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SupplyChainManagementALogisticsPerspective9thed.pdf

Supply Chain Management A LOGISTICS PERSPECTIVE

9e

JOHN J. COYLE The Pennsylvania State University

C. JOHN LANGLEY, JR. The Pennsylvania State University

ROBERT A. NOVACK The Pennsylvania State University

BRIAN J. GIBSON Auburn University

Australia • Brazil • Japan • Korea • Mexico • Singapore • Spain • United Kingdom • United States

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Supply Chain Management: A Logistics Perspective, Ninth Edition John J. Coyle, C. John Langley Jr., Robert A. Novack, Brian J. Gibson

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A very special note of thanks and appreciation is due to our families. John Coyle would like to thank his wife Barbara, their children John and Susan, and their grandchildren Lauren, Matthew, Elizabeth Kate, Emily, Ben, Cathryn, and Zachary. John Langley

would like to thank his wife Anne, their children Sarah and Mercer, and their grandchildren Bryson and Molly. Bob Novack would like to thank his wife Judith and their children Tom, Elizabeth, and Alex. Brian Gibson would like to thank his

wife Marcia and son Andy.

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Brief Contents

Preface xxii About the Authors xxvi

Part I Chapter 1 Supply Chain Management: An Overview 3 Chapter 2 Role of Logistics in Supply Chains 33 Chapter 3 Global Dimensions of Supply Chains 75

Part II Chapter 4 Supply Chain Relationships 107 Chapter 5 Supply Chain Performance Measurement

and Financial Analysis 137 Chapter 6 Supply Chain Technology—Managing

Information Flows 179

Part III Chapter 7 Demand Management 215 Chapter 8 Order Management and Customer

Service 255 Chapter 9 Managing Inventory in the Supply Chain 311 Chapter 10 Transportation—Managing the Flow of the

Supply Chain 395 Chapter 11 Distribution—Managing Fulfillment

Operations 459

Part IV Chapter 12 Supply Chain Network Analysis and

Design 509 Chapter 13 Sourcing Materials and Services 549 Chapter 14 Operations—Producing Goods and

Services 583 Chapter 15 Supply Chain Sustainability 619

Part V Chapter 16 Strategic Challenges and Change for Supply

Chains 645

Subject Index 673

Name Index 687 v

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Contents

Preface xxii About the Authors xxvi

Part I Chapter 1 Supply Chain Management: An Overview 3

SUPPLY CHAIN PROFILE: SAB Distribution: Another Sequel 4

Introduction 5 What Forces Are Driving the Rate of Change 7

Globalization 7 Technology 10 Organizational Consolidation and Power Shifts 10 The Empowered Consumer 11 Government Policy and Regulation 12

ON THE LINE: Malt-O-Meal Company: Going National 14

The Supply Chain Concept 15 Development of the Concept 15

Major Supply Chain Issues 24 Supply Chain Networks 24 Complexity 24 Inventory Deployment 25 Information 25 Cost and Value 25

ON THE LINE: Auto Parts Distributor LKQ Discovers the Key to Effective Carrier Management 26

Organizational Relationships 26 Performance Measurement 27 Technology 27 Transportation Management 27

SUPPLY CHAIN TECHNOLOGY: Trends in Retail Distribution 28 Supply Chain Security 28

Summary 29 Study Questions 29 Notes 30 Case 1.1: Central Transport, Inc. 31

Chapter 2 Role of Logistics in Supply Chains 33 SUPPLY CHAIN PROFILE: Jordano Foods: The Sequel 34

Introduction 35 What Is Logistics? 37

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Value-Added Roles of Logistics 39 Form Utility 39 Place Utility 40 Time Utility 40 Quantity Utility 40 Possession Utility 40

ON THE LINE: Building India: Transforming the Nation’s Logistics Infrastructure 41

Logistics Activities 41 Transportation 42 Storage 42 Packaging 43 Materials Handling 43 Inventory Control 43 Order Fulfillment 44 Forecasting 44 Production Planning 44 Procurement 44 Customer Service 45 Facility Location 45 Other Activities 45

Logistics in the Economy: A Macro Perspective 45 ON THE LINE: Ce De Candy’s Sweet Transformation 46

Logistics in the Firm: The Micro Dimension 49 Logistics Interfaces with Manufacturing or Operations 49 Logistics Interfaces with Marketing 50 Logistics Interfaces with Other Areas 52

Logistics in the Firm: Factors Affecting the Cost and Importance of Logistics 53 Competitive Relationships 53 Product Relationships 56 Spatial Relationships 59

Techniques of Logistics System Analysis 60 Short-Run/Static Analysis 60 Long-Run/Dynamic Analysis 61

Approaches to Analyzing Logistics Systems 63 Materials Management versus Physical Distribution 63 Cost Centers 64 Nodes Versus Links 65 Logistics Channels 65

