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©The McGraw-Hill Companies, Inc., 2006

Chapter 10

Supply Chain Strategy

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Supply-Chain Management Measuring Supply-Chain

Performance Bullwhip Effect Outsourcing Value Density Mass Customization

OBJECTIVES

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Supply-chain is a term that describes how organizations (suppliers, manufacturers, distributors, and customers) are linked together

What is a Supply Chain?

Suppliers

Inputs

Suppliers

Service support operations

Transformation

Manufacturing

Local service providers

Localization

Distribution

Customers

Output

Customers

Services

Supply networks

Manufacturing

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What is Supply Chain Management?

Supply-chain management is a total system approach to managing the entire flow of information, materials, and services from raw-material suppliers through factories and warehouses to the end customer

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What recent changes have caused supply chain management to gain importance?a. Competitive pressures from foreign firms.

b. Elevation of product quality to a very high level of importance.

c. International marketing and international purchasing.

d. Trends towards choosing sole-source suppliers and long term relationships.

e. Product varieties and ranges are rapidly changing, and speed of delivery to market is essential.

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f. Product life cycles have shortened necessitating knowledge and control of inventories in the various pipelines.

g. Adoption of JIT production has changed supplier relationships and has also increased the focus on reducing inventories.

h. Trends in the legal system hold manufacturers liable for product failures, even though causes of failure may lie outside of the production system itself.

i. Use of EDI in purchasing.

j. The growth of supplier development.

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Formulas for Measuring Supply-Chain Performance

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Formulas for Measuring Supply-Chain Performance

One of the most commonly used measures in all of operations management is “Inventory Turnover”

In situations where distribution inventory is dominant, “Weeks of Supply” is preferred and measures how many weeks’ worth of inventory is in the system at a particular time

valueinventory aggregate Average

sold goods ofCost turnoverInventory valueinventory aggregate Average

sold goods ofCost turnoverInventory

weeks52 sold goods ofCost

valueinventory aggregate Averagesupply of Weeks

weeks52

sold goods ofCost

valueinventory aggregate Averagesupply of Weeks

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Example of Measuring Supply-Chain Performance

Suppose a company’s new annual report claims their costs of goods sold for the year is $160 million and their total average inventory (production materials + work-in-process) is worth $35 million. This company normally has an inventory turn ratio of 10. What is this year’s Inventory Turnover ratio? What does it mean?

Suppose a company’s new annual report claims their costs of goods sold for the year is $160 million and their total average inventory (production materials + work-in-process) is worth $35 million. This company normally has an inventory turn ratio of 10. What is this year’s Inventory Turnover ratio? What does it mean?

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Example of Measuring Supply-Chain Performance (Continued)

= $160/$35 = 4.57

Since the company’s normal inventory turnover ration is 10, a drop to 4.57 means that the inventory is not turning over as quickly as it had in the past. Without knowing the industry average of turns for this company it is not possible to comment on how they are competitively doing in the industry, but they now have more inventory relative to their cost of goods sold than before.

= $160/$35 = 4.57

Since the company’s normal inventory turnover ration is 10, a drop to 4.57 means that the inventory is not turning over as quickly as it had in the past. Without knowing the industry average of turns for this company it is not possible to comment on how they are competitively doing in the industry, but they now have more inventory relative to their cost of goods sold than before.

valueinventory aggregate Average

sold goods ofCost turnoverInventory

valueinventory aggregate Average

sold goods ofCost turnoverInventory

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Bullwhip Effect O

rder

Q

uan t

ity

Time

Retailer’s Orders

Ord

er

Qua

n tit

y

Time

Wholesaler’s Orders

Ord

er

Qua

n tit

y

Time

Manufacturer’s Orders

The magnification of variability in orders in the supply-chain

The magnification of variability in orders in the supply-chain

A lot of retailers each with little variability in their orders….

A lot of retailers each with little variability in their orders….

…can lead to greater variability for a fewer number of wholesalers, and…

…can lead to greater variability for a fewer number of wholesalers, and…

…can lead to even greater variability for a single manufacturer.

…can lead to even greater variability for a single manufacturer.

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It indicates a lack of synchronization among supply chain member

Campbell Soup introduced continuous replenishment through EDI for the retailers where they can order and report their level of inventories and offers an “everyday low price” that eliminate discount.

Through this system CS can cut the retailers’ inventories to half and in turn increase profits by 50 percent.

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Marshall Fisher has developed a framework to help managers understand the nature demand for their products.

The importance aspects of product’ demand are : product life cycle, demand predictability, product variety, and market standards for lead times and service.

He has found that products can be categorized as either functional of innovative.

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Differences between functional and innovative products :

Functional products are staples that people buy in a wide range of retail outlets. Typically, they do not change much over time, have low profit margins, stable predictable demand and long life cycles.

Innovative products, on the other hand, give customers additional reasons to buy. Fashionable clothes and personal computers are examples of innovative products. Innovative products have short life cycles, high profit margins, and volatile demand.

