Homework 10

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Supply Chain Management: Strategy, Planning, and Operation

Seventh Edition

Chapter 10

Coordination in a Supply Chain

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Learning Objectives

10.1 Describe supply chain coordination and the bullwhip effect, and their impact on supply chain performance.

10.2 Identify obstacles to coordination in a supply chain.

10.3 Discuss managerial levers that help achieve coordination in a supply chain.

10.4 Understand some practical approaches to improve coordination in a supply chain.

Lack of Supply Chain Coordination and Its Impact on Performance

Supply chain coordination – all stages of the chain take actions that are aligned and increase total supply chain surplus

Requires that each stage share information and take into account the effects of its actions on the other stages

Lack of coordination results when:

Objectives of different stages conflict

Information moving between stages is delayed or distorted

Bullwhip Effect (1 of 2)

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

Distorts demand information within the supply chain

Results from a loss of supply chain coordination

Bullwhip Effect (2 of 2)

Figure 10-1 Demand Fluctuation at Different Stages of a Supply Chain

The Effect on Performance (1 of 2)

Lack of coordination increases variability and hurts supply chain surplus

Impact on costs

Manufacturing cost

Inventory cost

Replenishment lead time

Transportation cost

Labor cost for shipping and receiving

Level of product availability

Relationships across the supply chain

The Effect on Performance (2 of 2)

Table 10-1 Impact of the Lack of Coordination on Supply Chain Performance

Performance Measure	Impact of the Lack of Coordination
Manufacturing cost	Increases
Inventory cost	Increases
Replenishment lead time	Increases
Transportation cost	Increases
Shipping and receiving cost	Increases
Level of product availability	Decreases
Profitability	Decreases

Summary of Learning Objective 1

Supply chain coordination requires all stages to take actions that maximize total supply chain profits. A lack of coordination results if different stages focus on optimizing their local objectives or if information is distorted as it moves across the supply chain. The phenomenon that fluctuation in orders increases as one moves up the supply chain from retailers to wholesalers to manufacturers to suppliers is referred to as the bullwhip effect. This effect results in an increase in all costs in the supply chain and a decrease in customer service levels. The bullwhip effect moves all parties in the supply chain away from the efficient frontier and results in a decrease of both customer satisfaction and profitability within the supply chain.

Obstacles to Coordination in a Supply Chain

Incentive Obstacles

Information Processing Obstacles

Operational Obstacles

Pricing Obstacles

Behavioral Obstacles

Incentive Obstacles

Occur when incentives offered to different stages or participants in a supply chain lead to actions that increase variability and reduce total supply chain profits

Local optimization within functions or stages of a supply chain

Sales force incentives

Information Processing Obstacles

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

Forecasting based on orders and not customer demand

Lack of information sharing

Operational Obstacles (1 of 2)

Occur when placing and filling orders lead to an increase in variability

Ordering in large lots

Large replenishment lead times

Rationing and shortage gaming

Operational Obstacles (2 of 2)

Figure 10-2 Demand and Order Stream with Orders Every Five Weeks

Pricing Obstacles (1 of 2)

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

Lot-size based quantity decisions

Price fluctuations

Pricing Obstacles (2 of 2)

Figure 10-3 Retailer Sales and Manufacturer Shipments of Soup

Behavioral Obstacles (1 of 2)

Problems in learning within organizations that contribute to information distortion

Each stage of the supply chain views its actions locally and is unable to see the impact of its actions on other stages

Different stages of the supply chain react to the current local situation rather than trying to identify the root causes

Different stages of the supply chain blame one another for the fluctuations

Behavioral Obstacles (2 of 2)

No stage of the supply chain learns from its actions over time

A lack of trust among supply chain partners causes them to be opportunistic at the expense of overall supply chain performance

Summary of Learning Objective 2

A key obstacle to coordination in the supply chain is misaligned incentives that result in different stages optimizing local objectives instead of total supply chain profits. Other obstacles include lack of information sharing, operational inefficiencies leading to large replenishment lead times and large lots, sales force incentives that encourage forward buying, rationing schemes that encourage inflation of orders, promotions that encourage forward buying, and a lack of trust that makes any effort toward coordination difficult.

