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Page 1: Supply Chain Engineering

Supply Chain Engineering MN 799 1#

SUPPLY CHAIN ENGINEERING…MN 799• TEXT: SUPPLY CHAIN MANAGEMENT – Chopra and Meindl – Prentice Hall• COURSE OUTLINE – Description Book pages

– 1/22 Introduction, curriculum, rules, exams, Infrastructure (1-27)– 1/27 Strategic Fit and Scope. Supply Chain Drivers (27-51)– 2/05 No Class– 2/12 Demand Management (169-204)– 2/19 Aggregate Planning, Managing (205-225)– 2/26 Guest Lecture Network Operations (71-168)– 3/04 Managing Supply and Demand (121-144)– 3/11 Class trip to see Supply Chain in Operation– 3/18 No Class – 3/25 Mid Term – 4/01 Managing Inventory(249-295); – 4/08 Product Availability (297-384) – 4/15 Sourcing and Procurement (387-410)– 4/22 Transportation (411-219); Facility Decisions (109-133)– 4/29 Beer Game – 5/06 Co-ordination Information Information Technology & E-Business (477- 557) – 5/13 FINAL EXAMINATION

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GUIDELINES

• GRADING:– HOMEWORK – 20%– BEER GAME – 5%– MID TERM – 30%– FINAL – 45%

• HOMEWORK MUST BE COMPLETED IN TIME. LATE SUBMISSIONS WILL START WITH A ‘B’ GRADE

• CLASSES WILL START AT 6.00PM AND GO STRAIGHT THRU TO 8.00PM

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DEFINITION OF A SUPPLY CHAIN• WHAT IS A SUPPLY CHAIN?• A SUPPLY CHAIN COVERS THE FLOW OF

MATERIALS, INFORMATION AND CASH ACROSS THE ENTIRE ENTERPRISE

• SUPPLY CHAIN MANAGEMENT IS THE INTEGRATED PROCESS OF INTEGRATING, PLANNING, SOURCING, MAKING AND DELIVERING PRODUCT, FROM RAW MATERIAL TO END CUSTOMER, AND MEASURING THE RESULTS GLOBALLY

• TO SATISFY CUSTOMERS AND MAKE A PROFIT• WHY A ‘SUPPLY CHAIN’?

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Traditional View: Logistics in the Economy

1990 1996 2006• Freight Transportation $352, $455 $809 B• % Freight 57% 62%• Inventory Expense $221, $311 $ 446 B• % Inventory 39% 33%• Administrative Expense $27, $31 $ 50 B• Logistics related activity 11%, 10.5%,9.9%• % of GNP.

Source: Cass Logistics Homework: What are 2007 statistics?

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Traditional View: Logistics in the Manufacturing Firm

• Profit 4%

• Logistics Cost 21%

• Marketing Cost 27%

• Manufacturing Cost 48%

ProfitLogistics

Cost

Marketing Cost

Manufacturing Cost

Homework: What it the profile for Consumables; Pharamas and Computers

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Supply Chain Management: The Magnitude in the Traditional View

• Estimated that the grocery industry could save $30 billion (10% of operating cost by using effective logistics and supply chain strategies– A typical box of cereal spends 104 days from factory to sale– A typical car spends 15 days from factory to dealership

• Compaq estimates it lost $0.5 billion to $1 billion in sales in 1995 because laptops were not available when and where needed

• P&G estimates it saved retail customers $65 million by collaboration resulting in a better match of supply and demand

• Laura Ashley turns its inventory 10 times a year, five times faster than 3 years ago

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HAMBURGERS AND FRIES

HAMBURGERS (4/LB)• CATTLE FARM – 50c/lb• BUTCHER• PACKAGING• DISTRIBUTION CENTER• RETAILER• CUSTOMER

Provide Sales Price at each stage

FRIES (3Large/lb)• POTATO FARM 25C/lb• POTATO PROCESSOR• DISTRIBUTION CENTER• RETAILER• CUSTOMER

Provide Sales Price at each stage

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What problems do you foresee in this Supply Chain? Please write some down

Burger and FriesExamine this process – What do you observe?

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Understanding the Supply Chain …a chain is only as good as its weakest link   Recall that saying? The saying applies to the principles of building a competitive infrastructure:

Strong, well-structured supply chains are critical to sustained competitive advantage.

Manufacturer Wholesaler Retailer CustomerSupplier

…there is a limit to the surplus or profit in a supply chain

We are all part of a Supply Chain in everything we buy

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OBJECTIVES OF A SUPPLY CHAIN

• MAXIMIZE OVERALL VALUE GENERATED– SATISFYING CUSTOMER NEEDS AT A PROFIT– VALUE STRONGLY CORRELATED TO PROFITABILITY– SOURCE OF REVENUE – CUSTOMER– COST GENERATED WITHIN SUPPLY CHAIN BY FLOWS OF

INFORMATION, PRODUCT AND CASH– FLOWS OCCUR ACROSS ALL STAGES – CUSTOMER,

RETAILER, WHOLESALER, DISTRIBUTOR, MANUFACTURER AND SUPPLIER

– MANAGEMENT OF FLOWS KEY TO SUPPLY CHAIN SUCCESS

UNDERSTAND EACH OBJECTIVE

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DECISION PHASES IN A SUPPLY CHAIN• OVERALL STRATEGY OF COMPANY – EFFICIENT OR

RESPONSIVE• SUPPLY CHAIN STRATEGY OR DESIGN ?

– LOCATION AND CAPACITY OF PRODUCTION AND WAREHOUSE FACILITIES?

– PRODUCTS TO BE MANUF, PURCHASED OR STORED BY LOCATION?– MODES OF TRANSPORTATION?– INFORMATION SYSTEMS TO BE USED?– CONFIGURATION MUST SUPPORT OVERALL STRAGEGY

• SUPPLY CHAIN PLANNING?– OPERATING POLICIES – MARKETS SERVED, INVENTORY HELD,

SUBCONTRACTING, PROMOTIONS, …?

• SUPPLY CHAIN OPERATION?– DECISIONS AND EXECUTION OF ORDERS?

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Basic Supply Chain Architectures (Examples)

1. Indirect Channel

2. Direct Channel

3. Virtual Channel

Supplier

Supplier

Supplier

Supplier

Supplier

Supplier

Supplier Supplier

Customer

Customer

Customer

Customer

Customer

Factory

Factory

Factory

Wholesale

Wholesale

Integrator

ExpressFreight

Retailer

Retailer

Retailer

Virtual Store

Fabricator

Fabricator

CreditService

C 1999. William T. Walker, CFPIM, CIRM with the APICS Educational & Research Foundation. All Rights Reserved.

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SOLE SOURCESINGLE SOURCEMULTI-SOURCE

LOCAL REGIONAL GLOBALMARKET MARKET MARKET

INDIRECT CHANNELDIRECT CHANNEL

VIRTUAL CHANNEL

MAKEvs.

BUY

Supply

DemandSupply Chain Architecture

Strategic Issues . Demand Reach

. Demand Risk

•Cost Structure• Asset Utilization• Responsiveness

Supply Risk

C 1999. William T. Walker, CFPIM, CIRM with the APICS Educational & Research Foundation. All Rights Reserved.

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SUPPLY CHAIN FRAMEWORK AND INFRASTRUCTURE

PRINCIPLE:

BUILD A COMPETITIVE INFRASTRUCTURE

This principle is about

VELOCITY

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Cycle View of Supply Chains DEFINES ROLES AND RESPONSIBILITIES OF MEMBERS OF

SUPPLY CHAIN

Customer Order Cycle

Replenishment Cycle

Manufacturing Cycle

Procurement Cycle

Customer

Retailer

Distributor

Manufacturer

Supplier

to

to

to

to

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PROCESS VIEW OF A SUPPLY CHAIN

• CUSTOMER ORDER CYCLE– TRIGGER: MAXIMIZE CONVERSION OF CUSTOMER

ARRIVALS TO CUSTOMER ORDERS– ENTRY: ENSURE ORDER QUICKLY AND ACCURATELY

COMMUNICATED TO ALL SUPPLY CHAIN PROCESSES– FULFILLMENT: GET CORRECT AND COMPLETE ORDERS

TO CUSTOMERS BY PROMISED DUE DATES AT LOWEST COST

– RECEIVING: CUSTOMER GETS ORDER

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PROCESS VIEW OF A SUPPLY CHAIN• REPLENISHMENT CYCLE

– REPLENISH INVENTORIES AT RETAILER AT MINIMUM COST WHILE PROVIDING NECESSARY PRODUCT AVAILABILITY TO CUSTOMER

– RETAIL ORDER: • TRIGGER – REPLENISHMENT POINT – BALANCE SERVICE AND

INVENTORY• ENTRY – ACCURATE AND QUICK TO ALL SUPPLY CHAIN• FULFILLMENT – BY DISTRIBUTOR OR MFG. – ON TIME• RECEIVING – BY RETAILER, UPDATE RECORDS

• MANUFACTURING CYCLE– INCLUDES ALL PROCESSES INVOLVED IN REPLENISHING

DISTRIBUTOR (RETAILER) INVENTORY, ON TIME @ OPTIMUM COST– ORDER ARRIVAL – PRODUCTION SCHEDULING– MANUFACTURING AND SHIPPING– RECEIVING

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PROCESS VIEW OF A SUPPLY CHAIN

• PROCUREMENT CYCLE– SEVERAL TIERS OF SUPPLIERS– INCLUDES ALL PROCESSES INVOLVED IN ENSURING

MATERIAL AVAILABLE WHEN REQUIRED

• SUPPLY CHAIN MACRO PROCESSES• CRM – All processes focusing on interface between firm and

customers• ISCM – A processes internal to firm• SRM – All processes focusing on interface between firm and

suppliers

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A Customer’s View of the Supply Chain

Order the product...with configuration complexity on-line

Pay for the product...in a foreign currency by credit card

Service the product... anywhere in the world

Take delivery... the next day at home, and get started without a hassle

C 1999. William T. Walker, CFPIM, CIRM with the APICS Educational & Research Foundation. All Rights Reserved.

Ex.-Travel arrangements on line

FRONT OFFICE

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Push/Pull View of Supply Chains PULL – PROCESSES IN RESPONSE TO A CUSTOMER ORDER

PUSH – PROCESSES IN ANTICIPATION OF A CUSTOMER ORDER Procurement,Manufacturing andReplenishment cycles

Customer OrderCycleCustomerOrder arrives

PUSH PROCESSES PULL PROCESSES

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UNDERSTANDING THE SUPPLY CHAIN

• Homework• EXAMPLES:

– EXAMPLES OF SUPPLY CHAINS –1.5 – pp 20-25– WHAT ARE SOME OF THE KEY ISSUES IN THESE SUPPLY

CHAINS– ANALYSE AND COMMENT ON 7-Eleven and Amazon– ANSWER

QUESTIONS 1TO 6 FOR EACH

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SUPPLY CHAIN PERFORMANCE – STRATEGIC FIT AND SCOPE (Lesson 2)

NewProduct

Development

Marketingand

Sales Operations Distribution Service

Finance, Accounting, Information Technology, Human Resources

Business Strategy

New ProductStrategy

MarketingStrategy Supply Chain Strategy

Supply and Manufacture

FILM – CHAIN REACTION

EXAMPLES?

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ACHIEVING STRATEGIC FIT

• Step 1. Understanding the Customer and Demand– Quantity - Lot size– Response time– Product variety– Service level– Price– Innovation

ImpliedDemand

UncertaintySee Table 2.1

Regular Demand Uncertainty due to

customers demand and Implied Demand

Uncertainty due to uncertainty in Supply Chain

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Levels of Implied Demand Uncertainty

Low High

Price ResponsivenessCustomer Need

Implied Demand Uncertainty Attributes (Table 2-2)Low Implied Uncertainty High Implied Uncertainty

Product Margin Low – High Aver. Forecast Error 10% 40-100%; Aver. Stockout rate 1-2% 10-40%; Aver. markdown 0% 10-25%

DetergentLong lead time steel

High FashionEmergency steel

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SUPPLY SOURCE UNCERTAINTY

• TABLE 2.3 SUPPLY UNCERTAINTY– FREQUENT BREAKDOWNS– UNPREDICTABLE AND/OR LOW YIELDS– POOR QUALITY– LIMITED SUPPLIER CAPACITY– INFLEXIBLE SUPPLY CAPACITY– EVOLVING PRODUCTION PROCESSES

• LIFE CYCLE POSITION OF PRODUCT– NEW PRODUCTS HIGH UNCERTAINTY

• DEMAND AND SUPPLY UNCERTAINTY FIG 2.2

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Step 2 - Understanding the Supply Chain: Cost-Responsiveness Efficient Frontier (Table: 2.4)

High Low

Low

High

Exercise: Give examples of products that are: Highly efficient, Somewhat efficient, Somewhat responsive and highly responsive

Cost (efficient)

Responsiveness

Responsiveness – to Quantity, Time, Variety, Innovation, Service level

Fig 2.3

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Step 3. Achieving Strategic Fit

Implied uncertainty spectrum

Responsive supply chain

Efficient supply chain

Certain demand

Uncertain demand

Responsiveness spectrum Zone o

f

Strateg

ic Fit

Low Cost

High CostCompanies try to move

Zone of Strategic fit

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SCOPE• Comparison of Efficient & Responsive Supply Chain Table 2.4

– EFF Vs RESPON. STRATEGY for DESIGN; PRICING; MANUF; INVEN; LEAD TIME; SUPPLIER

– THERE IS A RIGHT SUPPLY CHAIN STRATEGY FOR A GIVEN COMPETITIVE STRATEGY (without a competitive strategy there is no right supply chain!)

• OTHER ISSUES AFFECTING STRATEGIC FIT– MULTIPLE PRODUCTS AND CUSTOMER SEGMENTS

• TAILOR SC TO MEET THE NEEDS OF EACH PRODUCT’S DEMAND– PRODUCT LIFE CYCLE Fig 2.8

• AS DEMAND CHARACTERISTICS CHANGE, SO MUST SC STRATEGY - EXAMPLES– COMPETITIVE CHANGES OVER TIME (COMPETITOR)

• EXPANDING STRATEGIC SCOPE– INTERCOMPANY INTERFUNCTIONAL SCOPE

• MAXIMIZE SUPPLY CHAIN SURPLUS VIEW – EVALUATE ALL ACTIONS IN CONTEXT OF ENTIRE SUPPLY CHAIN (FIG 2.12)

– FLEXIBLE INTERCOMPANY INTERFUNCTIONAL SCOPE• FLEXIBILITY CRITICAL AS ENVIRONMENT BECOMES DYNAMIC

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Strategic Scope

Suppliers Manufacturer Distributor Retailer Customer

Competitive Strategy

Product Dev. Strategy

Supply Chain Strategy

Marketing Strategy

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Drivers of Supply Chain Performance

Efficiency Responsiveness

Inventory Transportation Facilities Information

Supply chain structure

Drivers

TRADE OFF FOR EACH DRIVER

Competitive Strategy

Supply Chain Strategy

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INVENTORY– ‘WHAT’ OF SUPPLY CHAIN– MISMATCH BETWEEN SUPPLY AND DEMAND– MAJOR SOURCE OF COST– HUGE IMPACT ON RESP0NSIVENESS– MATERIAL FLOW TIME

• I = R T (I – Inventory, R – Throughput, T – Flow time)– ROLE IN COMPETITIVE STRATEGY– COMPONENTS

• CYCLE INVENTORY – AVERAGE INVENTORY BETWEEN REPLENISHMENTS

• SAFETY INVENTORY - TO COVER DEMAND AND SUPPLY UNCERTAINITY

• SEASONAL INVENTORY – COUNTERS PREDICTABLE VARIATION

– OVERALL TRADE OFF: RESPONSIVENESS VS EFFICIENCY

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TRANSPORTATION• ‘HOW’ OF SUPPLY CHAIN• LARGE IMPACT ON RESPONSIVENESS AND EFFICIENCY• ROLE IN COMPETITIVE STRATEGY• COMPONENTS

– MODE – AIR, TRUCK, RAIL, SHIP, PIPELINE, ELECTRONIC– ROUTE SELECTION– IN HOUSE OR OUTSOURCE

• OVERALL TRADE OFF: RESPONSIVENESS VS EFFICIENCY

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FACILITIES

• ‘WHERE’ OF SUPPLY CHAIN• TRANSFORMED (FACTORY) OR STORED

(WAREHOUSE)• ROLE IN COMPETITIVE STRATEGY• COMPONENTS

– LOCATION - CENTRAL OR DECENTRAL– CAPACITY – FLEXIBILITY VS EFFICIENCY– MANUFACTURING METHODOLOGY – PRODUCT OR

PROCESS FOCUS– WAREHOUSING METHODOLOGY – STORAGE – SKU, JOB

LOT, CROSSDOCKING• OVERALL TRADE OFF: RESPONSIVENESS VS

EFFICIENCY

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INFORMATION• AFFECTS EVERY PART OF SUPPLY CHAIN

– CONNECTS ALL STAGES– ESSENTIAL TO OPERATION OF ALL STAGES

• ROLE IN COMPETITIVE STATEGY– SUBSTITUTE FOR INVENTORY

• COMPONENTS– PUSH VS PULL– COORDINATION AND INFORMATION SHARING– FORECASTING AND AGGREGATE PLANNING– ENABLING TECHNOLOGIES

• EDI• INTERNET• ERP• SCM

• OVERALL TRADE OFF: RESPONSIVENESS VS EFFICIENCY ?