SUPPLY CHAIN TECHNOLOGY: Mission Foods’ Wireless Evolution 68 Logistics and Systems Analysis 68

viii Contents

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Summary 70 Study Questions 70 Notes 71 Case 2.1: Senco Electronics Company: A Sequel 72 Case 2.2: Pete’s 74

Chapter 3 Global Dimensions of Supply Chains 75 SUPPLY CHAIN PROFILE: Red Fish–Blue Fish, LLP: A Sequel 76

Introduction 77 Supply Chains in a Global Economy 79 ON THE LINE: More Deliveries, Same Cost 80

The Scope and Magnitude of Global Business 81 Global Markets and Strategy 83 ON THE LINE: Serving Emerging Markets: A Survival Guide 84 ON THE LINE: Asia’s Widening Middle 86

Supply Chain Security: A Balancing Act 87 SUPPLY CHAIN TECHNOLOGY: Tracing through the Supply Chain 88

Ports 89 North American Free Trade Agreement 90 Maquiladora Operations 91 Asian Emergence 92 New Directions 93 Global Transportation Options 93

Ocean 93 Air 95 Motor 96 Rail 96

Global Intermediaries 96 Foreign Freight Forwarders 96 Airfreight Forwarders 97 Non-Vessel-Operating Common Carriers 97 Export Management Companies 97 Export Trading Companies 98 Customs House Brokers 98

Storage Facilities and Packaging 99 Storage Facilities 99 Packaging 99

Summary 100 Study Questions 100 Notes 101 Case 3.1: Red Fish–Blue Fish, LLP: Another Sequel 103

Contents ix

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Part II Chapter 4 Supply Chain Relationships 107

SUPPLY CHAIN PROFILE: Client Intimacy: A New Mission for Supply Chain Managers? 108

Introduction 108 Logistics Relationships 109

Types of Relationships 109 Intensity of Involvement 109 Model for Developing and Implementing Successful

Supply Chain Relationships 111 Need for Collaborative Relationships 115

Third-Party Logistics—Industry Overview 117 ON THE LINE: Collaborative Distribution Can Show You the Path to Lower Supply Chain Costs and Carbon Emissions 117 Definition of Third-Party Logistics 119 Types of 3PL Providers 119 3PL Market Size and Scope 121

Third-Party Logistics Research Study—Industry Details 123 Profile of Logistics Outsourcing Activities 123 Strategic Role of Information Technology 124

SUPPLY CHAIN TECHNOLOGY: Technology a Key Driver of 3PL Competitiveness 125

Management and Relationship Issues 127 Customer Value Framework 129 A Strategic View of Logistics and the Role of 3PLs 130

Summary 132 Study Questions 132 Notes 133 Case 4.1: CoLinx, LLC 134 Case 4.2: Ocean Spray Cranberries, Inc. 136

Chapter 5 Supply Chain Performance Measurement and Financial Analysis 137 SUPPLY CHAIN PROFILE: CLGN Book Distributors.com 138

Introduction 140 Dimensions of Supply Chain Performance Metrics 140 Developing Supply Chain Performance Metrics 145 Performance Categories 146 The Supply Chain–Finance Connection 151 ON THE LINE: Profit-Focused Supply Chain Planning 152

The Revenue–Cost Savings Connection 153 The Supply Chain Financial Impact 154

x Contents

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Financial Statements 158 ON THE LINE: Leased Assets to Go Back on Your Books? 159

Financial Impact of Supply Chain Decisions 160 Supply Chain Service Financial Implications 164 Summary 172 Study Questions 172 Notes 174 Case 5.1: CPDW 175 Case 5.2: Paper2Go.com 176

Appendix 5A Financial Terms 177

Chapter 6 Supply Chain Technology—Managing Information Flows 179 SUPPLY CHAIN PROFILE: The Precision Imperative 180

Introduction 181 The Role of Information in the Supply Chain 182

Information Requirements 183 Information Technology Capabilities 184 Information Technology Challenges 185

A Framework for Managing Supply Chain Information 186 Foundation Elements 186 Key Requirements 188 Differentiating Capabilities 189

SCM Software 190 Planning 191 Execution 192 Event Management 193 Business Intelligence 193 Related Tools 194 Enterprise Resource Planning 195

Supply Chain Technology Implementation 195 Needs Assessment 196 Software Selection 196

ON THE LINE: SaaS Capabilities Boost Transportation Software Sales 199 Technical Issues 199 Asking the Right Questions 201

Supply Chain Technology Innovations 202 Radio-Frequency Identification (RFID) 202 Cloud Computing 203 Mobile Computing 204

SUPPLY CHAIN TECHNOLOGY: Smartphones and SCM 204 3PLs as Technology Providers 205