Managerial Levers to Achieve Coordination

Aligning goals and incentives

Improving information accuracy

Improving operational performance

Designing pricing strategies to stabilize orders

Building strategic partnerships and trust

Aligning Goals and Incentives

Align goals and incentives so that every participant in supply chain activities works to maximize total supply chain profits

Align goals across the supply chain

Align incentives across functions

Pricing for coordination

Alter sales force incentives from sell-in (to the retailer) to sell-through (by the retailer)

Improving Information Visibility and Accuracy

Sharing customer demand data

Implementing collaborative forecasting and planning

Designing single-stage control of replenishment

Continuous replenishment programs (C R P)

Vendor managed inventory (V M I)

Improving Operations to Synchronize Supply and Demand

Reducing replenishment lead time

Reducing lot sizes

Rationing based on past sales and sharing information to limit gaming

Designing Pricing Strategies to Stabilize Orders

Encouraging retailers to order in smaller lots and reduce forward buying

Moving from lot size-based to volume-based quantity discounts

Stabilizing pricing

Building Strategic Partnerships and Trust

Easier to use levers to achieve coordination if trust and strategic partnerships are built

Sharing accurate information

Lower transaction costs between stages

All parties must believe that the benefits of improved coordination are being shared equally

Improving Coordination in Practice

Get top management commitment for coordination

Devote resources to coordination

Focus on communication with other stages

Summary of Learning Objective 3

Managers can improve coordination in the supply chain by aligning goals and incentives across different functions and stages of the supply chain. Other actions that managers can take to improve coordination include sharing of sales information and collaborative forecasting and planning, implementation of single-point control of replenishment, improving operations to reduce lead times and lot sizes, E D L P and other pricing strategies that limit forward buying, and the building of trust and strategic partnerships within the supply chain. Top management commitment, the devotion of resources to coordination, and a focus on communication across the supply chain are important requirements for coordination to improve in practice.

Some Practical Approaches to Improve Supply Chain Coordination (1 of 2)

Continuous replenishment and vendor-managed inventories

A single point of replenishment

C R P – wholesaler or manufacturer replenishes based on P O S data

V M I – manufacturer or supplier is responsible for all decisions regarding inventory

Substitutes

Some Practical Approaches to Improve Supply Chain Coordination (2 of 2)

Collaborative planning, forecasting, and replenishment (C P F R)

Sellers and buyers in a supply chain may collaborate along any or all of the following

Strategy and planning

Demand and supply management

Execution

Analysis

Common C P F R Scenarios

Table 10-2 Four Common C P F R Scenarios

C P F R Scenario	Where Applied in Supply Chain	Industries Where Applied
Retail event collaboration	Highly promoted channels or categories	All industries other than those that practice E D L P
D C replenishment collaboration	Retail D C or distributor D C	Drugstores, hardware, grocery
Store replenishment collaboration	Direct store delivery or retail D C-to-store delivery	Mass merchants, club stores
Collaborative assortment planning	Apparel and seasonal goods	Department stores, specialty retail

Collaborative Planning, Forecasting, and Replenishment (C P F R) (1 of 2)

Retail event collaboration

D C replenishment collaboration

Store replenishment collaboration

Collaborative assortment planning

Organizational and technology requirements for successful C P F R

Risks and hurdles for a C P F R implementation

Collaborative Planning, Forecasting, and Replenishment (C P F R) (2 of 2)

Figure 10-4 Collaborative Organizational Structure

Summary of Learning Objective 4

V M I and C P F R are two practical approaches to improve coordination in the supply chain. Under V M I, the supplier is responsible for managing product inventories at the retailer while ensuring an agreed upon level of service. Under C P F R, supply chain members manage forecasting, planning, and replenishment in a collaborative manner. Partners may set C P F R relationships to collaborate on store events, D C replenishment, store replenishment, or assortment planning. D C replenishment collaboration is often the easiest to implement because it requires aggregate-level data. Store replenishment collaboration requires a higher level of investment in technology and data sharing to be successful.