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Considerations for Supply Chain Drivers

Driver Efficiency Responsiveness

Inventory Cost of holding Availability

Transportation Consolidation Speed

Facilities Consolidation /Dedicated

Proximity /Flexibility

Information What information is best suited foreach objective

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MAJOR OBSTACLES TO ACHIEVING FIT• Multiple global owners / incentives in a supply chain

– Information Coordination & Contractual Coordination

• Increasing product variety / shrinking life cycles / demanding customers/customer fragmentation

Increasing demand and supply uncertainty

Local optimization and lack of global fit

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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• ALL INCREASE UNCERTAINTY

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Dealing with Product Variety: Mass Customization

MassCustomization

Low

HighHigh

Low

Long

Short

Lea

d T

ime

Cost

Customization

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Fragmentation of Markets and Product Variety

• Are the requirements of all market segments served identical?

• Are the characteristics of all products identical?

• Can a single supply chain structure be used for all products / customers?

• No! A single supply chain will fail different customers on efficiency or responsiveness or both.

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HOMEWORK

• Page 49 – Nordstrom– Answer Questions 1 to 4

• Answer the above questions for Amazon.com• Page 67

– Answer Questions 1 to 4

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REVIEW QUESTIONS• WHAT IS STRATEGIC FIT? HOW IS IT ACHIEVED?

– COMPANY’S APPROACH TO MATCH DEMAND REQUIREMENTS AND SUPPLY POSITIONING

– MULTIPLE PRODUCTS AND CUSTOMER SEGMENTS– PRODUCT LIFE CYCLE

• WHAT IS STRATEGIC SCOPE?– INTERCOMPANY, INTERFUNCTIONAL EXTENSION

• WHAT ARE THE SUPPLY CHAIN DRIVERS. WHAT ARE THEIR ROLES AND COMPONENTS?– INVENTORY; FACILITIES; TRANSPORTATION; INFORMATION

• OBSTACLES

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Forecasting (uncertainty) Order service (certainty)

Demand management

Demand-Management Activities

RULE: Do not forecast what you can plan, calculate, or extract from supply chain feedback.

Source: Adapted from Plossl, “Getting the Most from Forecasts,” APICS 15th International Conference Proceedings, 1972

Lesson 3

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DETERMINING DEMAND

• FORECASTING– TWO TYPES – WRONG AND LUCKY– TWO NUMBERS – QUANTITY AND DATE– ELEMENTS of a GOOD FORECASTING SYSTEM:

• EQUAL CHANCE OF BEING OVER OR UNDER• INCLUDES KNOWN FUTURE EVENTS• HAS RANGE OR FORECAST ERROR ESTIMATE• REVIEWED REGULARLY

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FORECASTING• GENERAL PRINCIPLES:

– MORE ACCURATE AT THE AGGREGATE LEVEL– MORE ACCURATE FOR SHORTER PERIODS OF TIME CLOSER TO

PRESENT– SET OF NUMBERS TO WORK FROM, NOT TO WORK TO– MOSTLY ALWAYS WRONG

– EXAMPLE: MONTHLY vs DAILY EXPENDITURE

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FORECASTING• MAIN TECHNIQUES:

– QUALITATIVE • MANAGEMENT REVIEW• DELPHI METHOD• MARKET RESEARCH

– QUANTITIVE• MOVING AVERAGE• WEIGHTED MOVING AVERAGE• EXPONENTIAL SMOOTHING• REGRESSION ANALYSIS• SEASONALILTY• PYRAMID

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FORECASTING• QUALITATIVE

– USEFUL ON NEW PRODUCTS– AS A SUPPLEMENT TO QUANTITATIVE NUMBERS

• QUANTITATIVE– NEEDS HISTORICAL DATA OR PROJECTED DATA– AVAILABLE– CONSISTENT– ACCURATE– UNITS - MEASURABLE

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MonthSKU Jan Feb Mar Apr May Jun

A 25 21 23 2321 21

B 27 23 26 21 25

C 16 18 17 23 30

D 23 26 25 52 23

E 29 30 ? 26 28

Total 120 118 91 2443 127

What actions should be taken?What is forecast for June?

For each SKU? For total?

WORK OUT JUNE’s FORECASTS FOR ALL SKU’s

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Simple Moving Averages (SMA)

Simple Moving Average (SMA)n

DDDF 2

--+

++=

Where F = Forecast T = Current time periodD = Demand n = Number of periods( max)

Forecast ForecastDemand (3-period 4-period

start-up start-up

Exercise: Work out the SMA for two periodsQuestion: What determines the number of periods used? Why?

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Weighted Moving AveragesWeighted Moving Average (WMA) 1nT1nT1T1TTT1T DWDWDWF ......

Where: F = Forecast T = Current time periodD = Demand n = Number of periods (max)

W = Weight, where greatest weight applies to most recent period and sum of weights = 1

Forecast ForecastDemand

start-up start-up

Exercise: Work out forecast for two periods with weights of 0.4,0.6What periods and weights will use for forecasting soap and fashion clothes Why?

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Exponential Smoothing

1n2

Decision

þ Select or compute a smoothing constant ()

þ Relationship of exponential smoothing to simple moving average

Wheren = number of past periods

to be captured

WhereF = forecast valueT = current time periodD = demand = exponential factor <1

)F(DFF or

)F(1DF

TTT1T

TT1T

Formulas

)F(DFF or

)F(1DF

TTT1T

TT1T

)F(DFF or

)F(1DF

TTT1T

TT1T

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Period Demand Forecast Forecast Forecast ( = .1) (= .5) (= .9)

0 180 start-up start-up start-up1 160 180 180 1802 220 178 170 1623 200 182 195 2144 260 184 198 2015 240 192 229 2546 196 234 241

Exponential Smoothing —Continued

FT+1 = FT + a (DT – FT)

Work out forecasts with =0.3What ’s will use for forecasting soap and fashion clothes Why?

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Simple Trended Series — Example

Algebraic Trend ProjectionX Y a. Trend (“rise” over “run”) = (13 - 4)/3 = 3 = b 0 41 72 103 13 c. Period 4: Y = a + bX = 4 + 3 (4 [for period 4]) =

16

b.Y-intercept (a) = “compute”the Y value for X = 0, thus Y-int = 4

1 2 3

13

10

7

4 Run

Rise

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REGRESSION ANALYSIS

• Regression formula b=slope, a=intercept

• Slope b= Intercept• and

• Work out this example:• Year Variable Y (Passengers)• 1 77• 2 75• 3 72• 4 73• 5 71• What is the regression equation? What is the forecast for Year 6?

Xb-Ya

bXaY b

22 )( XXnYXXYn

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TRENDED TIME SERIES FORECASTING

• Question: How do you forecast a seasonal item

• Y(forecast) = [A (intercept) + X (trend) x T (time period) ] x S (seasonality factor)

• FIRST DETERMINE LEVEL AND TREND - IF SEASONAL DESEASONALIZE

• THEN FORECAST USING EXPONENTIAL OR TREND• RESEASONALIZE

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Seasonal Series Indexing

SeasonalMonth Year 1 Year 2 Year 3 Total Index

Jan 10 12 11 33 0.33Feb 13 13 11 37 0.37Mar 33 38 29 100 1.00

Apr 45 54 47 146 1.46May 53 56 55 164 1.64Jun 57 56 55 168 1.68

Jul 33 27 34 94 0.94Aug 20 18 19 57 0.57Sep 19 22 20 61 0.61

Oct 18 18 15 51 0.51Nov 46 50 45 141 1.41Dec 48 53 47 148 1.48

Total 395 417 388 1200 12.00

Yr 1 Yr2

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Seasonal Series Indexing Sample Data — Continued

Monthly Total (MT)Formula: Seasonal Index (SI) = Average Month (AM)

33SIJAN = = .33100

94SIJUL = = .94100

Where:1200AM = = 10012

1. FIND SEASONALITY FOR EACH PERIOD2. DEASONALIZE3. PROJECT USING EXPONENTIAL, REGRESSION ETC4. REASONALIZE

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Given Deseasonalized Seasonal Demand Forecast Index

July 34 36 0.94Aug 0.57

Rationale and Computations

1. Deseasonalize current (July) actual demand

2. Use exponential smoothing to project deseasonalized data one period ahead ( = .2)

3. Reseasonalize forecast for desired month (August)= Deseasonalized forecast seasonal factor

= 36.03 0.57 = 20.53 or 21

36.03(36) (0.8)(36.17) (0.2))F(1D F TT1T

Integrative Example: Calculating a Forecast with Seasonal Indexes and Exponential Smoothing

36.1734/0.94 index Seasonaldemand Actual 36.1734/0.94 index Seasonal

demand Actual 36.1734/0.94 index Seasonaldemand Actual 36.1734/0.94 index Seasonal

demand Actual 340.94

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Exercise• Boler Corp has the following sales history:• Quarter Year1 Year2• 1 140 210• 2 280 350• 3 70 140• 4 210 280• What seasonal index for each quarter could be used to forecast the

sales of the product for Year 3?• What would be a forecast for year 3 using an a=0.3 and assuming the

forecast for year 2 was 1000? What would be the forecast for each quarter in this forecast?

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Source: Adapted from CPIM Inventory Management Certification Review Course (APICS, 1998).

95.44%

99.74%

68.26%x

Normal DistributionUsing the Measures of Variability

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Standard Deviation (sigma)

F=A =

ActualError

(Sales – ErrorPeriod Forecast Sales Forecast) Square

d – – – –

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Standard Deviation — Continued

Standard Deviation ( )

( )

n

FA

n

F

2

ii

2

ii

==-

=

==-

-=

About the use of n or n - 1 in the above equations

n Use with a large population (> 30 observations)n - 1 Use with a small population (< 30 observations)

Standard Deviation

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Cumulative sum of error =

Bias =

Mean Absolute Deviation (MAD)

=

200FA ii

Bias and MAD

( )n

F ii ==-

Fn

ii ==-

F =A =

ActualError

Sales – AbsolutePeriod Forecast Sales Forecast) Error – – – –

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Cumulative Sum of Error

Bias

Mean Absolute Deviation (MAD)

Standard Deviation=1.25 MAD or

NOTE: About the use of n or n-1 in the above equations n Use with a large population (> 30 observations) n-1 Use with a small population (< 30 observations)

Measures of Forecast Error

F( ) - i i

A

( )n

FA i i -

nF ii -

( )nF

ii

-- ( )

nFA

i i -or

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Definition A confidence interval is a measure of distance, increments of which are represented by the z value

Formulas

Relationship 1 standard deviation () = 1.25 MAD In the example data = 1.25 MAD

= 1.25 160 = 200Source: Raz and Roberts, “Statistics,” 1987

Confidence Intervals

( ) ( ) ( )

s

s

s

zxxor

xxDeviationStandard

MeanDistancez

nFA

ORnFA

DevStd

i

i

2

ii

2

ii

+=

-=-=

-

-

-=

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Expressing z Values (for +ve probabilities)

Probabilit y

D +1 SD +2 SD +3 SD

Cumulative normal distribution from left side of distribution (x + z)

z

ack

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Application Problem — Service Level Given

Average sales for item P is 50 units per week with a standard deviation of 4

Required What is the probability that more than 60 units will be sold?

a. .006 b. .494 c. .506 d. .994

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Homework

Q1 - 2. A demand pattern for ten periods for a certain product was given as 127, 113, 121, 123, 117, 109, 131, 115, 127, and 118. Forecast the demand for period 11 using each of the following methods: a three-month moving average, a three-month weighted moving average using weights of 0.2, 0.3, and 0.5, exponential smoothing with a smoothing constant of 0.3, and linear regression. Compute the MAD for each method to determine which method would be preferable under the circumstances. Also calculate the bias in the data, if any, for all four methods, and explain the meaning.

Q2 - The following information is presented for a product:• 2001 2002• Forecast Demand Forecast Demand• Quarter I 200 226 210 218

Quarter II 320 310 315 333• Quarter III 145 153 140 122• Quarter IV 230 212 240 231• a) What are the seasonal indicies that should be used for each quarter? • What is the MAD for the data above?

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Supply Chain NetworkFundamentals

William T. Walker, CFPIM, CIRM, CSCPPractitioner, Author, and Supply Chain Architect

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• Understanding How Supply Chains Work• The Value Principle and Network Stakeholders• Mapping a Supply Chain Network• The Velocity and Variability Principles• Locating the Push/Pull Boundary• The Vocalize and Visualize Principles• Summary

Session Outline

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Learning Objectives

By teaching the principles of supply chain management to understand how a supply chain network works...

We learn how to map a supply chain network.

We learn how to engineer reliable network infrastructure by maximizing velocity and minimizing variability.

We learn how the Bill Of Materials relates to the network.

We learn how locating the push/pull boundary converts network operations from Build-To-Stock to Build-To-Order.

We learn how to maximize throughput by engineering the means to vocalize demand and to visualize supply.

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A SUPPLY CHAIN is the global network used to deliver products and services from raw materials to end customers through engineered flows of information, material, and cash.

Contributed to the APICS Dictionary, 10th Edition by William T. Walker

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Network Terminology

Physical FlowInfo Flow

Cash Flow

"Source" "Make" "Deliver" "Return" Upstream Midstream Downstream Reverse Stream Zone Zone Zone Zone

Customer

Value-Adding Value-Subtracting

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Supplier Customer Trading

Partner

$3

M1 M2 M3

$1 $2Cash

Material

Material moves downstream to the customer.Cash moves upstream to the supplier.

Supply Chain Network Operations

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Suppliers Customers Trading Partner

Shareholders

Employees

Value isthe Perfect

Order

Value isEmployment

Stability

Value isReturn In

Investment

Value isContinuityof Demand

The Value Principle:The Value Principle:Every stakeholder wins when throughput is maximized.

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The Network RulesIn an effective supply chain networkeach trading partner works to... Maximize velocity, Minimize variability, Vocalize demand, and Visualize supply ...in order to maximize throughput providingValue for each stakeholder. However, a lack of trust often gets in the way.

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The Network Trust FactorNetwork trust is based upon personal relationshipsand the perception that things are okay regarding:

Network operating rules are clear

Supply and demand information is shared

Performance measures are agreed upon

Relationship non-disclosures are kept secret

Inventory investment is not a win-lose game

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Bill Of Materials

S3

S5

S4

S2S1

D1

A3

B5 B2

C1 C2 C3

BOM Level 0.

BOM Level 1.

BOM Level 2.

BOM Level 3.

For ExampleItems: A3, B2, B5, C1, C2, C3, D1Suppliers: S1, S2, S3, S4, S5

Item Master- Stock Keeping Unit (SKU) Number- Description- Unit Of Measure- Approved Supplier- Country Of Origin- Cost- Lead Time

Product Structure- Parent To Child Relationship- Quantity Per Relationship

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Supply Chain Network Map

Upstream Midstream Downstream Driven by the Bill Of Materials Driven by the Delivery Channel

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1. Start midstream and imagine finished goods sitting on a rack at the central depot.

2. Now, use the Bill Of Materials and work upstream to reach each raw material supplier.

3. Then, identify each different fulfillment channel used to reach the local mission.

4. Determine which organizations are trading partners versus nominal trading partners.

5. Logistics service providers, informationservice providers, and financial serviceproviders are not part of the network map.

How To Map A Network

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The Velocity Principle:The Velocity Principle:In network implementation throughput is maximized

when order-to-delivery-to-cash velocity is maximizedby minimizing process cycle time.

The 5V Principles of Supply Chain Management explain how a supply chain network works by answering what, when, where, why, and how:

Velocity – how are relationships connected to make the delivery?

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The Network Flow Model

Supplier Customer Trading Partner

Order-To-Delivery Order-To-Stock

Invoice-To-PayInvoice-To-Cash

Material Material

Cash Cash

Info Info

From: William T. Walker, Supply Chain Architecture: A Blueprint forNetworking the Flow of Material, Information, and Cash, CRC Press,©2005.

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Logistics Touches Every Subcycle

Order-To-Delivery Order-To-Stock

Invoice-To-PayInvoice-To-Cash

Transportation moves material from seller to buyer In some cases orders/ invoices/ cash move by mail Warehouse issues trigger invoices Warehouse receipts trigger payments

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Import/ Export Boundaries

Country A Country B Buyer

Return

Seller ShipmentExports Imports

ExportsImports

Country A exports and Country B imports in a forward supply chain.

Country B exports and Country A imports in a reverse supply chain.

Import duty and export licensing add complexity to network linkages decreasing velocity and increasing variability.

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The Variability Principle:The Variability Principle: In network implementationthroughput is maximized

when order-to-delivery-to-cash variability is minimizedby minimizing process variance.

The 5V Principles of Supply Chain Management explain how a supply chain network works by answering what, when, where, why, and how:

Variability – what is likely to change from one delivery to the next?

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Outward Signs of Variability Unplanned demand Backordered inventory Inventory leakage Capacity constraints Lower than normal yields Longer than expected transit times Delays in clearing Customs Delayed payment

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To Maximize Velocity Eliminate unnecessary process steps Shorten the longest serial process steps by

eliminating queue time and automating steps Convert serial process steps into

parallel process steps

To Minimize Variability Rank order the variances Minimize the root cause of largest variance Continue with the next largest variance, etc.

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Push/Pull Boundary

PullPush

Order

Push/Pull Boundary

Forecast

Demand Supply

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Customer Lead Time

CustomerDemand

PullPush

OrderBuild-To-Order (BTO)

Push/Pull Boundary

CustomerDemand

PullPush

Build-To-Stock (BTS)

Push/Pull Boundary

Order

F/C

F/C

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1. Know the competitive situation; for example, ifcompetitive products are off-the-shelf, then thepush/pull boundary must be close to the customer.