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Hau Lee’s Concepts of Supply Chain Management

Hau Lee’s approach to supply chain (SC) is one of aligning SC’s with the uncertainties revolving around the supply process side of the SC

A stable supply process has mature technologies and an evolving supply process has rapidly changing technologies

Types of SC’s– Efficient SC’s– Risk-Hedging SC’s– Responsive SC’s– Agile SC’s

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Hau Lee’s SC Uncertainty Framework

Demand Uncertainty

Low (Functional products)

High (Innovative products)

Efficient SC

Ex.: Grocery

Responsive SC

Ex.: Computers

Risk-Hedging SC

Ex.: Hydro-electric power

Agile SC

Ex.: Telecom

Low(Stable Process)

High(Evolving Process)

Supply

Uncertainty

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What are characteristics of efficient, responsive, risk-hedging and agile supply chains?

Can a supply chain be both efficient and responsive? Risk-hedging and Agile? Why or Why not?

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Efficient supply chains are designed to minimize cost that requires high utilization, minimizing inventory, and selecting vendors based primarily on cost and quality, and designing products that are produced at minimum cost.

Market-responsive supply chains are designed to minimize lead time to respond to unpredictable demand, thus minimizing stockout costs and obsolete inventory costs.

Risk sharing supply chains are those that share resources so that risks in the supply chain can be shared.

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Agile are those supply chains that are flexible while still sharing risks of shortages across the supply chain.

Generally, these supply chains carry excess capacity and higher buffer stocks.

Vendor in responsive supply chains would be selected for speed, flexibility, and quality.

It is possible to be both efficient and responsive, and both Risk-hedging and Agile.

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What is Outsourcing?

Outsourcing is defined as the act of moving a firm’s internal activities and decision responsibility to outside providers

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Reasons to Outsource

Organizationally-driven

Improvement-driven

Financially-driven

Revenue-driven

Cost-driven

Employee-driven

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Value Density

Value density is defined as the value of an item per pound of weight

It is used as an important measure when deciding where items should be stocked geographically and how they should be shipped

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For an example, Assume that the inventory carrying cost rate is 30 percent per year of the product value. This cost rate captures the cost of capital, insurance, warehouse cost, and so on.

Our alternative transportation modes are highway service provided by United Parcel Service (UPS) by ship and Federal Express by air.

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Where :

Break-Even Product Value

= 365 x Shipping cost savings

0.30 x 6

Shipping cost savings

= Air shipping cost – Regular highway shipping cost

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Mass Customization

Mass customization is a term used to describe the ability of a company to deliver highly customized products and services to different customers

The key to mass customization is effectively postponing the tasks of differentiating a product for a specific customer until the latest possible point in the supply-chain network

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How to do it?Principle 1:

A Product should be designed so it consists of independent modules that can be assembled into different forms of the product easily and inexpensively.

Principle 2:

Manufacturing and service processes should be designed so that they consist of independent modules that can be moved or rearranged easily to support different distribution network design.

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Principle 3:The supply network-the positioning of inventory and the location, number, and structure of service, manufacturing, and distribution facilities-should be designed to provide two capabilities.

First, it must be able to supply the basic product to the facilities performing the customization in a cost-effective manner

Second, it must have the flexibility and the responsiveness to take individual customers’ orders and deliver the finished, customized good quickly.

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Question Bowl

A typical supply chain would include which of the following?

a. Suppliersb. Manufacturersc. Distributiond. All of the abovee. None of the above

Answer: d. All of the above

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Question Bowl

The supply chain measure of “Inventory Turnover” is which of the following ratios?

a. Avg. inventory value/total costsb. Costs of goods sold/Avg. aggregate

inventory valuec. Total costs of goods/Avg. costs of

goodsd. Weeks worth of inventory/No. of

weekse. None of the above

Answer: b. Costs of goods sold/Avg. aggregate inventory value

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Question Bowl

If the “cost of goods sold” for a company is $1,000,000 and the “average aggregate inventory value” is $25,000, which of the following is the “inventory turnover”?

a. 10b. 25c. 40d. 50e. None of the above

Answer: c. 40 (1,000,000/25,000=40)

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Question Bowl

If the “cost of goods sold” for a company is $250,000 and the “average aggregate inventory value” is $5,000, which of the following is the “inventory turnover”?

a. 10b. 25c. 40d. 50e. None of the above

Answer: d. 50 (250,000/5,000=50)

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Question Bowl

If the “cost of goods sold” for a company is $1,000,000 and the “average aggregate inventory value” is $50,000, which of the following is the “weeks of supply” measure for supply chain performance?

a. 1 weekb. 2.6 weeksc. 20 weeksd. 30 weekse. None of the above

Answer: b. 2.6 (50,000/1,000,000)x52=2.6)

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Question Bowl

Which of the following refers to the phenomenon of increasing variability as we move from the customer to the producer in the supply chain?

a. Continuous replenishingb. Stable supply processc. Evolving supply processd. Agile supply chainse. None of the above

Answer: e. None of the above (The correct term is “Bullwhip effect”.)

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Question Bowl

Which of the following are reasons why an organization should use “outsourcing” as a supply chain strategy?

a. Reduces investment in assetsb. Turns fixed costs into variable costsc. Gives employees a stronger careerd. All of the abovee. None of the above

Answer: d. All of the above

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Question Bowl

Which of the following “transportation modes” provides flexibility in delivery, timing and at reasonable rates for small quantities and over short distances?

a. Railb. Highway (trucking)c. Waterd. Pipelinee. Air

Answer: b. Highway (trucking)

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End of Chapter 10