Contents xi

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Summary 207 Study Questions 207 Notes 208 Case 6.1: Bazinga Licensing Ltd. 210 Case 6.2: Catnap Pet Products 211

Part III Chapter 7 Demand Management 215

SUPPLY CHAIN PROFILE: LuAnn’s Chocolates 216

Introduction 217 Demand Management 217 Balancing Supply and Demand 220 Traditional Forecasting 221

Factors Affecting Demand 221 Simple Moving Average 222 Weighted Moving Average 223 Exponential Smoothing 225 Adjusting Exponential Smoothing for Trend 225 Seasonal Influences on Forecasts 228

Forecast Errors 229 SUPPLY CHAIN TECHNOLOGY: Delivering APS Value in Six Months 231

Sales and Operations Planning 234 ON THE LINE: BASF Credits S&OP as a Cornerstone of Success 236

Collaborative Planning, Forecasting, and Replenishment 237

Fulfillment Models 240 Channels of Distribution 240 Direct-to-Customer (DTC) Fulfillment 242

Summary 249 Study Questions 249 Notes 250 Case 7.1: Tires for You, Inc. 251 Case 7.2: ChipSupreme 253

Chapter 8 Order Management and Customer Service 255 SUPPLY CHAIN PROFILE: Tom’s Food Wholesalers 256

Introduction 256 Influencing the Order—Customer Relationship

Management 258 Step 1: Segment the Customer Base by Profitability 258 Step 2: Identify the Product/Service Package for Each

Customer Segment 259

xii Contents

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Step 3: Develop and Execute the Best Processes 259 Step 4: Measure Performance and Continuously

Improve 260 Activity-Based Costing and Customer Profitability 261

Executing the Order—Order Management and Order Fulfillment 267 Order-to-Cash (OTC) and Replenishment Cycles 268 Length and Variability of the Order-to-Cash Cycle 272

E-Commerce Order Fulfillment Strategies 273 SUPPLY CHAIN TECHNOLOGY: Get Ready to go Mobile 274

Customer Service 275 The Logistics/Marketing Interface 275 Defining Customer Service 277 Elements of Customer Service 277 Performance Measures for Customer Service 281

Expected Cost of Stockouts 283 Back Orders 284 Lost Sales 284 Lost Customer 285 Determining the Expected Cost of Stockouts 285

Order Management Influences on Customer Service 286 Product Availability 286

ON THE LINE: Plus-Sized Customer Service 288 Financial Impact 290 Order Cycle Time 292 Logistics Operations Responsiveness 295 Logistics System Information 298 Postsale Logistics Support 300

SUPPLY CHAIN TECHNOLOGY: Connecting with Big Customers 302

Service Recovery 303 Summary 305 Study Questions 305 Notes 306 Case 8.1: Telco Corporation 307 Case 8.2: The Bullpen 309

Chapter 9 Managing Inventory in the Supply Chain 311 SUPPLY CHAIN PROFILE: Micros and More 312

Introduction 313 Inventory in the U.S. Economy 314 Inventory in the Firm: Rationale for Inventory 315

Batching Economies or Cycle Stocks 317 Uncertainty and Safety Stocks 318 Time/In-Transit and Work-in-Process Stocks 318

Contents xiii

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SUPPLY CHAIN TECHNOLOGY: Logistics Provider Prescribes Inventory Management 319 Seasonal Stocks 321 Anticipatory Stocks 322 Summary of Inventory Accumulation 322 The Importance of Inventory in Other Functional

Areas 322 Inventory Costs 323

Inventory Carrying Cost 323 Ordering and Setup Cost 328 Carrying Cost Versus Ordering Cost 330 Expected Stockout Cost 331 In-Transit Inventory Carrying Cost 335

Fundamental Approaches to Managing Inventory 336 Key Differences Among Approaches to Managing

Inventory 337 Principal Approaches and Techniques for Inventory

Management 339 Fixed Order Quantity Approach (Condition of Certainty)

339 Fixed Order Quantity Approach (Condition of

Uncertainty) 348 Fixed Order Interval Approach 356 Summary and Evaluation of EOQ Approaches to Inventory

Management 357 Additional Approaches to Inventory Management 357

Just-in-Time Approach 357 ON THE LINE: Inventory Optimization: Show Me the Money 358 Materials Requirements Planning 361 Distribution Requirements Planning 366 Vendor-Managed Inventory 369

Classifying Inventory 370 ABC Analysis 371 Quadrant Model 373 Inventory at Multiple Locations—The Square-Root

Rule 374 Summary 377 Study Questions 378 Notes 378 Case 9.1: MAQ Corporation 380 Case 9.2: Baseball Card Emporium 381

Appendix 9A Special Applications of the EOQ Approach 382 Adjusting the Simple EOQ Model for Modal Choice

Decisions—The Cost of Inventory in Transit 382 Adjusting the Simple EOQ Model for Volume