2. The push/pull boundary is a physical inventory location that bisects the entire supply chain.

3. Order-To-Delivery Cycle Time = Order Processing and Transmission Time + Shipment Processing, Picking, and Packing Time + Transportation and Customs Clearance Time

How To Locate A Push/Pull Boundary

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The Vocalize Principle:The Vocalize Principle:In network operations

throughput is maximizedby pulling supply to demand

by vocalizing actual demand at the network constraint.

The 5V Principles of Supply Chain Management explain how a supply chain network works by answering what, when, where, why, and how:

Vocalize – who knows the full requirements of the order?

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Common Causes of Stockouts

L

Quantity

Time

RSS

L

Q

Quantity

Time

RSS

L

Q

Quantity

Time

RSS

Q

Demand Uncertainty

Supply Uncertainty

Lead Time Variability (LT = Cycle Time + Transit Time)

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The Planning Interface

Pull ToDemand

Push From Forecast

Sales & Operations PlanMaster Schedule

DownstreamThe Supply Chain Network

Push Zone Pull Zone

Push/Pull Boundary

I

MRP MaterialsRequirements

CRP CapacityRequirements

I

Upstream

C C

CapableNetwork

PreloadInventory

Throughput

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IThroughput

Push ZoneForecast

Safety Safety

C

Push Inventory And Capacity

Ending Inventory = Starting Inventory - Forecasted Demand + Production

When actual demand exceeds forecasted demand,either capacity or inventory can constrain productioncausing lead time to expand.

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IThroughput

Pull ZoneOrder

C

Pull Inventory And Capacity

Max Max

Ending Inventory = Starting Inventory - Actual Demand + Production

Throughput is limited to the smaller of limited inventoryor limited capacity.

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The Visualize Principle:The Visualize Principle:

In network operationsthroughput is maximized

by pushing supply to demand by visualizing actual inventory supply across the network.

The 5V Principles of Supply Chain Management explain how a supply chain network works by answering what, when, where, why, and how:

Visualize – where is the inventory now and when will it be available?

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[ ] Transportation and warehousing costsare a function of cubic dimensions and weight.

[ ] Items that have to be repalletized fortransport or storage cost more.

[ ] Cartons, plastic cushions, and labelsmay be missing from the product BOM.

[ ] RFID/ bar code on all packaging.

[ ] Select a wall thickness and box burststrength to protect the product.

[ ] Keep Country Of Origin labeling consistent from the product to the outside packaging.

Cartons

MasterCarton

Unit Load

Packaging And Labeling

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Track and Trace

TrackTrace

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Apply Technology To Visualize• Bar Code and 2D Bar Code

• Point Of Use Laser Scanners

• Radio Frequency Identification (RFID)

• Global Positioning by Satellite (GPS)

• Wireless Communication

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Measuring Network Inventory

1. Look for leakages between upstream issues and downstream receipts.2. Look for inventory balance discrepancies at each trading partner.3. Look for process yield issues within each trading partner.

Upstream Issues = Downstream ReceiptsEnding Inventory = Starting Inventory + Receipts – Issues

Complete Products Reflect BOM Part Proportions

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To Vocalize Be precise about units and configurations Acknowledge and handshake all information Don't skip any link holding inventory in the chain

Measure throughput rather than production Measure the network capacity constraint Measure total network inventory

To Visualize

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Suppliers CustomersTradingPartner

Employees

We win!

I win!

Shareholders

I win!

We win!

Work the 5V Principles to maximize throughput.In Summary

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AGGREGRATE PLANNING (Chap8) Lesson 5• PROCESS OF DETERMINING LEVELS OF

– PRODUCTION RATE– WORKFORCE – OVERTIME– MACHINE CAPACITY– SUBCONTRACTING– BACKLOG– INVENTORY

• GIVEN DEMAND FORECAST – DETERMINE PRODUCTION, INVENTORY/BACKLOG AND CAPACITY LEVEL FOR EACH PERIOD

• FUNDAMENTAL TRADE-OFFS– CAPACITY(REGULAR TIME, OVERTIME, SUBCONTRACING)/COST– INVENTORY/SERVICE LEVEL– BACKLOG/LOST SALES

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AGGREGRATE PLANNING STRATEGIES• STRATEGIES - SYNCHRONIZING PRODUCTION WITH DEMAND

– CHASE- USING CAPACITY AS THE LEVER• BY VARYING MACHINE OR WORKFORCE (numbers or flexibility)• DIFFICULT TO IMPLEMENT AND EXPENSIVE. LOW LEVELS OF

INVENTORY– TIME FLEXIBILITY – UTILIZATION AS THE LEVER

• IF EXCESS MACHINE CAPACITY, VARYING HOURS WORKED (workforce stable, hours vary)

• LOW INVENTORY AND LOWER UTILISATION THAN CHASE• USEFUL WHEN INVENTORY COST HIGH AND CAPACITY CHEAP

– LEVEL – USING INVENTORY AS THE LEVER• STABLE WORKFORCE AND CAPACITY• LARGE INVENTORIES AND BACKLOGS• MOST PRACTICAL AND POPULAR

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SOP FORMAT

• PRODUCTION PLAN = SALES + END INV – BEGIN INV• PRODUCTION PER MONTH = PRODUCTION PLAN

NUMBER OF PERIODS• PRODUCTION PLAN = SALES – END BACKLOG +

BEGIN BACKLOG

1 2 3 4 5 6

SALES

PRODUCTION

INVENTORY/ BACKLOG

PERIOD

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Sales and Operations Planning Strategies

M a s t e r P l a n n i n g , R e v . 4 . 2

T o t a la n n u a l

( o r p e r i o d )0 1 2 3 4 5 6 7 8 9 1 0 1 1 1 2 u n i t s

L e v e l M e t h o dP r o d u c t i o n 2 0 2 0 2 0 2 0 2 0 2 0 2 0 2 0 2 0 2 0 2 0 2 0 2 4 0S a l e s 5 5 5 1 5 2 5 3 5 3 5 3 5 3 5 2 5 1 5 5 2 4 0I n v e n t o r y 3 0 4 5 6 0 7 5 8 0 7 5 6 0 4 5 3 0 1 5 1 0 1 5 3 0 5 4 0C a p a c i t y - - - - - - - - - - - - 0

C h a s e S t r a t e g yP r o d u c t i o n 5 5 5 1 5 2 5 3 5 3 5 3 5 3 5 2 5 1 5 5 2 4 0S a l e s 5 5 5 1 5 2 5 3 5 3 5 3 5 3 5 2 5 1 5 5 2 4 0I n v e n t o r y 3 0 3 0 3 0 3 0 3 0 3 0 3 0 3 0 3 0 3 0 3 0 3 0 3 0 3 6 0C a p a c i t y - - - 1 1 1 - - - 1 1 1 6

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Production Rates and Levels Application 1 — Make-to-Stock

• Table Format (Inventory)Period 0 1 2 3 4Forecast 150 150 150 150Production planInventory 200 100

FOR A LEVEL STRATEGY, WORK OUT THE PRODUCTION PLAN AND INVENTORY BY PERIOD

PRODUCTION = SALES + END INV – BEGIN INV

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Production Rates and LevelsApplication 2 — Make-to-Order

• Table Format (Backlog)Period 0 1 2 3 4Forecast 150 150 150 150Production planBacklog 200 100

FOR A LEVEL STRATEGY WORK OUT THE PRODUCTION PLAN AND BACKLOG BY PERIOD

PRODUCTION = SALES + BEGIN BL - END BL

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OPTIMIZATION THRU LINEAR PROGRAMMING• AGGREGATE PLANNING MODEL – RED TOMATO Pp 210 (105)

– MAXIMIZING HIGHEST PROFIT OVER TIME PERIOD– DETERMINE DECISION VARIABLES PP212(107)– OBJECTIVE FUNCTION – MINIMIZE TOTAL COST

• DEVELOP EQUATIONS FOR ALL THE COST ELEMENTS- Eq 5/8.1– CONSTRAINTS EQUATIONS

• WORKFORCE• CAPACITY• INVENTORY• OVERTIME

– OPTIMIZE OBJECTIVE FUNCTION– FORECAST ERROR

• SAFETY INVENTORY• SAFETY CAPACITY

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Aggregate Planning (Define Decision Variables)Wt = Workforce size for month t, t = 1, ..., 6Ht = Number of employees hired at the beginning of month t, t = 1, ..., 6Lt = Number of employees laid off at the beginning of month t, t = 1, ..., 6Pt = Production in month t, t = 1, ..., 6It = Inventory at the end of month t, t = 1, ..., 6St = Number of units stocked out at the end of month t, t = 1, ..., 6Ct = Number of units subcontracted for month t, t = 1, ..., 6Ot = Number of overtime hours worked in month t, t = 1, ..., 6

Excel File

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Aggregate Planning 8.2

Item CostMaterials $10/unitInventory holding cost $2/unit/monthMarginal cost of a stockout $5/unit/monthHiring and training costs $300/workerLayoff cost $500/workerLabor hours required 4/unitRegular time cost $4/hourOver time cost $6/hourCost of subcontracting $30/unit

DEMAND Table 8.1 (5.1)

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Aggregate Planning (Define Objective Function) Monthly

6

1

6

1

6

1

6

1

6

1

6

1

6

1

6

1

30105

26500

300640

tt

tt

tt

tt

tt

tt

tt

tt

CPS

IOL

HWMin

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Aggregate Planning (Define Constraints Linking Variables)

• Workforce size for each month is based on hiring and layoffs

.80,6,...,10

,

0

1

1

WwheretforLHWW

orLHWWtttt

tttt

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Aggregate Planning (Constraints)

• Production for each month cannot exceed capacity

.6,...,1,0440

,440

tforPOW

OWPttt

ttt

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Aggregate Planning (Constraints)

• Inventory balance for each month

.500,0,000,1,6,...,1

,0,

60

0

11

11

IandSIwheretfor

SISDCPISISDCPI

ttttttt

ttttttt

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Aggregate Planning (Constraints)

• Over time for each month

.6,...,1,010

,10

tforOWWO

tt

tt

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SOLVING PROBLEM USING EXCEL

• STEP 1 BUILD DECISION VARIABLE TABLE (fig8.1)– ALL CELLS 0, EXCEPT PERIOD 0 FOR WORKFORCE AND INVENTORY– ENTER DEMAND (TABLE 8.4)

• STEP 2 CONSTRUCT CONSTRAINT TABLE (fig8.2)• STEP 3 CREATE a CELL HAVING THE OBJECTIVE FUNCTION

– (Formula 8.1) Optimizing TOTAL COSTS (Fig 8.3)• STEP 4 USE TOOLS SOLVER (Fig 8.4)• REPEAT IF OPTIMUM SOLUTION NOT OBTAINED

• HOMEWORK (see homework)

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AGGREGATE PLANNING IN PRACTICE

• MAKE PLANS FLEXIBLE BECAUSE FORECASTS ARE ALWAYS WRONG– PERFORM SENSITIVITY ANALYSIS ON THE INPUTS – I.E.

LOOK AT EFFECTS OF HIGH/LOW

• RERUN THE AGGREGATE PLAN AS NEW DATA EMERGES

• USE AGGREGATE PLANNING AS CAPACITY UTILIZATION INCREASES– WHEN UTILIZATION IS HIGH, THERE IS LIKELY TO BE

CAPACITY LIMITATIONS AND ALL THE ORDERS WILL NOT BE PRODUCED

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Process Flow Measures • FLOW RATE (Rt), CYCLE TIME (Tt), & INVENTORY (It)

RELATIONSHIPS– F = Flow Rate or Throughput is output of a line in pieces per time– T = Cycle time is the time taken to complete an operation– I = Inventory is the material on the line– LITTLE’s LAW: Av. I = Av. R x Av. T x Variability factor Examples:

• If Inventory is 100 pieces and Cycle time is 10 hours, the Throughput rate is 10 pcs per hour

• If Cycle time is halved; Throughput is doubled• If Inventory is halved; cycle time is halved

See Equation 8.6 How do we get Av Inv of 895 and Flow time of 0.34 months on page 227/216

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Homework

• Ex. Work out Inventory, Rate and cycle time for values in Tables 8.4,8.5

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Supply Chain Network Basics – Lesson 4

• Guest Lecture – go to Poly Blackboard

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MANAGING SUPPLY AND DEMANDPREDICTABLE VARIABILITY (LESSON 6)

• Predictable Variability – Change in Demand that can be forecast or guided– MANAGING DEMAND – Short time price discounts, trade promotions

• MANAGING SUPPLY – Capacity, Inventory, Subcontracting & Backlog, Purchased product– MANAGING CAPACITY

• TIME FLEXIBILITY FROM WORKFORCE (OVERTIME)• USE OF SEASONAL WORKFORCE• USE OF SUBCONTRACTING• USE OF DUAL FACILITIES – DEDICATED AND FLEXIBLE• DESIGN PRODUCT FLEXIBILITY INTO PRODUCTION• USE OF MULTI-PURPOSE MACHINES (CNC MACHINE CENTERS)

– MANAGING INVENTORY• USING COMMON COMPONENTS ACROSS MULTIPLE PRODUCTS• BUILD INVENTORY OF HIGH DEMAND OR PREDICTABLE DEMAND PRODUCTS

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MANAGING DEMAND (Predictable Variability)• Manage demand with pricing

– Factors influencing the timing of a promotion:• Impact on demand; product margins; cost of holding inventory; cost

of changing capacity

• Demand increase (from discounting) due to:– Market growth– Stealing market share– Forward buying

Discount of $1 increases period demand by 10%Reduce price by $1 in Jan, increases sales by 10% in first month - Tab

9.4, 9.5 – effect on cost, profit, inventory If discount is in April, highest demand month - Tab 9.6, 9.7• See the effects of various combination Tab 9-12• Summary Tab 9.12 & 9.13 Discuss

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PREDICTABLE VARIABILITY IN PRACTICE

• COORDINATE MARKETING, SALES AND OPERATIONS– SALES AND OPERATIONS PLANNING– ONE GOAL MAXIMIZING PROFIT, ONE GAME PLAN

• TAKE PREDICABLE VARIABILITY INTO ACCOUNT WHEN MAKING STRATEGIC DECISIONS

• PARTNER WITH PRINCIPAL CUSTOMERS, ELIMINATE PREDICTIONS!

• PREEMPT (PROMOS ETC.), DO NOT JUST REACT TO PREDICTABLE VARIABILITY

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MANUFACTURING - MANAGING LEAD TIME

• CRITICAL DRIVER OF ALL MANUFACTURE– LAYOUT AND WORKPLACE ORGANIZATION– CONSTRAINT MANAGEMENT– VARIABILITY AND QUEUES– LOT SIZES AND SET UP REDUCTION– WORK IN PROCESS– FLEXIBILITY

• MUST BE COMPANY FOCUS• MEASURED AND MONITORED

– X BUTT TO BUTT

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MANAGING INVENTORY

• The role of inventory in the supply chain – Cycle Inventory (making or purchasing inventory in large

lots) takes advantage of economies of scale to lower total cost – material cost, fixed ordering cost and holding cost.

