costs of a stockout, we can use stockout probability information to determine the expected stockout cost. Last, we can analyse alternative customer service levels directly by comparing the expected cost of stockouts with the revenue enhancing benefits of customer service.


Effects of stockouts• A stockout occurs when desired quantities of

finished goods are not available when and where a customer needs them. When a seller is unable to satisfy demand with available inventory, one of four possible events may occur:

1. The customer waits until the product is available

2. The customer back orders the product

3. The seller loses a sale

4. The seller loses a customer


Back Order

A company having to back order an item that is out of stock will incur expenses for special order processing and transportation.

The extra order processing traces the back order’s movement , in addition to the normal processing for regular replenishments.

The customer usually incurs extra transportation charges because a back order is typically a smaller shipment and often incurs higher rates.


Lost sales

Most firms find that although some customers may prefer a back order, others will turn to alternative supply sources.

Most companies have competitors who produce substitute products; and when one source does not have an item available, the customer will order that item from another source. In such cases, the stockout has caused a lost sale.

The seller’s direct loss is the loss of profit on the item that was unavailable when the customer wanted it.

Thus, a seller can determine direct loss by calculating profit on one item and multiplying it by the number the customer ordered. For eg. If the order was for 100 units and the profit is Rs. 10 per unit, the loss is Rs 1000.


Lost Customer• The customer permanently switches to

another supplier. A supplier who loses a customer loses a future stream of income.


Determining the Expected Cost of Stockouts

• The first step is to identify a stockout’s potential consequences. These include a back order, a lost sale, and a lost customer. The second step is to calculate each result’s expense or loss of profit and then to estimate the cost of a single stockout.

• Assume : 70% of all stockouts result in a back order, and a back order requires extra handling costs of Rs. 6; 20% results in a lost sale for the item, and this loss equals Rs. 20 in lost profit margin; and 10% result in a lost customer, or a loss of Rs. 200.

• Overall impact :

70% of Rs 6 = Rs. 4.20

20% of Rs. 20 = Rs 4

10% of Rs. 200 = Rs 20

Total estimated cost per stockout = Rs 28.20

A firm should carry additional inventory to protect against stockouts only as long as carrying the additional inventory costs less than Rs. 28.20.


Channels of Distribution• A channel of distribution consists of one or

more companies or individuals who participate in the flow of goods, services, information and finances from the producer to the final user or consumer. This encompasses a variety of intermediary firms, including those that we classify as wholesalers or retailers.


Types of ChannelsManaging distribution channels requires firms to

coordinate and integrate logistics and marketing activities in a manner consistent with overall corporate strategy.

• Logistical channel refers to the means by which products flow physically from where they are available to where they are needed.

• Marketing channels refers to the means by which necessary transactional elements are managed. (e.g. customer orders, billing, accounts receivable etc.)


Logistical and Marketing Channels

Logistical channel Marketing Channel

Supplier

Transportation

Manufacturer

Transportation

Distribution center

Transportation

Retail store

Consumer

E-Procurement

National account sales

Wholesaler/Distributor

Retail customer


Example of channels of distribution for the food products manufacturing industry

Food Manufacturing firms

Food Service distributors

Grocery wholesalers

Food brokers

Internet (direct)

Restaurants

Specialty (airlines

etc.) Retail chains

(local and regional)

Retail groce

rs

Institutional

buyers

Retail chains

Internet

retailer

Consumers of manufactured food products

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