Chapter 10 • Coordination in a Supply Chain 251

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FIGURE 10-1 Demand Fluctuations at Different Stages of a Supply Chain

to coordinate information exchange with thousands of suppliers and dealers. The fundamental challenge today is for supply chains to achieve coordination in spite of multiple ownership and increased product variety.

One outcome of the lack of supply chain coordination is the bullwhip effect, in which fluctuations in orders increase as they move up the supply chain from retailers to wholesalers to manufacturers to suppliers, as shown in Figure 10-1. The bullwhip effect distorts demand information within the supply chain, with each stage having a different estimate of what demand looks like.

Procter & Gamble (P&G) has observed the bullwhip effect in the supply chain for Pampers diapers.1 The company found that raw material orders from P&G to its suppliers fluctuated significantly over time. Farther down the chain, when sales at retail stores were studied, the fluctuations, while present, were small. It is reasonable to assume that the consumers of diapers (babies) at the last stage of the supply chain used them at a steady rate. Although consumption of the end product was stable, orders for raw material were highly variable, increasing costs and making it difficult to match supply and demand.

HP also found that the fluctuation in orders increased significantly as they moved from the resellers up the supply chain to the printer division to the integrated circuit division.2 Once again,

1 Lee, Padmanabhan, and Whang (1997). 2 Ibid.

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FIGURE 10-2 Demand and Order Stream with Orders Every Five Weeks

Because orders are batched and placed every five weeks, the order stream has four weeks without orders followed by a large order that equals five weeks of demand. A manufacturer supplying several retailers that batch their orders faces an order stream that is much more variable than the demand the retailers experience. If the manufacturer batches its orders to suppliers, the effect is further magnified. In many instances, there are certain focal-point periods, such as the first or the last week of a month, when a majority of the orders arrive. This concen- tration of orders further exacerbates the impact of batching.

LARGE REPLENISHMENT LEAD TIMES Information distortion is magnified if replenishment lead times between stages are long. Consider a situation in which a retailer has misinterpreted a random increase in demand as a growth trend. If the retailer faces a lead time of two weeks, it will incorporate the anticipated growth over two weeks when placing the order. In contrast, if the retailer faces a lead time of two months, it will incorporate into its order the anticipated growth over two months (which will be much larger). The same applies when a random decrease in demand is interpreted as a declining trend.

RATIONING AND SHORTAGE GAMING Rationing schemes that allocate limited production in proportion to the orders placed by retailers lead to a magnification of information distortion. This can occur when a high-demand product is in short supply. In such a situation, manufacturers come up with a variety of mechanisms to ration the scarce supply of product among various distributors or retailers. One commonly used rationing scheme is to allocate the available supply of product based on orders placed. Under this rationing scheme, if the supply available is 75 percent of the total orders received, each retailer receives 75 percent of its order.

This rationing scheme results in a game in which retailers try to increase the size of their orders to increase the amount supplied to them. A retailer needing 75 units orders 100 units in the hope of getting 75. The net impact of this rationing scheme is to artificially inflate orders for

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the product. In addition, a retailer ordering based on what it expects to sell gets less and as a result loses sales, whereas a retailer that inflates its order is rewarded.

If the manufacturer is using orders to forecast future demand, it will interpret the increase in orders as an increase in demand even though customer demand is unchanged. The manufacturer may respond by building enough capacity to be able to fill all orders received. Once sufficient capacity becomes available, orders return to their normal level because they were inflated in response to the rationing scheme. The manufacturer is now left with a surplus of product and capacity. These boom-and-bust cycles thus tend to alternate.