• Why hold inventory?– Economies of scale

• Batch size and cycle time• Quantity discounts• Short term discounts / Trade promotions

– Stochastic variability of supply and demand• Evaluating service level given safety inventory• Evaluating safety inventory given desired service level

• Levers to improve performance

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Role of Inventory in the Supply Chain

• Overstocking: Amount available exceeds demand– Liquidation, Obsolescence, Holding

• Understocking: Demand exceeds amount available– Lost margin and future sales

Goal: Matching supply and demand

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ROLE OF CYCLE INVENTORY (10.1)• Q – lot or batch size of an order• D – Demand• When demand steady : Cycle Inven = lot size/2 = Q/2

Saw tooth diagram• Average flow time = cycle inven / demand = Q/2D

• C – material cost• S – fixed ordering cost• H – holding cost• h – cost of holding $1 in inventory for one year• H = hC cost of holding one piece for one year

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Cycle Inventory related costs in Practice

• Inventory holding costs – usually expressed as a % per $ per year– Cost of capital (Opportunity cost of capital)– Obsolescence or spoilage cost– Handling cost– Occupancy cost (space cost)– Miscellaneous costs (security, insurance)

• Order costs (same as set up costs in a machining environment)– Buyer time– Transportation costs– Receiving costs– Other costs

• Cycle Inventory exists in a supply chain because different stages exploit economies of scale to lower total cost – material cost, fixed ordering cost and holding cost

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Fixed costs: Optimal Lot Size and Reorder Interval (EOQ)

C: Cost per unit ($C/unit)h: Holding cost per year as a fraction of

product cost ($%/unit/Year)H: Holding cost per unit per yearQ: Lot SizeD: Annual demand S: Setup or Order CostAnnual order cost = (D/Q)SAnnual inventory cost = (Q/2)hCOptimum Q = 2DS/hCT: Reorder interval (Q/D)# orders/yr = D/Q = Optimal order freqTotal Annual Cost = CD+(D/Q)S+(Q/2)hC

See Fig 10-2 Showing effects of Lot Size

DHST

HDSQ

hCH

2

2

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Example 10.1

Demand, D = 12,000 computers per yearUnit cost, C = $500Holding cost, h = 0.2Fixed cost, S = $4,000/orderWhat is the order quantity Q, the flow time, the reorder

interval and Total cost?Q = 980 computers Cycle inventory = Q/2 = 490Flow time = Q/2D = 0.049 monthReorder interval, T = 0.98 monthTotal Cost = 49,000 + 49,000 + 6,000,000 = $6,098,000

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EXPLOITING ECONOMIES OF SCALE• SINGLE LOT SIZE OF SINGLE PRODUCT (EOQ) = Q

– ANNUAL MATERIAL COST = CD– NO. OF ORDERS PER YEAR = D/Q– ANNUAL ORDER COST = (D/Q)*S– ANNUAL HOLDING COST = (Q/2)H = (Q/2)hC– TOTAL ANNUAL COST (TC) = CR+(D/Q)*S+(Q/2)hC– Optimal lot size Q* = 2DS/hC– Optimal ordering frequency = n* = D/Q* = DhC/2S – Key Point: Total Ordering and Holding costs are relatively stable

around the EOQ and a convenient lot size around the EOQ is OK (rather than a precise EOQ)

– Key Point: If demand increases by a factor of k, the optimal lot size and no of orders increases by a factor of k. Flow time decreases by a factor of k

– Key point: To reduce Q by a factor of k, fixed cost S must be reduced by a factor of k2

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Reducing Lot Size - Aggregating

• Exercise: • To reduce Q from 980 to 200, how much must order cost be reduced• Key point: To reduce Q by a factor of k, fixed cost S must be reduced

by a factor of k2

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LOT SIZING WITH MULTIPLE PRODUCTS & CUSTOMERS

• Lot sizing with Multiple Product or Customers– Aggregating replenishment across products, retailers or suppliers in a single order,

allows for a reduction in lot sizes because fixed costs spread across multiple products and businesses

– Ordering and delivering independently (See Ex.10.3)• Each order has independent Holding, Ordering and Annual costs with independent

EOQ’s and Flow Times – Table 10-1• Total cost = $155,140

– Total cost Ordered and delivered jointly (See Ex.10.4)• Independent holding costs but combined fixed order cost Table 10-2• Total Cost = $136,528

– Transportation capacity constraint – aggregating multiple products from same supplier; single delivery from multiple suppliers (Ex. 10-5)

• Key Point –The key to reducing cycle inventory is reducing lot size. The key to reducing lot size without increasing costs is to reduce fixed costs associated with each lot – by reducing the fixed cost itself or aggregating lots across multiple products, customers or suppliers. We reduce lot size to reduce cycle time

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Impact of product specific order cost

Total Costs Product specific order cost = $1000

No Aggregation

$155,140 (10-3)

Complete Aggregation

$136,528 (10-4)

Tailored Aggregation

$130,767 (10-6)

Tailored aggregation – Higher volume products ordered more frequently and lower volume products ordered less frequently (rather than ordered and delivered jointly) 10-6

Summary

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Delivery Options

• No Aggregation: Each product ordered separately

• Complete Aggregation: All products delivered on each

truck

• Tailored Aggregation: Selected subsets of products on

each truck

Page 136: Supply Chain Engineering

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Economies of Scale to exploit Quantity Discounts

• Two common Lot Size based discount schemes– All unit quantity discounts

• Pricing based on specific quantity break points

– Marginal unit quantity discounts or multiblock tariffs• Pricing based on quantity break points, but the price is not the

average per block, but the marginal cost of a unit that decreases at breakpoint

– See example in book on these discounts pages 276-280

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WHY QUANTITY DISCOUNTS– Improved coordination to increase total supply chain profits

• Commodity Products = price set by market. • Large Manufacturers should use lot based quantity discounts, to

maximize profits (cycle inventory will increase)• The supply chain profit is lower if each stage makes pricing decisions

independently, maximizing its own profit• Coordination to maximize profit

– Two part tariff or quantity discounts – supplier passes on some of the profit to the retailer, depending on volume

– Extraction of surplus through price discrimination– Trade Promotions

– Lead to significant forward buying by the retailer– Retailer should pass on optimal discount to customer and keep rest for

themselves

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Quantity Discounts• Discounts improve coordination between Supplier and Retailer to

maximize Supply Chain profits.• Quantity Discounts are a form of manufacturer returning some reduced

costs (less orders) to the retailer (costs increase as more holding costs) • Supply chain profit is lower, if each stage of supply chain independently

makes its pricing decisions with the objective of maximizing its own profit. A coordinated solution results in higher profit

• For products that have market power, two-part tariffs or volume based quantity discounts can be used to achieve coordination in the supply chain and maximize profits

• Promotions lead to significant increase in lot size and cycle inventory, because of forward buying by the retailer. This generally reduces the supply chain profits 280-281

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Strategies for reducing fixed costs

• Wal-Mart: 3 day replenishment cycle • Seven Eleven Japan: Multiple daily replenishment• P&G: Mixed truck loads• Efforts required in:

– Transportation (Cross docking)– Information– Receiving

Aggregate across products, supply points, or delivery points in a single order, allows reduction of lot size for individual products Ex 10.6

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ESTIMATING CYCLE INVENTORY COSTS

• HOLDING COSTS– Cost of capital– Obsolescence or spoilage costs– Handling costs– Occupancy cost– Miscellaneous

• Order Cost– Buyer time– Transportation costs– Receiving costs– Other costs

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Lessons From Aggregation

• Key to reducing cycle inventory is reducing lot size. Key to reducing lot size without increasing costs is to reduce the fixed cost itself by aggregation (across multiple products, customers or suppliers)

• Aggregation allows firm to lower lot size without increasing cost

• Complete aggregation is effective if product specific fixed cost is a small fraction of joint fixed cost

• Tailored aggregation is effective if product specific fixed cost is large fraction of joint fixed cost

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Lessons From Discounting Schemes

• Lot size based discounts increase lot size and cycle inventory in the supply chain

• The supply chain profit is lower if each stage independently makes pricing decisions with the objective of maximizing its own profit. Coordinated solution results in higher profit

• Lot size based discounts are justified to achieve coordination for commodity products – competitive market and price fixed by market

• Volume based discounts with some fixed cost passed on to retailer are more effective in general– Volume based discounts are better over rolling horizon

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Levers to Reduce Lot Sizes Without Hurting Costs

• Cycle Inventory Reduction– Reduce transfer and production lot sizes

• Aggregate fixed cost across multiple products, supply points, or delivery points

– Are quantity discounts consistent with manufacturing and logistics operations?

• Volume discounts on rolling horizon• Two-part tariff – volume based discount in stages

– Are trade promotions essential?• EDLP (Every day low pricing)• Base on sell-thru (customers) rather than sell-in (retailers)

• HOMEWORK• EXERCISES 1 AND 2 Pp291/297

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Discussions on Site Visit• Macy’s Distribution Center (DC)• In teams please answer the following:

– What is the size of the operation– What strategy do they adopt and why– What are the key competitive practices– How do they deal with each of the Supply Chain Drivers

• Measurements used for efficiency?

• How can they improve their operations?

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Mid Term• Show your calculations• Do not get stuck on any question1. Strategy applications and implications 152. Demand Management 203. Aggregate Demand 204. Cycle Inventory 205. Supply Chain Networks 25

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Role of Inventory in the Supply Chain (LESSON 7)

Improve Matching of Supplyand Demand

Improved Forecasting

Reduce Material Flow Time

Reduce Waiting Time

Reduce Buffer Inventory

Economies of ScaleSupply / Demand

VariabilitySeasonal

Variability

Cycle Inventory Safety InventoryFigure Error! No text of

Seasonal Inventory

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WHY HOLD SAFETY INVENTORY? (SAFETY STOCK)• DEMAND UNCERTAINTY• SUPPLY UNCERTAINTY• TODAY’S ENVIRONMENT

– INTERNET MAKES SEARCH EASIER– PRODUCT VARIETY GROWN WITH CUSTOMIZATION– EASE AND VARIETY PUTS PRESSURE ON PRODUCT

AVAILABILITY– PUSH UP LEVELS OF INVENTORY / SAFETY STOCK

• KEY QUESTIONS– APPROPRIATE LEVEL OF SAFETY STOCK– WHAT ACTIONS IMPROVE AVAILABILITY AND REDUCE

SAFETY STOCK?Measures of product availability

– Product fill rate (fr)– Order fill rate– Cycle service level (CSL) - THIS COURSE WILL DEAL mainly WITH CSL

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APPROPRIATE LEVEL OF SAFETY STOCK DEPENDS ON: UNCERTAINTY OF DEMAND OR SUPPLY REPLENISHMENT LEAD TIME & DESIRED SERVICE LEVELCSL – Cycle service level -CSL is the fraction of replenishment cycles that end with all the customer demand being met. A replenishment cycle is the interval between two successive replenishment deliveries

Time

InventoryCycle Inventory Q/2

Safety Stock

Demand during Lead time

ROP

Lot Size = Q

SS = ROP - DL

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Replenishment policies

• Replenishment policies– When to reorder?– How much to reorder?

Continuous Review: Order fixed quantity when total inventory drops below Reorder Point (ROP)

Periodic Review: Order at fixed time intervals to raise total inventory to Order up to Level (OUL)

Factors driving safety inventory– Demand and/or Supply uncertainty– Desired level of product availability– Replenishment lead time

• Demand Uncertainty– Av.Demand; Stnd Devn; Lead Time

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Continuous Review Policy: Safety Inventory and Cycle Demand Uncertainty & Service Level

L: Lead time for replenishmentD: Average demand per unit timeD:Standard deviation of demand

per periodDL : Mean demand during lead time L: Standard deviation of demand

during lead timeCSL: Cycle service level –

Probability of not stocking out in replenishment cycle

SS: Safety inventoryROP: Reorder pointCv: Coefficient of variance

Average Inventory = Q/2 + SS

SS = ROP - RL

Page 151: Supply Chain Engineering

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FORMULAS USED FOR CALCULATING SERVICE LEVELS

)1,1,0,/(]1,1,0,/(1[(/)(/1

)1,,,(),(/

),,(

,

LLL

LLLL

LL

L

DL

L

ssNORMDISTssNORMDISTssorESCQESCQQESCfr

ROPNORMDISTDROPFCSLcv

ROPFCSL

ssROP

L

LD

D

DD

D

Page 152: Supply Chain Engineering

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Example 11.1&2, 11.4 (Continuous Review Policy) = 8.xx New book

11.1: R = 2,500 /week; R = 500L = 2 weeks; Q = 10,000; ROP = 6,000 CSL = 90%SS = ROP - DL = Average Inventory = Average Flow Time =11.2: Evaluating CSL given a replenishment policyCSL = Prob (demand during lead time <= ROP)Distribution of demand during lead time of 2 weeks

Cycle service level, CSL = F(RL + ss, RL , L ) = F(ROP, RL , L ) Excel: NORMDIST (ROP, RL , L ,1)

X1= Xbar + Z L or ROP = RL + Z L Calculate the % z represents. Calculate Safety Stock for above

DL

L

L

DLD

Z Chart

Page 153: Supply Chain Engineering

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Examples of Safety Stock Calculations• Weekly demand for Lego at Wal Mart is normally distributed with a mean of

2500 boxes and a standard deviation of 500. The replenishment lead time is 2 weeks. Assuming a continuous replenishment policy, evaluate the safety inventory that the store should carry to achieve a cycle service of 90 percent

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Factors Affecting Fill Rate• Fill Rate: Proportion of customer demand that is satisfied from

Inventory. Directly related to CSL• Safety inventory: Safety inventory is increased by:

– Increasing fill rate (Table 11-1)– Increasing CSL– Increasing supplier lead time by factor k – SS increases by factor of SQRT k – Increasing standard deviation of demand by factor k – SS increases by factor

of k• Lot size: Fill rate increases on increasing the lot size even though cycle service

level does not change.

Actions: 1. Reduce supplier Lead Time L 2. Reduce underlying uncertainty of demand R

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Evaluating Safety Inventory Given Fill Rate

Fill Rate Safety Inventory

97.5% 67

98.0% 183

98.5% 321

99.0% 499

99.5% 767

Required safety stock grows rapidly with increase in the desired Product availability

The required SS grows rapidily with increase in desired Fill RateThe required SS increases with increase in Lead time and the σ of demand

Page 156: Supply Chain Engineering

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Impact of Supply Uncertainty

Considering variation in Demand and in Replenishment Lead time (Ex 11.6)

• D: Average demand per period D: Standard deviation of demand per period• L: Average lead time for replenishment sL: Standard deviation of supply lead time

sDD

LL

L

DL

DL222

Standard Deviationof demand during lead time

Mean demand during lead time

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Supply Chain Engineering MN 799 157#

Impact of Supply Uncertainty ((See Ex. 11.6 & Table 11.2)

Ex.11.6: R = 2,500/day; R = 500; L = 7 days; Q = 10,000; CSL = 0.90 (z=1.29); sL = Standard Deviation of lead time=7days What is S.S? Large potential benefits of reducing Lead time or lead time variability in

reduction of Safety stockSS units SS (d) Stnd Dev(L )

Safety inventory when sL = 0 1,695 0.68 1,323Safety inventory when sL = 1 3,625 1.45 2,828Safety inventory when sL = 2 6,628 2.65 5,172Safety inventory when sL = 3 9,760 3.90 7,616Safety inventory when sL = 4 12,927 5.17 10,087Safety inventory when sL = 5 16,109 6.44 12,750Safety inventory when sL = 6 19,298 7.72 16,109Safety inventory when sL = 7 is 22,491 8.99 17,550

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Basic Quick Response Initiatives

• Reduce information uncertainty in demand• Reduce replenishment lead time• Reduce supply uncertainty or replenishment lead

time uncertainty• Increase reorder frequency or go to continuous

review

Page 159: Supply Chain Engineering

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Factors Affecting Value of Aggregation• DEMAND CORRELATION –

– AS CORRELATION INCREASES, THE SS BENEFIT OF AGGREGRATION DECREASES

– IF THERE IS LITTLE CORRELATION BETWEEN DEMAND, AGGREGRATION REDUCES STND. DEVN. OF DEMAND AND HENCE SAFETY STOCK (see ex. 11.7, Table 11.3)

• Coefficient Of Variation = Stnd Devn/Mean (uncertainty relative to size of demand) p=0 No Correlation

– THE HIGHER THE COEFFICIENT OF VARIATION OF AN ITEM, THE GREATER THE REDUCTION IN SAFETY STOCK AS A RESULT OF CENTRALIZATION (LOW COEFFICIENT OF VARIATION ALLOW ACCURATE FORECASTING AND DECENTRALIZED STOCKING)

• REDUCING SUPPLY VARIATION REDUCES SAFETY STOCK WITHOUT REDUCING CSL

• VALUE OF A PRODUCT– DIRECTLY DETERMINES THE SAFETY STOCK LEVEL

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IMPACT OF AGGREGRATION ON SAFETY STOCK• HOW TO REDUCE SS WITHOUT REDUCING CSL?

– AGGREGRATION REDUCES STANDARD DEVIATION OF DEMAND, ONLY IF DEMAND ACROSS AREAS IS NOT CORRELATED, THAT IS EACH AREA IS INDEPENDENT

• See Table 11.4 p323– AGGREGRATION REDUCES SS BY THE SQRT OF NUMBER OF AREAS

AGGREGRATED (REDUCING NUMBER OF STOCKING LOCATIONS)–SQUARE ROOT LAW (Ex. AMAZON) See Fig 11.4

– INFORMATION CENTRALIZATION – ORDERS FILLED FROM WAREHOUSE CLOSEST TO CUSTOMER

– SPECIALIZATION BY LOCATION • LOW DEMAND, SLOW MOVING ITEMS: CENTRALIZED – HIGH

COEFFICIENT OF VARIATION• HIGH DEMAND, FAST MOVING ITEMS: DECENTRALIZED – LOW

COEFFICIENT OF VARIATION

– Centralization Disadvantage: • Increase in Response time; • Increase in Transport costs

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IMPACT OF AGGREGRATION ON SAFETY STOCK

• HOW TO REDUCE SS WITHOUT REDUCING CSL?– PRODUCT SUBSTITUTION

• MANUFACTURER DRIVEN – AGGREGATE DEMAND & REDUCE SS; • IF PRODUCTS STRONGLY CORRELATED, LESS VALUE IN SUBSTITUTION • CUSTOMER DRIVEN – TWO WAY SUBSTITUTION – ALLOWS REDUCTION

IN SS WHILE MAINTAINING HIGH PRODUCT AVAILABILITY• GREATER THE VARIABILITY AND LESS THE CORRELATION OF

DEMAND, THE GREATER THE BENEFIT IN SUBSTITUTION– COMPONENT COMMONALITY (TABLE 11.5)

• WITHOUT COMMONALITY, UNCERTAINTY OF DEMAND FOR COMPONENTS SAME AS THAT FOR PRODUCT (SEE Ex. 11.9)

– POSTPONMENT• DELAY DIFFERENTIATION OR CUSTOMIZATION AS CLOSE TO SALE

TIME AS POSSIBLE– COMMON COMPONENTS IN PUSH PHASE– POWERFUL CONCEPT FOR E-COMMERCE

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Example 11.9: Value of Component CommonalityY Axis – SS Quantity; X Axis – No. of common components

050000

100000150000200000250000300000350000400000450000

1 2 3 4 5 6 7 8 9

SS

Without component commonality and postponment, product differentiation Occurs early in the Supply Chain and inventories are disaggregate

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ESTIMATING AND MANAGING SS IN PRACTICE• ACCOUNT FOR LUMPY SUPPLY CHAIN DEMAND

– CAUSED BY LARGE LOT SIZES & ADDS TO VARIABILITY– EMPIRICALLY – RAISING SS BY HALF LOT SIZE

• ADJUST INVENTORY POLICY IF DEMAND SEASONAL– CHANGE BOTH MEAN AND STND DEVN

• USE SIMULATION TO TEST INVENTORY POLICIES– EXCEL

• START WITH A PILOT• MONITOR SERVICE LEVELS• FOCUS ON REDUCING SAFETY STOCK• PERIODIC REVIEW REPLENISHMENT REQUIRES MORE SAFETY STOCK

THAN CONTINUOUS REVIEW POLICIES

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Mass Customization I: Customize Services Around Standardized Products

DEVELOPMENT PRODUCTION MARKETING DELIVERY

Deliver customized services aswell as standardized productsand services

Market customized services with standardizedproducts or services

Continue producing standardized products or services

Continue developing standardized products or services

Source: B. Joseph Pine

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Mass Customization II: Create Customizable Products and Services

DEVELOPMENT PRODUCTION MARKETING DELIVERY

Deliver standard (but customizable) productsor services

Market customizable products or services

Produce standard (but customizable) products or services

Develop customizable products or services

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Mass Customization III: Provide Quick Response Throughout Value Chain

DEVELOPMENT PRODUCTION MARKETING DELIVERY

Reduce Delivery Cycle Times

Reduce selection and order processing cycle times

Reduce Production cycle time

Reduce development cycle time

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Mass Customization IV: Provide Point of Delivery Customization

DEVELOPMENT PRODUCTION MARKETING DELIVERY

Deliver standardize portion

Market customized products or services

Produce standardized portion centrally

Develop products where point of delivery customization is feasible

Point of deliverycustomization

ens Warehouse and Restaurants

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Mass Customization V: Modularize Components to Customize End Products

DEVELOPMENT PRODUCTION MARKETING DELIVERY

Deliver customized product

Market customized products or services

Produce modularized components

Develop modularized products

utos

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Types of Modularity for Mass Customization

Component Sharing Modularity

Cut-to-Fit Modularity

Bus Modularity

Mix Modularity

Sectional Modularity

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Example of Point of Service Replenishment• Safety Stock and Re-order point management in Toyota

Another advantage of Toyota’s new system is that safety stock criteria can be adjusted according to seasonal requirements. Previously, the company had no ability to recognize the seasonality of items such as wiper blades. It worked from one forecast model — a simple moving average — that didn’t allow for fine-tuning or sudden shifts in consumer taste. Reorder points were recalculated just once a month.

To support the new system, Toyota implemented Exam Inventory, a solution made by Entity Software in Epson, U.K. Exam is an inventory management program that runs on a PC and is fed raw data directly from a computer. As a result, Toyota (GB) was able to fully customize the package to its needs with minimal impact on the company’s larger computers. The software allows for more sophisticated forecasting and more accurate calculation of reorder points (ROPs), while keeping safety stocks low.

Toyota now has moved to weekly ROP calculations and hopes eventually to carry out that function on a daily basis when the technology permits, Results of the program so far include an improvement in Toyota’s service level from 94 percent to 96 percent, reduction in the number of manual order changes from 3,000 a day to 50, and reduction in run times from 12 to 3.5 hours.

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Cautions in Implementing Postponement and Modularity

• End products must look suitably different to the consumer• Design and production costs can only be justified over a

family of products• Performance and cost of a product can be optimized by

eliminating modularity. Do a small set of products provide most of the sales?

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Summary of Learning Objectives

Reduce Buffer Inventory

Economies of ScaleSupply / Demand

VariabilitySeasonal

Variability

Cycle Inventory Safety Inventory Seasonal Inventory

Match Supply & Demand

•Reduce fixed cost•Aggregate across products•Volume discounts•EDLP•Promotion on Sell thru

•Quick Response measures•Reduce Info Uncertainty•Reduce lead time•Reduce supply uncertaint

•Accurate Response measures•Aggregation•Component commonalit and postponement

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HOMEWORK

• Page 336 Q4 and Q5

• Provide actual examples of the five types of customization

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OPTIMUM LEVEL OF PRODUCT AVAILABILITY Exercise: Swimsuit Production Lesson 8

• Fashion items have short life cycles, high variety of competitors• SnowTime Sporting Goods

– New designs are completed– One production opportunity– Based on past sales, knowledge of the industry, and economic conditions,

the marketing department has a probabilistic forecast– The forecast averages about 13,000, but there is a chance that demand will

be greater or less than this• Production cost per unit (C): $80• Selling price per unit (S): $125• Salvage value per unit (V): $20• Fixed production cost (F): $100,000• Q is production quantity, D demand• Profit = Revenue - Variable Cost - Fixed Cost + Salvage

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Demand Distribution

Demand Scenarios

0%5%

10%15%20%25%30%

Sales

Pro

babi

lity

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Exercise• Scenario One:

– Suppose you make 12,000 jackets and demand ends up being 13,000 jackets.

– Profit = 125(12,000) - 80(12,000) - 100,000 = $440,000• Scenario Two:

– Suppose you make 12,000 jackets and demand ends up being 11,000 jackets.

– Profit = 125(11,000) - 80(12,000) - 100,000 + 20(1000) = $ 335,000• Find order quantity that maximizes weighted average profit.• Average demand is 13,100 (work out – Σp.D)• Question: Will this quantity be less than, equal to, or greater than

average demand?• Look at marginal cost Vs. marginal profit

– if extra jacket sold, profit is 125-80 = 45– if not sold, cost is 80-20 = 60

• So we will make less than average

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Profitability Calculations

Expected Profit

$0

$100,000

$200,000

$300,000

$400,000

8000 12000 16000 20000

Order Quantity

Prof

it

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Profitability scenarios

0%

20%

40%

60%

80%

100%

Cost

Prob

abili

ty

Q=9000

Q=16000

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OPTIMAL LEVEL OF PRODUCT AVAILABILITY

• FACTORS AFFECTING OPTIMAL PRODUCT AVAILABILITY– COST OF OVERSTOCKING Co

• PROFIT FROM SALES• INVENTORY HOLDING COSTS • OBSELESCENCE – SALVAGE COSTS

– COST OF UNDERSTOCKING Cu• LOST SALES• LOST CUSTOMERS

• EXAMPLE OF L.L.BEAN (Table 12.1)– For all references New Book 12.xx

Page 180: Supply Chain Engineering

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Parkas at L.L. Bean

Cost per parka = $45Sale price per parka = $100Discount price per parka = $50Holding and transportation cost = $10

• Profit from selling parka = $100-$45 = $55• Cost of overstocking = $45+$10-$50 = $5• Expected demand = =1026, ordered 1000 parkas CSL51%• Expected profit from ordering 1000 parkas = $49,900• See formula on page 224

– Expected profit =

)(1000)10

41()])(1000()([ cpiiii

iPpscDcpD

ii pD

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Summary• Tradeoff between ordering enough to meet demand and ordering too much• Several quantities have the same average profit• Average profit does not tell the whole story• Question: 9000 and 16000 units lead to about the same average

profit, so which do we prefer? Work out probabilities of profit and loss• The optimal order quantity is not necessarily equal to average forecast demand

(13,100)• The optimal quantity depends on the relationship between marginal profit and

marginal cost• As order quantity increases, average profit first increases and then decreases• As production quantity increases, risk increases. In other words, the

probability of large gains and of large losses increases

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How much to order? Parkas at L.L. Bean (Table 12.1)Demand

(00’s) Probabability Cumulative Probability of

demand being this size or less Probability of demand greater than this size

4 .01 .01 .99 5 .02 .03 .97 6 .04 .07 .93 7 .08 .15 .85 8 .09 .24 .76 9 .11 .35 .65

10 .16 .51 .49 11 .20 .71 .29 12 .11 .82 .18 13 .10 .92 .08 14 .04 .96 .04 15 .02 .98 .02 16 .01 .99 .01 17 .01 1.00 .00

The probability that demand is greater than 1100 is 0.29 but the probability that demand is greater than or equal to 1100 is 0.49. O.51 is the probability that the demand is 1000 or less. Thus, 1-0.51 = 0.49 is the probability that the demand is greater than 1000 = probability that demand is greater than or equal to 1100

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Parkas at L.L. Bean (Table 12.2)Expected Marginal Contribution of each 100 parkas Fig 9.1

Additional 100s

Expected Marginal Benefit

Expected Marginal Cost

Expected Marginal Contribution

11th 5500.49 = 2695 500.51 = 255 2695-255 = 2440

12th 5500.29 = 1595 500.71 = 355 1595-355 = 1240

13th 5500.18 = 990 500.82 = 410 990-410 = 580

14th 5500.08 = 440 500.92 = 460 440-460 = -20

15th 5500.04 = 220 500.96 = 480 220-480 = -260

16th 5500.02 = 110 500.98 = 490 110-490 = -380

17th 5500.01 = 55 500.99 = 495 55-495 = -440

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Optimal Order Quantity

0

0.2

0.4

0.6

0.8

1

1.2

4 5 6 7 8 9 10 11 12 13 14 15 16 87

Probability

Optimal Order Quantity = 13

0.917

Prob

Page 185: Supply Chain Engineering

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Optimal level of service (Eqn. 12.1)p = retail sale price; s = outlet or salvage price; c = purchase price; Co = cost of overstocking by one unit, Co = c - sCu = cost of understocking by one unit, Cu = p - cCSL* = Optimal SL. Optimal order size O* If O* +1, expected marginal benefit from increasing order size by 1 = (1-

CSL*)(p - c) (understocking cost x prob of understock)If O* -1, Expected Marginal Cost = CSL*(c - s).

Thus expected marginal contribution of O* to O* +1 (1-CSL*)Cu - CSL* Co (or optimally) = 0

CSL*= prob. (dem. =< O* ) = Cu / (Cu + Co) = (p-c) (p-s)

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Order Quantity for a Single Order (ex 12.1)

Salvage value = $80

Co = Cost of overstocking

= c-s = $20

Cu = Cost of understocking

= p – c = $150

O* = Optimal order size

46810018.1350*

88.020150

150

)(Pr *CSL *

xzO

Demandob

CCC

R

ou

u

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MANAGERIAL LEVERS TO IMPROVE PROFITABILITY

• How to Estimate Demand Distribution?– Historical data: Time series forecasting

– Dependent factors: Regression, causal forecasting

– Expert opinion: Buying committee

Key: Forecast must include estimated demand and uncertainty (standard deviation) of demand

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Levers for Increasing Supply Chain Profitability• Increase salvage value (cost of overstock) or decrease margin lost from stockout –

backup sourcing; rain checks. • As Co/Cu gets smaller, optimal level of product availability (CSL) increases (see Fig

12.2). Companies with high margin have high cost of understocking and so provide high CSL

• Improved forecasting to lower demand uncertainty (table 12.3) – CSL is constant. Optimum order size decreases and Expected profit increases

• Quick response Reduce replenishment lead time so as to increase number of orders per season (table 12.4, 12.5). With two or more orders:– Possible to provide same CSL with less inventory– Average overstock at end of season is less– Profits higher with second order

• If quick response allows multiple orders in the season, profits increase and overstock quantity reduces (Fig 12.4,12.5)

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Levers for Increasing Supply Chain Profitability

• Postponement of product differentiation– Better match of supply and demand for products not positively

correlated and about the same size– Postponment may reduce overall profits, if one product contributes

to majority of demand (extra cost of later manufacturing)– Tailored postponement only uncertain part of demand, producing

predictable part at lower cost without postponement

• Tailored supply sourcing – focus on two sources– One source focus on cost; unable to handle uncertainty –

predictable portion– One source focus on flexibility; at a higher cost – unpredictable

portion

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Tailored Sourcing: Multiple Sourcing Sites

Characteristic Primary Site Secondary Site

ManufacturingCost

High Low

Flexibility(Volume/Mix)

High Low

Responsiveness High Low

EngineeringSupport

High Low

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Dual Sourcing Strategies

Strategy Primary Site Secondary Site

Volume baseddual sourcing

Fluctuation Stable demand

Product baseddual sourcing

Unpredictableproducts,Small batch

Predictable,large batchproducts

Model baseddual sourcing

Newerproducts

Older stableproducts

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SUPPLY CHAIN CONTRACTS• DOUBLE MARGINALIZATION (SUBOPTIMIZATION)

– BUY BACK (Ex. Mfg cost 10, retailer cost 100, selling 200 – SC profit 190, retailer profit – 100, manuf profit 90). EACH TRY TO MAXIMIZE OWN PROFIT, NOT THE SUPPLY CHAINS)

– RETAILER ORDERS LESS AS THE LOSS FROM UNSOLD PRODUCT HIGH (100). Loss to Supply Chain is 10 only

– MANUFACTURER IN BUYING BACK UNSOLD PRODUCT, INCREASES SALVAGE VALUE, AND INDUCES RETAILER TO ORDER MORE (table 9.70

– TOTAL SUPPLY CHAIN PROFITS INCREASE• QUANTITY FLEXIBILITY CONTRACTS

– MANUFACTURER ALLOWS RETAILER TO CHANGE CONTRACTS AFTER CHANGING DEMAND

– INCREASES PROFITABILITY OF ALL AND TOTAL SUPPLY CHAIN• VMI REPLENISHMENT BY MANUFACTURER (Ex. P&G/WALMART)

• CONTROL OF REPLENISHMENT MOVES TO MANUFACTURER• CUSTOMER INFORMATION TO MANUFACTURER

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SETTING OPTIMAL LEVELS OF PRODUCT AVAILABILITY

• USE ANALYTICAL FRAMEWORK TO INCREASE PROFITS– COMPANIES SET TARGETS WITHOUT ANALYSIS

• BEWARE OF PRESET LEVELS OF AVAILABILITY– OFTEN SET WITHOUT JUSTIFICATION– WORK ANALYSIS TO MAXIMIZE PROFITS

• USE APPROXIMATE COSTS AS PROFIT MAXIMIZING SOLUTIONS ARE ROBUST

• ESTIMATE A RANGE FOR STOCKING OUT• ENSURE THAT LEVELS OF PRODUCT AVAILABILITY FIT WITH

STRATEGY

• HOME WORK Page 373 Ex. 1 and 3

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CASE STUDY – OPTIMIZED DEMAND PULL

• HIGHLY VARIABLE, HI TECH, HIGH COST– 12 MONTH ROLLING FORECAST WITH MANUFACTURING

LEAD TIME COMMITTED– CHANGE OUTSIDE LEAD TIME LIMITED TO +/- 20%– TWO YEAR FORECAST ON YEAR FORECAST

COMMITTED TO, NOT MONTHLY QUANTITIES– INCENTIVES FOR INCREASED FORECAST, DISCOUNTS

FOR REDUCED FORECASTS– REPLENISHMENT RATE DRIVEN BY MAX/MIN ON HAND

LEVELS– WEEKLY ON HAND– MONTHLY 12 MONTH ROLLING FORECAST

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SOURCING and PROCUREMENT (CH 14) Lesson 9

• SOURCING– Entire set of business processes to purchase goods and services– Includes:

• Selection of supplies• Design of supplier contracts• Product design collaboration• Procurement of material• Evaluation of Supplier performance

• PROCUREMENT– Process of purchasing materials, products and services– COGS 50% or more of product cost– Even higher % with outsourcing

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EFFECTIVE SOURCING• ECONOMIES OF SCALE – ORDERS AGGREGRATED• MORE EFFICIENT PROCUREMENT TRANSACTIONS

(LESS) REDUCES OVERALL COST• DESIGN COLLABORATION• IMPROVE FORECASTING• CONTRACTS FOR SHARING RISK• LOWER PURCHASING PRICE

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IN HOUSE OR OUTSOURCE

• HOW DO THIRD PARTIES INCREASE SUPPLY CHAIN SURPLUS– CAPACITY AGGREGRATION– INVENTORY AGGREGRATION– TRANSPORTATION AGGREGRATION– WAREHOUSING AGGREGRATION– PROCUREMENT AGGREGRATION– INFORMATION AGGREGRATION– RECEIVABLE AGGREGRATION– RELATIONSHIP AGGREGRATION– LOWER COSTS AND HIGHER QUALITY (Table 14.1)

Page 198: Supply Chain Engineering

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RISKS OF USING A THIRD PARTY• THE PROCESS IS BROKEN – lack control• UNDERESTIMATE COST OF COORDINATION• REDUCED SUPPLIER/CUSTOMER CONTACT• LOSS OF INTERNAL CAPABILITY AND GROWTH IN THIRD

PARTY POWER• LEAKAGE OF SENSITIVE DATA AND INFORMATION• INEFFECTIVE CONTRACTS

• THIRD AND FOURTH PARTY PROVIDERS (Table 14-2)– Transportation– Warehousing– Information technology– Reverse Logistics– International– Special skills/handling

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SUPPLIER SCORING AND ASSESSMENTMUST BE BASED ON IMPACT ON TOTAL COST (Tab14-3)

• IN ADDITION TO PRICE • REPLENISHMENT LEAD TIME; • ON TIME PERFORMANCE• SUPPLY FLEXIBILITY • DELIVERY FREQUENCY/ MINIMUM LOT SIZE• SUPPLY QUALITY• INBOUND TRANSPORTATION COSTS• INFORMATION COORDINATION CAPABILITY• DESIGN COST REDUCTION• EXCHANGE RATES, TAXES AND DUTIES• SUPPLIER VISIBILITY• RESPONSIVENESS

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SOURCING DECISIONS• SUPPLIER PERFORMANCE BASED ON IMPACT ON TOTAL

COST (see Table 14.1)– Ex. Green Thumb gets bearings at $1.00 in lots of 2,000 with a lead time

of 2 weeks and a stnd devn of 1 week. New supplier offers $0.97 with lot size of 8000, a lead time of 6 weeks and stnd devn of 4 weeks. Given 1000 bearings needed per week with a stnd devn of 300 and that holding costs are 25% and CSL is 95% which supplier should be selected

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SOURCING DECISIONS• CONTRACTS

– BUYBACK OR RETURN CONTRACTS• LOWERS COST OF OVERSTOCKING

– REVENUE SHARING CONTRACTS• REDUCES COST PER UNIT TO RETAILER & COST OF OVERSTOCKING

– QUANTITY FLEXIBILITY CONTRACTS – BEST• RETAILER CAN MODIFY ORDER CLOSER TO POINT OF SALE

– CONTRACTS TO INDUCE PERFORMANCE IMPROVEMENT• SHARED SAVINGS CONTRACT

• DESIGN COLLABORATION– HELPS REDUCE COST, IMPROVE QUALITY AND TIME TO MARKET

• PROCUREMENT PROCESS – FOCUS ON IMPROVING DIRECT MATERIALS COORDINATION AND

VISIBILITY WITH SUPPLIER– LOOKING SEPARATELY AT DIRECT AND INDIRECT MATERIAL COSTS (14-7)– CLASSIFYING ITEMS PER COST AND CRITICALITY (FIG 14.2)– FOCUS ON IMPROVING INDIRECT MATERIALS BY DECREASING

TRANSACTION COST OF ORDER– BOTH SHOULD CONSOLIDATE ORDERS FOR ECONOMIES OF SCALE

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SOURCING DECISIONS

• SOURCING DECISIONS IN PRACTICE– USE MULTIFUNCTIONAL TEAMS– ENSURE APPROPRIATE COORDINATION ACROSS

REGIONS AND BUSINESS UNITS– ALWAYS EVALUATE TOTAL COST OF OWNERSHIP– BUILD LONG TERM RELATIONSHIP WITH KEY

SUPPLIERS

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Make or Buy Decision

– Cost– Time– Capacity Utilization– Control of Production/Quality– Design Secrecy– Supplier Reliability and Technical Expertise– Volume– Workforce Stability

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Make-or-Buy Decision•Original Data:•Produce 10,000 units

Cost FactorsRaw material $9,000Direct labor $12,000Variable factory overhead $5,000Fixed factory overhead $24,000

Total Cost to Make $50,000

Make cost per unit = $50,000/10,000 = $5.00/unitPurchase proposal = $4.50/unitShould the product be bought?