This phenomenon is fairly common in the electronics industry, in which alternating periods of component shortages followed by a component surplus are often observed. In particular, memory chip manufacturing experienced a couple of such cycles in the 1990s.

Pricing Obstacles

Pricing obstacles arise when the pricing policies for a product lead to an increase in variability of orders placed.

LOT SIZE–BASED QUANTITY DISCOUNTS Lot size–based quantity discounts increase the lot size of orders placed within the supply chain (see Chapter 11) because lower prices are offered for larger lots. As discussed earlier, the resulting large lots magnify the bullwhip effect within the supply chain.

PRICE FLUCTUATIONS Trade promotions and other short-term discounts offered by a manufac- turer result in forward buying, by which a wholesaler or retailer purchases large lots during the discounting period to cover demand during future periods. Forward buying results in large orders during the promotion period followed by very small orders after that (see Chapter 11), as shown in Figure 10-3 for chicken noodle soup.

Observe that the shipments during the peak period are higher than the sales during the peak period because of a promotion offered. The peak shipment period is followed by a period of low

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FIGURE 10-3 Retailer Sales and Manufacturer Shipments of Soup Source: Reprinted by permission of Harvard Business Review. Adapted from “What Is the Right Supply Chain for Your Product?” by Marshall L. Fisher, Harvard Business Review (March–April 1997): 83–93. Copyright © 1997 by the Harvard Business School Publishing Corporation; all rights reserved.

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if one of the partners changes its scale or technology, the other partner is forced to follow suit or lose the collaborative relationship. Finally, the implementation of CPFR and the resolution of exceptions require close interactions between two entities whose cultures may be very different. The inability to foster a collaborative culture across the partner organizations can be a major hurdle for the success of CPFR. One of the biggest hurdles to success is often that partners attempt store-level collaboration, which requires a higher organizational and technology invest- ment. It is often best to start with an event- or DC-level collaboration, which is more focused and easier to collaborate on. One of the biggest hurdles for successful CPFR, however, is that demand information shared with partners is often not used within the organization in an integrated manner. It is important to have integrated demand, supply, logistics, and corporate planning within the organization to maximize the benefits of a CPFR effort with a partner.

10.7 ACHIEVING COORDINATION IN PRACTICE

1. Quantify the bullwhip effect. Companies often have no idea that the bullwhip effect plays a significant role in their supply chain. Managers should start by comparing the variability in the orders they receive from their customers with the variability in orders they place with their suppliers. This helps a firm quantify its own contribution to the bullwhip effect. Once its contri- bution is visible, it becomes easier for a firm to accept the fact that all stages in the supply chain contribute to the bullwhip effect, leading to a significant loss in profits. In the absence of this concrete information, companies try to react better to the variability rather than eliminate the variability itself. This leads companies to invest significant amounts in inventory management and scheduling systems, only to see little improvement in performance or profits. Evidence of the size of the bullwhip effect is effective in getting different stages of the supply chain to focus on efforts to achieve coordination and eliminate the variability created within the supply chain.

2. Get top management commitment for coordination. More than any other aspect of supply chain management, coordination can succeed only with top management’s commitment. Coordination requires managers at all stages of the supply chain to subordinate their local interests to the greater interest of the firm and even the supply chain. Coordination often requires the resolution of trade-offs in a way that requires many functions in the supply chain to change their traditional practices. These changes often run counter to approaches that were put in place when each function focused only on its local objective. Such changes within a supply chain

Customer 1 Team Demand Planning

Sales Customer Service/

Logistics

Customer 2 Team Demand Planning

Sales Customer Service/

Logistics

Category Team

• Merchandise Planning • Buying

• Replenishment

Manufacturer Organization Retailer Organization

FIGURE 10-4 Collaborative Organizational Structure Source: Adapted from Voluntary Interindustry Commerce Standards, CPFR: An Overview, 2004.

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