•Factors to Consider:1. You only avoid 80% of the variable factory overhead cost2. And only avoid 10% of the fixed factory overhead cost

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Cost Avoidance Analysis (Solution)

SolutionCost avoided by purchasingTotal cost to make $50,000

Less cost avoided:Raw material $9,000Direct labor $12,000Variable factory overhead ($5,[email protected]) $4,000Fixed factory overhead ($24,[email protected]) $2,400

Total Avoided Cost $27,400Analysis

Cost not avoided $22,600Plus cost to purchase $45,000Total cost to purchase $67,600

Compare to cost to make $50,000

Increase in cost to purchase $17,600

Actual cost per purchased item 67500/1000 = $6.75/unit !

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SUPPLIER PARTNERSHIPS

• QUALIFICATION AND SELECTION– RATIONALIZATION OF SUPPLIER BASE

• PARTNERSHIP– WIN-WIN AND TRUST– SHARING OF RISK AND COMMITMENT– PRICE REDUCTIONS AND INCREASES BASED ON FORECAST– RATE REPLENISHMENT

• MEAUREMENT AND FEEDBACK– QUALITY, DELIVERY, RESPONSIVENESS– QUARTERLY FEEDBACK – IMPLICATIONS

Page 207: Supply Chain Engineering

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HOMEWORK

• Exercises 1 & 2

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MANAGING TRANSPORTATION IN A SUPPLY CHAIN (Chap 13) – Lesson 10

• Key modes of transport and major issues• Transportation System Design• Tradeoffs in transportation design – costs vs.

responsiveness– Transportation and inventory: Choice of mode– Transportation and inventory: Consolidation

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LOGISTICAL PROCESSES• TRANSPORTATION

– PALLETIZATION AND CONTAINERIZATION– FREIGHT FORWARDERS AND CUSTOMS– TRADE-OFF IN TRANSPORTATION TYPES & TRANSITONS

• WAREHOUSING AND DISTRIBUTION– CENTRALIZED OR REGIONAL– REPLENISHMENT STRATEGIES

• DRP• POINT OF USE

– CROSS DOCKING

• DELIVERY • GLOBAL SUPPLY CHAINS

Page 210: Supply Chain Engineering

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Principle: Leverage World-Wide Logistics

This principle is about Variability.

C 1999. William T. Walker, CFPIM, CIRM with the APICS Educational & Research Foundation. All Rights Reserved.

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Fundamental Logistics Tradeoffs

Transit Time Variability

Landed Cost

Supply ChainInventory Units

C 1999. William T. Walker, CFPIM, CIRM with the APICS Educational & Research Foundation. All Rights Reserved.

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Tailored Logistics• Transportation costs in 1996 - $455 billion (6% GNP). In 2005 744b 10%

GDP• E-com and home delivery of small loads makes transport more significant

– Wal-Mart – low inventory, frequent replenish, cross dock– Amazon – centralized warehouses, package carriers and postal system– Dell – centralized assembly, package carriers (Airborne)

• Each Logistically Distinct Business (LDB) will have distinct requirements in terms of– Inventory– Transportation– Facility– Information

Key: How to gain efficiencies while tailoring logistics?

Page 213: Supply Chain Engineering

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FACTORS AFFECTING TRANSPORTATION DECISIONS

• CARRIER– VEHICLE RELATED COST – cost of vehicle– FIXED OPERATING COST – terminals, labor– TRIP RELATED COST – fuel, labor– QUANTITY RELATED COST - weight– OVERHEAD COST – planning, dispatching

• SHIPPER– TRANSPORTATION COST – cost per Ton mile– INVENTORY COST – holding – FACILITY COST - storage– PROCESSING COST – loading unloading– SERVICE LEVEL COST – not making delivery

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Transportation Modes (See Table 13.1 )

• Trucks– TL – LTL – Carload – Intermodal

• Rail• Air • Package Carriers• Water• Pipeline

DISCUSS USES AND ISSUES

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AIR

• Freight Revenue 777b 2002 (96.7% change from 1993)• Average revenue / ton-mile (1996) = 58.75 cents• Average haul = 1,260 miles• Average load = 10.5 tons• 1998 Freight expense $22.678b• Key Issues

– Location/Number of hubs– Location of fleet bases / crew bases– Schedule optimization– Fleet assignment– Crew scheduling– Yield management

• Best Use

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Truckload (TL)

• Freight Revenue 6,660b (42.2% change from 1993)• Average revenue per ton mile (1996) = 9.13 cents• Average haul = 274 miles• Average Capacity = 42,000 - 50,000 lb.• 1998 Freight expense $ 401.68billion• Low fixed and variable costs• Major Issues

– Utilization (Idle and empty travel)– Consistent service– Backhauls

• Best Use?

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Less Than Truckload (LTL)

• Average revenue per ton-mile (1996) = 25.08 cents• Average haul = 646 miles• 1998 Freight expense with TL• Higher fixed costs (terminals) and low variable costs• Major Issues

– Location of consolidation facilities– Utilization– Vehicle routing– Customer service (delivery time and reliability)

• Best Use?

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Rail

• Freight Revenue 388b (39.2% change from 1993)• Average revenue / ton-mile (1996) = 2.5 cents• Average haul = 720 miles• Average load = 80 tons• 1998 Freight expense $35.35billion• Key Issues

– Scheduling to minimize delays / improve service– Off track delays (at pick up and delivery end) – Yard operations, transitions– Variability of delivery times

• Best Use?

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Other Modes• Water – 0.73c per ton mil

– Freight Revenue 867b (39.9% change from 1993)– average haul miles 500 internal to 1500 coast– 1998 Freight expense $ 25.35b– Cheapest mode for global shipping– Issues: delays at ports, customs, management of containers

• Pipe – 1.40c per ton mile– Freight Revenue 285b (-8.7% change from 1993)– Average haul 400 products to 760 crude– 1998 Freight expense $ 8.74b– Issues: Infrastructure

• Intermodal– Freight Revenue 1,111b (67% change from 1993)– Combination – most common truck/rail– Very useful in global trade– Issues: exchange of information to facilitate transfer

Page 220: Supply Chain Engineering

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Tradeoffs in Transportation Design

• Transportation, facility, and inventory cost tradeoff– Choice of transportation mode– Inventory aggregation

• Transportation cost and responsiveness tradeoff• Ranking of Transportation Modes in terms of Supply

Chain performance – Table 13-3

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DESIGN OPTIONS FOR TRANSP NETWORK• DIRECT SHIP NETWORK (fig 13.2)

– IF REPLENISHMENT LARGE ENOUGH FOR TL• DIRECT SHIP WITH MILKRUNS (fig 13.3)

– SINGLE SUPPLIER TO MULTIPLE RETAILER OR VICE VERSA– ELIMINATE INTERMEDIATE WAREHOUSES– LOWER TRANSPORTATION COSTS

• ALL SHIPMENTS VIA CDC (FIG 13.4, 13.5)– DC STORE INVENTORY OR TRANFER LOCATION– CROSS DOCKING– SHIP VIA DC WITH MILK RUN

• TAILORED NETWORK (FIG 13.5)

EXERCISE: ADVANTAGES AND DISADVANTAGES OF EACH – next slide

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PROS AND CONS OF TRANP. NETWORKS (Tab 13.2)

Network Structure Pros Cons

Direct Shipping *No intermediate Whse* Simple to coordinate

*High inventories*Significant Receiving expense

Direct Shipping with milk runs *Lower transp costs small lots*Lower inventories

* More coordination complexity

All shipments via CDC with inventory storage

*Consolidation less inbound transp cost

*Increased Inventory*Increased handling

Ship via CDC with cross docking

*Very low inventory*Consolidation-less trans Cost

* More coordination complexity

Shipping via DC using milk runs

* Lower outbound trans cost for small lots

*Further increase in coordin complexity

Tailored network *Match trans choice with needs *Highest coordin complexity

Page 223: Supply Chain Engineering

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TRADE OFFS IN TRANSPORTATION DESIGNTRANSPORTATION AND INVENTORY COST TRADE-OFF

• Choice of Transport Mode: Eastern Electric Corp (Ex 13.1)

• Annual demand = 120,000 motors Traditional lot size 3000

• Cost per motor = $120 Weight 10lbs

• Current order size = See Table 13.4

• Safety stock carried = 50% of demand during delivery lead time

• Holding cost =25%. Annual holding cost =120 x 0.25 =$30/motor

• Lead times – 1 day to process, transit time days - rail 5, road 3

• Work out the total cost for each transport proposal See Table 13.5

• Proposal Quantity over 250cwt $4/cwt to $3/cwt and shipment batch size 4000. What

should plant do

Total Costs = Inventory costs (include Cycle, Safety) + Transportation costs (depend on

weight and form of transport)

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Eastern Electric Corporation (Table 13.5)

Alternative (Lot size)

Transport Cost

Cycle Inventory

Safety Inventory

Transit Inventory

Inventory Cost

Total Cost

AM Rail (2,000)

$78,000 1,000 986 1,644 $108,900 $186,900

Northeast Trucking (1,000)

$90,000 500 658 986 $64,320 $154,320

Golden (500)

$96,000 250 658 986 $56,820 $152,820

Golden (2,500)

$86,400 1,250 658 986 $86,820 $173,220

Golden (3,000)

$78,000 1,500 658 986 $94,320 $172,320

Golden (4,000)

$67,500 2,000 658 986 $109,320 $176,820

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Inventory Aggregation at HighMed Ex 13.2 (Table 13.6)

Highval (cost $200/unit, 0.1 lbs/unit) demand in each territoryH = 2, H = 5, CSL= 0.997, Holding cost = 25%

Lowval (cost $30/unit, 0.04 lbs/unit) demand in each territoryL = 20, L = 5

UPS rate: $0.66 + 0.26x {for replenishments}FedEx rate: $5.53 + 0.53x {for customer shipping} where x is quantity shipped in lbsFactory 1 week replenish, local inventory 4 wks replenishAverage customer order – 1 Highval & 10 LowvalOption A – Replenish weekly instead of every 4 weeksOption B – Elimin inventory in territories, aggregate all inven in one

warehouse, replenish warehouse once a week

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Inventory Aggregation at HighMed (13.6)

Current Scenario

Option 1 Option 2

# Locations 24 24 1 Reorder Interval 4 weeks 1 week 1 week Inventory Cost $54,366 $29,795 $8,474 Shipment Size(dltxlt) 8 H + 80 L 2 H + 20 L 1 H + 10 L Transport Cost $530 $1,148 $14,464 Total Cost $54,896 $30,943 $22,938

If shipment size to customer is 0.5H + 5L, total cost of option 2 increases to $36,729.

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Physical Inventory Aggregation: Inventory vs. Transportation cost

• Firms can significantly reduce SS by physically aggregating inventory in one location

• As a result of physical aggregation– Inventory costs decrease– Inbound transportation cost decreases – one destination DC– Outbound transportation cost increases – several deliveries

• Advantageous when inventory and facility costs form a large fraction of supply chain costs– Large value to weight ratio (ex PC’s)– High demand uncertainty and large value (ex designer dresses)– Large customer orders to cover economies of scale on outbound

transportation

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Tailored Transportation (Table 13.9)

• Factors affecting tailoring – Optimizing response vs cost– Customer distance and density

» Short distance Med distance Long distance

Hi Density Private fleet milk runs Crossdock, milk runs Crossdock, milk runsMed Dens Third party milk runs LTL carrier LTL or package carrierLow Dens Third party milk runs or LTL LTL or package carr Package carrier

– Customer size• Large can use a TL; medium and small LTL use LTL or milk runs

– Product demand and value (Table 13.10)• Product Hi value Lo value• High demand Disaggreg cycle inven Disaggreg all inven, use inexpen trans

» Aggregate safety stock, for replen inven» inexpen transp for replen, cycle &» fast mode for safety inventory

• Low demand Aggregate all inven. Use fast Aggregate Safety inven only. Use inexpen» trans for filling cust orders trans for replen cycle inven

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ROUTING AND SCHEDULING IN TRANSPORTATION Chapter 5)

• Framework for Network Design Decisions (Table 5.2)– Phase I : Define a supply chain strategy– Phase II: Define regional facility configuration– Phase III: Select a set of desirable potential sites– Phase IV: Location Choices– Exercise Sun Oil Fig 5-3

• Phase II Network Optimization Models: Capacitated Plant Location Model– Decide on Network design that maximizes profits

• Phase III: Gravity Location Models (Table 5-1) – Work out manually– Identify the distance matrix– Identify the savings matrix– Assign customers to vehicles or routes– Sequence customers within routes

Page 230: Supply Chain Engineering

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RISK MANAGEMENT IN TRANSPORTATION

• RISK THAT SHIPMENT IS DELAYED• RISK THAT SHIPMENT DOES NOT REACH ITS

FINAL DESTINATION, BECAUSE INTERMEDIATE NODES DISRUPTED

• RISK OF HAZARDOUS MATERIAL

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MAKING TRANSPORTATION DECISIONS IN PRACTICE

• ALIGN TRANSPORTATION STRATEGY WITH COMPETITIVE STRATEGY

• CONSIDER BOTH IN HOUSE AND OUTSOURCED TRANSPORTATION– STRATEGIC IMPORTANCE AND PROFITABILITY

• DESIGN A TRANSPORTATION NETWORK THAT CAN HANDLE E-COMMERCE

– DECREASE IN SHIPMENT SIZE & INCREASE IN HOME DELIVERY• USE TECHNOLOGY TO IMPROVE TRANSPORTATION PERFORMANCE

– IDENTIFY LOCATION AND SHIPMENT IN VEHICLE• DESIGN FLEXIBILITY INTO THE TRANSPORTATION NETWORK

– TAKE INTO ACCOUNT UNCERTAINTYIN DEMAND AND IN AVAILABILITY OF TRANSPORTATION

Page 232: Supply Chain Engineering

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HOMEWORK

• EXERCISE 13.1 Coal and MRO• Ex 13.2 Work out single location and 1 week replenishment• EXAMPLE HIGHMED (Ex 13.2)

– WORK OUT OPTION A & IF SHIPMENT SIZE IS 0.5H + 5.0L– WHAT ARE YOUR CONCLUSIONS?

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FACILITY DECISIONS: Network Design Decisions Lesson 11 (Chap 4)

• FACILITY ROLE– What processes are performed

• FACILITY LOCATION– Where should facilities be located

• CAPACITY ALLOCATION– How much capacity should be allocated to each facility

• MARKET & SUPPLY ALLOCATION– What markets should each facility serve– What supply sources should feed each facility

Page 234: Supply Chain Engineering

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Factors Influencing Network Design Decisions

• Strategic – Cost or Responsiveness focus

• Technological– Fixed costs and flexibility determine consolidation

• Macroeconomic– Tariffs and Tax incentives. Stability of currency

• Political stability - clear commerce & legal rules• Infrastructure

– sites, labor, transportation, highways, congestion, utilities

• Competition• Logistics and facility costs

Page 235: Supply Chain Engineering

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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 Hi (LONG)Low (QUICK)

Low

Hi

Page 236: Supply Chain Engineering

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LOGISTICS AND FACILITIES COSTS

• INVENTORY COSTS• TRANSPORTATION COSTS

– INBOUND AND OUTBOUND

• FACILITY (SETUP AND OPERATING) COSTS• TOTAL LOGISTICS COSTS

SEE SUCCEEDING CHARTS

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Service and Number of Facilities

Number of Facilities

ResponseTime

Costs

Costs

ResponseTime

AS THE NUMBER OF FACILITIES INCREASE, RESPONSE TIME REDUCES, AND COST INCREASES

Page 238: Supply Chain Engineering

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Costs and Number of Facilities

Costs

Number of facilities

Inventory

Transportation

Facility costs

Frequent inbound trans

Page 239: Supply Chain Engineering

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Percent Service Percent Service Level Within Level Within

Promised TimePromised Time

TransportationTransportation

Cost Build-up as a function of facilitiesC

ost o

f Ope

ratio

nsC

ost o

f Ope

ratio

ns

Number of FacilitiesNumber of Facilities

InventoryInventoryFacilitiesFacilities

Total CostsTotal Costs

LaborLabor

Page 240: Supply Chain Engineering

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FRAMEWORK FOR NETWORK DESIGN DECISIONS

• DEFINE A SUPPLY CHAIN STRATEGY– COMPETITIVE STATEGY, COMPETITION, SWOT

• DEFINE A REGIONAL FACILITY STRATEGY– LOCATION, ROLES AND CAPACITY

• SELECT DESIRABLE SITES– HARD INFRASTURCTURE – TRANSPORT, UTILITIES,

SUPPLIERS, WAREHOUSES– SOFT INFRASTRUCTURE – SKILLED WORKFORCE,

COMMUNITY• CHOOSE LOCATION

– PRICE LOCATION AND CAPACITY ALLOCATIONSEE FRAMEWORK NEXT

Page 241: Supply Chain Engineering

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A Framework for Global Site Location (107)

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

Page 242: Supply Chain Engineering

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Tailored Network: Multi - Echelon Finished Goods Network

RegionalRegionalFinishedFinished

Goods DCGoods DC

RegionalRegionalFinishedFinished

Goods DCGoods DC

Customer 1Customer 1DCDC

Store 1Store 1

NationalNationalFinishedFinished

Goods DCGoods DC

Local DCLocal DCCross-DockCross-Dock

Local DC Local DC Cross-DockCross-Dock

Local DCLocal DCCross-DockCross-Dock

Customer 2Customer 2DCDC

Store 1Store 1

Store 2Store 2

Store 2Store 2

Store 3Store 3

Store 3Store 3

Page 243: Supply Chain Engineering

Supply Chain Engineering MN 799 243#

Network Optimization Models• Allocating demand to production facilities• Locating facilities and allocating capacity

– Speculative Strategy• Single sourcing

– Hedging Strategy• Match revenue and cost exposure

– Flexible Strategy• Excess total capacity in multiple plants• Flexible technologies

Which plants to establish? How to configure the network?

Key Costs:

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

Page 244: Supply Chain Engineering

Supply Chain Engineering MN 799 244#

Gravity Methods for Location – Min. cost of transportn 316,116)ASSUMPTION: TRANSPORT COSTS GROW LINEARLY WITH SHIPMENTS

• Ton Mile-Center Solution • (Table 11.29, 5.1)

– x,y: Warehouse Coordinates

– xn, yn : Coordinates of delivery location n

– dn : Distance to delivery location n

– Fn : Cost per ton mile to delivery location n

– Dn Quantity to be shipped

– Fi = Dn Fn

n

i i

i

n

i

i

ii

n

i i

i

n

i

i

ii

n

dF

d

Fyd

Fd

Fxyyxxd

y

x

nn

1

1

1

1

22 )()(

Min )()( 22 yyxxF iii

Total Cost TC=

k

n 1Dnd nFn

Reiterate x,y calculation till x,y values close

Page 245: Supply Chain Engineering

Supply Chain Engineering MN 799 245#

Demand Allocation Model (pp319) (Table 5.2)• Which market is served by which plant?• Which supply sources are used by a plant?

xij = Quantity shipped from plant site i to customer j

Cij = cost to produce & ship one unit from factory i to market j

n = no. of factory locations m = no. of markets Dj = Annual demand from market j

Ki = Annual capacity of factory i

0

.

1

1

1 1

xKx

Dx

xc

ij

i

m

jij

j

n

iij

n

i

m

jijij

st

Min

All mkt demand satisfied

No factory capacity exceed

Page 246: Supply Chain Engineering

Supply Chain Engineering MN 799 246#

NETWORK DESIGN DECISIONS IN PRACTICE

• DO NOT UNDERESTIMATE THE LIFE SPAN – LONG LIFE HENCE LONG TERM CONSEQUENCES– ANTICIPATE EFFECT FUTURE DEMANDS, COSTS AND TECHNOLOGY

CHANGE– STORAGE FACILITIES EASIER TO CHANCE THAN PRODUCTION

FACILITIES

• DO NOT GLOSS OVER CULTURAL IMPLICATIONS– LOCATION – URBAN, RURAL, PROXIMITY TO OTHERS

• DO NOT IGNORE QUALITY OF LIFE ISSUES– WORKFORCE AVAILABILITY AND MORALE

• FOCUS ON TARIFFS& TAX INCENTIVES WHEN LOCATING FACILITIES– PARTICULARLY IN INTERNATIONAL LOCATIONS

Page 247: Supply Chain Engineering

Supply Chain Engineering MN 799 247#

HOMEWORK

• Page 330– Exercise 2

Page 248: Supply Chain Engineering

Supply Chain Engineering MN 799 248#

BEER GAME Lesson 12

• Beer Game• HOMEWORK –• WRITE UP A SUMMARY OF THE LESSONS FROM

THE BEER GAME• GIVE AN EXAMPLE OF THIS PHENOMENA IN REAL

LIFE• WHAT WOULD YOU DO TO CORRECT IT

Page 249: Supply Chain Engineering

Supply Chain Engineering MN 799 249#

DISCUSSION OF BEER GAME

• GET INTO SAME TEAMS• FORMULATE TWO OR LEARNINGS – WHAT IS THE

EFFECT; WHY IS IT CAUSED; HOW CAN IT BE REDUCED?– FROM THE GAME– FROM YOUR INTUITION– FROM YOUR KNOWLEDGE OR INDUSTRY

• PRESENT THEM TO CLASS FOR DISCUSSION

Page 250: Supply Chain Engineering

Supply Chain Engineering MN 799 250#

SUPPLY CHAIN COORDINATION (Chap 16) Lesson 13

• The role of Information Technology– What is coordination? Take action to increase total SC profits– Obstacles to coordination:

• The Bull-Whip Effect –every trading partner must understand effect of its actions on other trading partners

– Effect of lack of coordination• Increased costs – Manufacturing, Inventory, Transportation, labor• Increased Replenishment lead time• Lower level of Product availability

– Countermeasures to achieve coordination– The role of information technology in a supply chain

Page 251: Supply Chain Engineering

Supply Chain Engineering MN 799 251#

Supplier

Manufacturer

RetailerCustomer

Distributor

As Information Moves Thru A Supply Chain

Demand uncertainty

becomes more

AND MOREdistorted

C 1999. William T. Walker, CFPIM, CIRM with the APICS Educational & Research Foundation. All Rights Reserved.

Page 252: Supply Chain Engineering

Supply Chain Engineering MN 799 252#

Bullwhip Effect

Ord

er

Qua

ntity

Time

Retailer’s Orders

Ord

er

Qua

ntity

Time

Wholesaler’s Orders

Ord

er

Qua

ntity

Time

Manufacturer’s Orders

The magnification of variability in orders in the supply-chain.

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 even greater variability for a single manufacturer.

Page 253: Supply Chain Engineering

Supply Chain Engineering MN 799 253#

Information Coordination: The Bullwhip Effect

Consumer Sales at Retailer

0

100

200

300

400

500

600

700

800

900

1000

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41

Con

sum

er d

eman

d

Retailer's Orders to Wholesaler

0

100

200

300

400

500

600

700

800

900

1000

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41

Ret

aile

r O

rder

Wholesaler's Orders to Manufacturer

0

100

200

300

400

500

600

700

800

900

1000

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41

Who

lesa

ler

Ord

er

Manufacturer's Orders with Supplier

0

100

200

300

400

500

600

700

800

900

1000

1 4 7 10 13 16 19 22 25 28 31 34 37 40

Man

ufac

ture

r O

rder

Page 254: Supply Chain Engineering

Supply Chain Engineering MN 799 254#

Impact of the Bullwhip Effect

Performance Measure Impact on PerformanceManufacturing CostInventoriesLead TimeTransport CostShipping & Receiving CostCustomer Service LevelProfitability

Page 255: Supply Chain Engineering

Supply Chain Engineering MN 799 255#

Bull Whip Effect - Incentive Obstacles• Contributing factors

– Incentives based on sell-in leading to forward buy– Localized optimization Ex Transportation Mgr linked to lowest transport cost –

even if inventory cost increased– Sales Force incentives – quantity sold to next stage, not final customer– Buying policies based on max profits at one stage of supply chain

• Counter Measures– Align goals and incentives across functions– Price for coordination - – Focus sales force on increasing sell-thru to customer– Incentives based on rolling horizon– Sales force do not compete with each other but with the competition

Page 256: Supply Chain Engineering

Supply Chain Engineering MN 799 256#

The Bullwhip Effect: Information Processing Obstacles

• Contributing factors– No visibility of end demand– Multiple forecasts, based on orders received not customer demand (magnifies incr/decr)– Long lead-time– Lack of information sharing

• Counter Measures– Collaborative forecasting and planning (CFAR, CPFR)– Access sell-thru or POS data. Sharing POS data– Direct sales (natural on web)– Single control of replenishment – continuous replenishment and VMI– Leadtime reduction

• State of Practice– Sell-thru data in contracts (e.g., HP, Apple, IBM)– CFAR, CPFR, CRP, VMI (P&G and Walmart)– Quick Response Mfg. Strategy– Dell direct supply to customer

Page 257: Supply Chain Engineering

Supply Chain Engineering MN 799 257#

Bull Whip Effect - Operational Obstacles (Batching)• Contributing factors

– High Order Cost – Ordering large lots– Large replenishment times– Full TL economies– Random or correlated ordering

• Counter Measures– Reduce replenishment lead time – EDI, manuf techniques, Advanced Shipping

notices (ASN), & Computer Assisted Ordering (CAO)– Reduce Lot sizes – reduce fixed costs to (order, manuf, transport, receive)– Discounted on Assorted Truckload, consolidated by 3rd party logistics– Regular delivery appointment, milk runs, mixing deliveries– Volume and not lot size discounts

• State of Practice– McKesson, Nabisco, ...– 3rd party logistics in Europe, emerging in the U.S.– P & G

Page 258: Supply Chain Engineering

Supply Chain Engineering MN 799 258#

Bull Whip Effect - Operational Obstacles (Rationing Game)

• Contributing factors– Rationing and Shortage gaming (inflating order rewarded)– Proportional rationing scheme– Ignorance of supply conditions– Unrestricted orders & free return policy

• Counter Measures– Allocation based on past sales.– Shared Capacity and Supply Information– Flexibility Limited over time, capacity reservation

• State of Practice– Saturn, HP– Schedule Sharing (HP with TI and Motorola)– HP, Sun, Seagate

Page 259: Supply Chain Engineering

Supply Chain Engineering MN 799 259#

Bull Whip Effect - Pricing Obstacles• Contributing factors

– Lot size based quantity discounts– High-Low Pricing leading to forward buy– Delivery and Purchase not synchronized

• Counter Measures– Lot size based to Volume based quantity discounts– EDLP (Every day low pricing)– Limited purchase quantities– Scan based promotions

• State of Practice– P&G (resisted by some retailers)– Scan based promotion

Page 260: Supply Chain Engineering

Supply Chain Engineering MN 799 260#

Managerial Implications of the Bull Whip Effect - Behavioral Factors

• Contributing factors– Lack of trust– Local reaction – to current local condition– Each stage sub –optimizes– Each stage blames each other for fluctuations

• Counter Measures– Building trust and partnership– Aligning incentives and objectives – co-identification– Sharing information – sales and production– Eliminating duplication (Inspection)

• State of Practice– Wal-Mart and P&G with CFAR

Page 261: Supply Chain Engineering

Supply Chain Engineering MN 799 261#

How Should A Middle Link Behave?

IF: The Middle Link makes an independent decision to increase production

THEN: Finished goods inventory increases for the Middle Link

THEN: Return On Assets are reduced for the Enterprise, and there is no improvement in end-to-end throughput!

IF: The Middle Link makes an independent decision to decrease production

THEN: The system constraint moves to the Middle Link

THEN: There is no reduction in operational costs for the Enterprise, and profit margins are lowered for every trading partner!

THEREFORE: The Middle Link should stay synchronized to the demand signal from the system constraint

C 1999. William T. Walker, CFPIM, CIRM with the APICS Educational & Research Foundation. All Rights Reserved.

Page 262: Supply Chain Engineering

Supply Chain Engineering MN 799 262#

ACHIEVING COORDINATION IN PRACTICE• QUANTIFY THE BULLWHIP EFFECT• GET TOP MANAGEMENT COMMITMENT • DEVOTE RESOURCES FOR COORDINATION - DEDICATED• FOCUS ON COMMUNICATION WITH OTHER STAGES• TRY TO ACHIEVE COORDINATION IN THE ENTIRE SUPPLY CHAIN

NETWORK• USE TECHNOLOGY TO IMPROVE CONNECTIVITY IN THE SUPPLY SIDE -

INCREASING VISIBILITY&COMMUNICATION• REDUCE TIME TO – ORDER, MAKE, TRANSPORT, REPLENISH• SHARE BENEFITS OF COORDINATION EQUITABLY

Page 263: Supply Chain Engineering

Supply Chain Engineering MN 799 263#

Principle: Synchronize Supply With Demand

This principle is about Vocalization.

C 1999. William T. Walker, CFPIM, CIRM with the APICS Educational & Research Foundation. All Rights Reserved.

Page 264: Supply Chain Engineering

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ROLE OF INFORMATION IN SUPPLY CHAIN SUCCESSInformation is the glue that binds the other three drivers, to create an integrated, coordinated supply chain. Provides facts to give visibility of whole supply chain and make sound decisions to improve performance* TYPES – Supplier, Manufacturing, Distribution & Retailing, and Demand* CHARACTERISTICS –Accurate, Timely, Accessible, Appropriate* OPTIMIZING – Inventory, Transportation, Facilities

Information Global Scope

CoordinatedDecisions

Supply ChainSuccess

Global scope enables decisions to maximize the total supply chain profit

Page 265: Supply Chain Engineering

Supply Chain Engineering MN 799 265#

USE OF INFORMATION

• INVENTORY– SETTING OPTIMUM INVENTORY POLICIES

• DEMAND PATTERNS, CARRYING COSTS, STOCK OUT COSTS, ORDERING COSTS, SERVICE LEVEL, LEAD TIMES ETC

• TRANSPORTATION– DECIDING NETWORKS, ROUTINGS, MODES, SHIPMENTS AND

VENDORS• COSTS, CUSTOMER LOCATIONS, SHIP COSTS & LOCATIONS

• FACILITY– DETERMINING LOCATION, CAPACITY AND SCHEDULE

• TRADE OFFS EFFICIENCY VS FLEXIBILITY; DEMAND, EXCHANGE RATES, TAXES ETC

Page 266: Supply Chain Engineering

Supply Chain Engineering MN 799 266#

Information Technology in a Supply Chain: Legacy SystemsTHERE ARE IT SYSTEMS ACROSS ENTIRE SUPPLY CHAIN

Supplier CustomerRetailerDistributorManufacturer

Strategic

Planning

Operational

STRATEGIC – HIGH ORGANIZATIONAL LEVEL, LONG TIME FRAME, LITTLE LOW LEVEL DETAIL, HIGHLY ANALYTICAL, TOP MANAGERSLEGACY – ONE FUNCTION OR ONE STAGE OF SUPPLY CHAIN, TRANSACTIONAL ABILITY, DIFFICULT TO MODIFY, NO ANALYTICAL

Page 267: Supply Chain Engineering

Supply Chain Engineering MN 799 267#

Information Technology in a Supply Chain: ERP Systems

Supplier CustomerRetailerDistributorManufacturer

Strategic

Planning

Operational

ERPPotential

ERP PotentialERP

ERP SYSTEMS – BROAD INFORMATION AVAILABILITY, REAL TIME, CAN USE ENABLING TECHNOLOGY LIKE INTERNET – WEAK ANALYTICAL

Page 268: Supply Chain Engineering

Supply Chain Engineering MN 799 268#

Information Technology in a Supply Chain: Analytical Applications

Supplier CustomerRetailerDistributorManufacturer

Strategic

Planning

Operational

SupplierApps

SCM

MES

Dem Plan

Transport execution &WMS

APS Transport & InventoryPlanning

CRM/SFA

Page 269: Supply Chain Engineering

Supply Chain Engineering MN 799 269#

The Least Common Denominator OfInformation Technology

Supply Chain Trading Partners

Cus

tom

er

Ret

ail

Who

lesa

le

Fact

ory

Supp

lier

Advanced Planning & SchedulingEnterprise Resource Planning

Data Warehousing

DRP Legacy SystemMRP II Legacy System

Electronic Data Interchange

Internet BrowserElectronic Mail

Voicemail

For orders, replenishment, payment, returns loops...

LCD

C 1999. William T. Walker, CFPIM, CIRM with the APICS Educational & Research Foundation. All Rights Reserved.

Page 270: Supply Chain Engineering

Supply Chain Engineering MN 799 270#

Information Technology in a Supply Chain: Future Trends and Issues

• Best of breed versus single integrator• Shifts in Platform Technology

– Client server– Browser based internet– Application service providers (ASP) – owns and hosts software and

charges for third party use of software

• The role of the Internet and B2B exchanges– Exchanges create efficient market

• AUCTIONS, REVERSE AUCTIONS, FIXED PRICE, BID/ASK– Collaboration between buyer and seller essential– Convergence between B2B and Supply Chain

What do you see? Teams – come up with three major trends - present

Page 271: Supply Chain Engineering

Supply Chain Engineering MN 799 271#

SUPPLY CHAIN INFORMATION TECHNOLOGY IN PRACTICE

• SELECT AN IT SYSTEM THAT ADDRESSES THE COMPANY’S KEY SUCCESS FACTORS– COMPUTERS – INVENTORY LEVEL, – OIL REFINERY - UTILIZATION

• ALIGN LEVEL OF SOPHISTICATION WITH NEED FOR SOPHISTICATION - KISS

• USE IT SYSTEMS TO SUPPORT DECISION MAKING, NOT TO MAKE DECISIONS

• THINK ABOUT THE FUTURE– WEB-BASED APPLICATIONS– FLEXIBILITY OF SYSTEMS TO ACCOMMODATE CHANGE

Page 272: Supply Chain Engineering

Supply Chain Engineering MN 799 272#

Which E-Business is Right for Your Supply Chain?

What is different about e-commerce?

What are some potential opportunities in a supply chain?

Implications of e-business in different industries

Page 273: Supply Chain Engineering

Supply Chain Engineering MN 799 273#

Applying the Framework to e-commerce:What is e-commerce?

• Commerce transacted over the Internet– Is product information displayed on the Internet?– Is negotiation over the Internet? EBay– Is the order placed over the Internet? Amazon– Is the order tracked over the Internet?– Is the order fulfilled over the Internet?– Is payment transacted over the Internet?

• Information publicly available, no dedicated connection required

• B to C and B to B• Expected to reduce prices, increase productivity, lower

labor costs

Page 274: Supply Chain Engineering

Supply Chain Engineering MN 799 274#

Existing Channels for Business

• Product information – Physical stores, EDI, catalogs, face to face, …

• Negotiation– Face to face, phone, fax, sealed bids, …

• Order placement– Physical store, EDI, phone, fax, face to face, …

• Order tracking– EDI, phone, fax, …

• Order fulfillment– Customer pick up, physical delivery

Page 275: Supply Chain Engineering

Supply Chain Engineering MN 799 275#

Potential Revenue Opportunities from E-Business

• Direct sales to customers• 24 hour access for order placement• Accessibility to all customers• Information aggregation• Personalization and Customization of Information• Information sharing in supply chain• Flexibility on pricing and promotion• Price and service discrimination• Faster time to market• Efficient funds transfer - reduce working capital• Disadvantage: Takes longer to deliver, transport costs and shipping time

Page 276: Supply Chain Engineering

Supply Chain Engineering MN 799 276#

Potential Cost Opportunities from E-Business• Direct customer contact for manufacturers (no handoffs)• Coordination in the supply chain• Customer participation• Postpone product differentiation to after order is placed• Downloadable product• Reduce product handling with shorter supply chain• Reduce facility and processing costs• Geographical centralization and resulting reduction in inventories• Improving supply chain coordination thru information sharing

Page 277: Supply Chain Engineering

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POTENTIAL COST DISADVANTAGES

• INCREASED TRANSPORTATION COSTS– INVENTORY AGGREGRATION– SMALLER, MORE FREQUENT ORDERS

• INCREASED HANDLING COSTS– COMPANY HAS TO PICK, PACK AND SHIP

• LARGE INITIAL INVESTMENT in INFORMATION INFRASTRUCTURE– PROGRAMMING – WEB SERVERS

• SECURITY ?? CASH AND PRODUCT

Page 278: Supply Chain Engineering

Supply Chain Engineering MN 799 278#

Basic evaluation framework

• How does going on line impact revenues?• How does going on line impact costs?

– Facility (site + personnel)– Inventory– Transportation– Information

• Should the e-commerce channel position itself for efficiency or responsiveness?

• Who in the supply chain can extract most value?• Is the value to existing players or new entrants?

Page 279: Supply Chain Engineering

Supply Chain Engineering MN 799 279#

The Computer Industry: Dell on-line

Customer Order andManufacturing Cycle

Procurement Cycle

Dell Supply Chain Cycles

Procurement cycleCustomer Order andManufacturing Cycle

CustomerOrder Arrives

PUSH PROCESSES PULL PROCESSES

Page 280: Supply Chain Engineering

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Potential opportunities exploited by Dell

• Revenue opportunities– 24 hour access for order placement– Direct sales– Providing customization and large selection information– Flexibility on pricing and promotion– Faster time to market– Efficient funds transfer –Negative working capital

• Revenue negatives– Longer response time than store and no help with selection

Page 281: Supply Chain Engineering

Supply Chain Engineering MN 799 281#

Potential opportunities exploited by Dell

• Cost opportunities– Geographical Centralization and reduced inventories (aggregated)– Reduce facility costs – no physical distribution or retail– Direct sales eliminating intermediary– Customer participation: Call center & catalog costs– Information sharing in supply chain– Postpone product differentiation to after order is placed using

product platforms and common components

• Outbound transportation costs increase

Page 282: Supply Chain Engineering

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Opportunities

• Significant, but must be combined with component commonality, and build to order. Must move product customization to pull phase of supply chain and hold inventories as common components during the push phase

• Opportunity most significant for new, hard to forecast products

• Complements strength of existing retail channels

Page 283: Supply Chain Engineering

Supply Chain Engineering MN 799 283#

Retailing: Amazon.com

Publisher

Distributor

Amazon

Customer

Amazon Supply Chain

Publisher

Warehouse (?)

Retail Store

Customer

Bookstore Supply Chain

Pull Pull

Page 284: Supply Chain Engineering

Supply Chain Engineering MN 799 284#

Potential opportunities exploited by Amazon

• Revenue opportunities– 24 hour access for order placement– Providing large selection and other information– Attract customers who do not want to go to store– Flexibility on pricing– Efficient funds transfer

• Revenue negatives– Intermediary (distributor) reduces margin– Longer response time than bookstore– Cannot browse

Page 285: Supply Chain Engineering

Supply Chain Engineering MN 799 285#

Potential opportunities exploited by Amazon

• Cost opportunities– Geographical centralization and reduced inventories: Most

effective for low volume, hard to forecast books, least effective for high volume best sellers

– Reduce facility costs

• Cost increases– Outbound transportation costs increase– Handling cost increase

Page 286: Supply Chain Engineering

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Opportunities

• Going on-line, by itself, offers lower cost advantages (may be some disadvantages) than in Dell model given current form of books

• Cost and availability advantages are more significant for low volume books

• On-line channel has significant cost benefit if books are downloadable

Page 287: Supply Chain Engineering

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How should bookstore chains react?

• An on line channel allows it to match Amazon’s revenue advantages

• Use a hybrid approach in stocking and pricing– High volume books for local storage– Low volume books for browsing and purchase on line– Pricing varies by delivery and pick up option

Page 288: Supply Chain Engineering

Supply Chain Engineering MN 799 288#

Grocery on-line

Manufacturer

Online Grocer

Customer

On-Line Supply ChainEx. Fresh Direct (NY)

Suppliers

Warehouse (?)

Supermarket

Customer

Supermarket Supply Chain

Page 289: Supply Chain Engineering

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Key Messages

• Some supply chains are better suited to exploit the cost benefits of going on-line– Ability to increase processes in pull phase– Ability to delay product differentiation– Big inventory benefit from geographical centralization– Significant facility cost reduction on centralization– Transport to customer is a small fraction of product cost

All are achieved if product is downloadable

Page 290: Supply Chain Engineering

Supply Chain Engineering MN 799 290#

B2B: Free Markets

• The worldwide market for direct materials procurement is approximately $5 trillion, with the U.S. segment at approximately $1 trillion

Morgan Stanley Dean Witter Internet Industry Research

FreeMarkets is a B2B Internet company that creates online auctions for procurers of direct materials

• MSDW Claim: FreeMarkets’ clients typically achieve savings of 2% to 25%

Page 291: Supply Chain Engineering

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B2B: Matching Base Demand and Capacity

• Potential opportunities– Ability to reach more bidders and get lower unit price– E Bay and Price Line (price set by customer)

• Key questions– What does it do to total cost of material?– How many bidders do you need to achieve this?– How does this impact cooperative relationships within supply

chain?– Does intermediary provide any value?

Page 292: Supply Chain Engineering

Supply Chain Engineering MN 799 292#

B2B: Matching Demand Shortage and Surplus Capacity

• Potential opportunities– Ability to aggregate and display all available surplus capacity– Better match of surplus capacity and unmet demand

Best provided by an intermediary• Key issue

– Total cost (product + transportation + …) must be accounted for in the auction

Page 293: Supply Chain Engineering

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Key Messages

• Significant B2B opportunity to use Internet to reduce cost and improve efficiency of existing processes

• Significant B2B opportunity to improve collaboration within existing supply chains

• Auction opportunity for B2B is primarily for matching demand shortage with surplus capacity, not for base load

Page 294: Supply Chain Engineering

Supply Chain Engineering MN 799 294#

USING E-BUSINESS TO CREATE MARKETS

• INTERNET EXCHANGES, MARKETPLACES or PORTALS –– ELECTRONIC MARKETPLACES AND COMMUNITIES OF INTEREST,

WHERE COMPANIES/INDIVIDUALS CAN OBTAIN INFORMATION AND BUY AND SELL PRODUCTS. CAN AGGREGRATE DEMAND AND SUPPLY

– BUYERS CAN USE EXCHANGES BY: • USING THIRD PARTY TO FACILITATE TRANSACTIONS• CONDUCTING AUCTIONS BETWEEN MANY BUYERS AND SELLERS

– ADVANTAGES FOR BUYERS:• REDUCE TRANSACTION COSTS, IMPROVE PERFORMANCE AND

COLLOBORATIVE PLANNING WITHIN THE SUPPLY CHAIN• OFFER BUYERs ABILITY TO SEARCH ACROSS MULTIPLE SUPPLIERS• DOWNWARD PRESSURE ON SELLING PRICES

– ADVANTAGES FOR SELLERS:• REDUCE REPLENISHMENT LEAD TIME AND BETTER SUPPLY DEMAND

MATCH THROUGH IMPROVED COORDINATION• USEFUL IN SELLING SURPLUS INVENTOY & CAPACITY

Page 295: Supply Chain Engineering

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SETTING UP E-BUSINESS IN PRACTICE• INTEGRATE THE INTERNET WITH THE EXISTING PHYSICAL NETWORK –

CLICKS AND MORTAR– SUCCESS CLOSELY LINKED TO DISTRIBUTION CAPABILITIES OF EXISTING

SUPPLY CHAIN NETWORK

• DEVISE SHIPPING STRATEGIES THAT REFLECT COSTS– MUST INCLUDE SIZE AND WEIGHT CONSIDERATIONS

• OPTIMIZE E-BUSINESS LOGISTICS TO HANDLE PACKAGES NOT PALLETS– NEED TO CONSOLIDATE OR BUNDLE, WITH OTHER SUPPLIERS

• DESIGN THE E-BUSINESS SUPPLY CHAIN TO HANDLE RETURNS EFFICIENTLY

– LIKELY TO BE INCREASED RETURNS – IDEALLY TO ONE LOCATION • KEEP CUSTOMERS INFORMED THROUGHOUT THE ORDER FULFILLMENT

CYCLE– STATUS ON LINE

END

Page 296: Supply Chain Engineering

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FINAL EXAM

Page 297: Supply Chain Engineering

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Factory Cash-To-Cash Cycle Time1. Arrange the trading partner nodes from supplier to customer.

2. Start with a negative number torepresent the time a factoryhas to pay a supplier’s invoice.

3. Work in a complete, closed loop.

4. Add the incremental time(s) to send the factory invoice down the chain to the next paying trading partner.

5. Add the incremental time(s) foreach node to send the payment back up the chain to the factory.

6. Sum the negative time of step #2 withthe positive loop time of step #4, #5.

CUSTOMER

RETAIL

WHOLESALE

FACTORY

SUPPLIER

C 1999. William T. Walker, CFPIM, CIRM with the APICS Educational & Research Foundation. All Rights Reserved.

Page 298: Supply Chain Engineering

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Continuously Stocked Items: Optimal Safety Inventory Levels (Eq 11.6)

For each order cycle– Benefit of increasing safety stock by one unit =

(1-CSL)Cu

– Cost of increasing safety stock by one unit = HQ*/R

where– CSL = probability of not stocking out in a cycle with current

level of safety stock = Cycle Service Level– H = cost of holding one unit for one year– R = Annual demand– Q* = Economic order quantity

Page 299: Supply Chain Engineering

Supply Chain Engineering MN 799 299#

Optimal Safety Inventory Levels (Ex 9.3)

CSL = 1-(HQ*/CuR)

R = 100 gallons/week; R= 20; H = $0.6/gal./yearL = 2 weeks; Q = 400; ROP = 300.

What is the imputed cost of stocking out?

Page 300: Supply Chain Engineering

Supply Chain Engineering MN 799 300#

Postponement Adds Value Within LogisticsBy Trading Information For Inventory

Without Postponement:

With Postponement:

TradingPartner

Postponement

FGI Orders None

FGI OrdersNone

Design for generic production Postpone to an actual order

“Postponement is delaying product differentiation until the customer demandis known.” Corey Billington, Hewlett-Packard Strategic Planning and Modeling

TradingPartner

TradingPartner

TradingPartner

TradingPartner

C 1999. William T. Walker, CFPIM, CIRM with the APICS Educational & Research Foundation. All Rights Reserved.

Page 301: Supply Chain Engineering

Supply Chain Engineering MN 799 301#

1. Arrange the trading partner nodesfrom customer to supplier.

2. Work in a complete, closed loop.

3. Add the incremental time(s) to sendthe order from the customer to thefirst node with product inventory.

4. Add the incremental time to pickthe product from inventory.

5. Add the incremental time(s) to transport the product to the customer.

Customer Order-To-Delivery Cycle Time

CUSTOMER

RETAIL

WHOLESALE

FACTORY

SUPPLIER

Customer Order-To-Delivery Cycle Time

C 1999. William T. Walker, CFPIM, CIRM with the APICS Educational & Research Foundation. All Rights Reserved.

Page 302: Supply Chain Engineering

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Amazon vs Barnes and Noble

• The effect of Barnes and noble Responsive supply chain strategies today, the company is enhancing its original system by transitioning the back-end services fulfillment systems to an on-line, real-time, Microsoft BackOffice-based shipping, order management, and financial reporting system called PRISM—or Pod Receiving and Integrated Shipping Management System. PRISM allows Barnes and Noble to ship products much faster and deliver higher service levels to customers

Amazon is going to become a market leader because of its early start in Web enabled low-cost access to an infinite number of customers. Treating every customer the same, with limited choice of access, is an unwise Barnes and Noble approach. Amazon has several advantages over Barnes and Noble, which could provide significant competitive leverage, such as:•Real-time customer information and transaction data,•Direct customer "dialog" opportunities, and•Low-cost channel operations

Page 303: Supply Chain Engineering

Supply Chain Engineering MN 799 303#

Amazon vs Barnes and Noble

• Both have some unpredictable demand and some predictable demand. Yes basically Amazon is efficient and B&N responsive (to a point). Both try and influence demand by suggesting (and discounting) what they have stock in and want purchased. Amazon stocks what it presumes or knows will be best sellers

I see the future bringing down the price of books further (particularly text books) by even more outsourcing. I also see inventory in supply chain reducing by print on demand, especially for books not commonly popular. There will also be a lot more on line books, and condensed books, that one can read or review

The key question is how will Amazon compete with a Chinese or Indian on line supplier with similar products. I do not think it can compete. I see Amazon partnering with a major Chinese and/or Indian company.

As for Barnes and Noble, they have to also move more to print on demand and outsource more (they are already doing a lot of that). They provide a social function that they are emphasizing, so there will be some need for them, but not as a major book supplier

Page 304: Supply Chain Engineering

Supply Chain Engineering MN 799 304#

Amazon• The company’s management has started to expand the business geographically, as well

as into new product areas. Amazon now has a U.K. subsidiary, headquartered in Slough, west of London, employing around 500 people — Amazon.co.uk — as well as a slightly smaller German one, Amazon.de, headquartered in Regensburg, Germany. It resoled in increasing the overall sales of the company. Amazon is currently achieving a run rate of $280m a year.

Amazon.co.uk started offering same-day delivery, at least within London... So, provided that customers order within a given time window, they are offered the option of same day delivery as a free upgrade. It resulted in better and efficient customer service than any other online stores.

Identifying desirable global locations for new distribution centers is one use Amazon will make of new supply-chain software from Manugistics of Rockville, Md. It would install Manugistics’ NetWORKS solutions to support its global expansion and operational improvement initiatives. It will use NetWORKS Strategy to model fixed and variable network costs, taking into consideration such factors as varying transportation and supplier lead times, and global constraints such as tariffs and taxes. The model will then be used to design an optimal global network


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