Transportation Rates 385

xiv Contents

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Adjusting the Simple EOQ Model for Private Carriage 388 Adjusting the Simple EOQ Model for the Establishment and

Application of In-Excess Rates 389 Summary 393

Chapter 10 Transportation—Managing the Flow of the Supply Chain 395 SUPPLY CHAIN PROFILE: Economic Recovery and Transportation Demand 396

Introduction 397 The Role of Transportation in Supply Chain Management

(SCM) 397 Challenges to Carrying out This Role 398 Modes of Transportation 401

Motor Carriers 401 Railroads 404 Air Carriers 405 Water Carriers 407

ON THE LINE: Piracy: A Modern Day Problem 409 Pipelines 409 Intermodal Transportation 411

Transportation Planning and Strategy 413 Functional Control of Transportation 414 Terms of Sale 415 Decision to Outsource Transportation 416 Modal Selection 418 Carrier Selection 423 Rate Negotiations 424

Transportation Execution and Control 424 Shipment Preparation 425 Freight Documentation 426 Maintain In-Transit Visibility 428 Monitor Service Quality 429 Transportation Metrics 429

Transportation Technology 432 SUPPLY CHAIN SUSTAINABILITY: Reducing Empty Miles 433

Transportation Management Systems 433 SUPPLY CHAIN TECHNOLOGY: TMS Shines Light on Inbound Supply Chain 435

Summary 438 Study Questions 438 Notes 439 Case 10.1: Supreme Sound Explosion 442 Case 10.2: Bob’s Custom BBQs 444

Contents xv

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Appendix 10A Federal Regulation of the Transportation Industry 446 Economic Regulation 446 Safety Regulation 449 Summary 451 Notes 451

Appendix 10B Basis of Transportation Rates 452 Cost of Service 452 Value of Service 453 Distance 454 Weight of Shipment 455 Commodity Characteristics 455 Level of Service 456 Summary 457 Notes 457

Chapter 11 Distribution—Managing Fulfillment Operations 459 SUPPLY CHAIN PROFILE: Kroger: Grocery Giant Changes the Game 460

Introduction 461 The Role of Distribution Operations in SCM 462

Distribution Facility Functionality 462 Distribution Tradeoffs 464 Distribution Challenges 467

Distribution Planning and Strategy 467 Capability Requirements 468 Network Design Issues 470 Facility Considerations 474

SUPPLY CHAIN TECHNOLOGY: Walmart’s Environmentally Friendly DCs 475

Distribution Execution 478 Product-Handling Functions 478

ON THE LINE: Goods-to-Person Puts a Different Spin on Order Picking 480 Support Functions 483

Distribution Metrics 484 Customer-Facing Measures 484 Internal Measures 485

Distribution Technology 486 Warehouse Management Systems 487

SUPPLY CHAIN TECHNOLOGY: Moving Coca-Cola by Voice 488 Automatic Identification Tools 490

Summary 492 Study Questions 493 Notes 493

xvi Contents

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Case 11.1: BathKing Industries 495 Case 11.2: Tele-Distributors Incorporated 497 Appendix Materials Handling 499

Appendix 11A Materials Handling 499 Objectives and Principles of Materials Handling 499 Materials-Handling Equipment 500 Summary 506 Notes 506

Part IV Chapter 12 Supply Chain Network Analysis and Design 509

SUPPLY CHAIN PROFILE: Volkswagen Opens U.S. Production Facility in Chattanooga, Tennessee 510

Introduction 511 The Need for Long-Range Planning 512

The Strategic Importance of Logistics/Supply Chain Network Design 512

Changing Customer Service Requirements 513 Shifting Locations of Customer and/or Supply

Markets 513 Change in Corporate Ownership 514 Cost Pressures 514 Competitive Capabilities 515 Corporate Organizational Change 515

Logistics/Supply Chain Network Design 515 Step 1: Define the Logistics/Supply Chain Network Design

Process 516 Step 2: Perform a Logistics/Supply Chain Audit 516 Step 3: Examine the Logistics/Supply Chain Network

Alternatives 517 Step 4: Conduct a Facility Location Analysis 518 Step 5: Make Decisions Regarding Network and Facility

Location 518 Step 6: Develop an Implementation Plan 519

Major Locational Determinants 519 Key Factors for Consideration 520

ON THE LINE: Global Sourcing and Manufacturing Compel Companies to Rethink U.S. Distribution Networks 522 Current Trends Governing Site Selection 524

Modeling Approaches 524 Optimization Models 525 Simulation Models 528 Heuristic Models 529 Potential Supply Chain Modeling Pitfalls to Avoid 530

Contents xvii

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SUPPLY CHAIN TECHNOLOGY: Supply Chain Network Design in an Era of Dynamic Costs 531

Example of a Heuristic Modeling Approach: The Grid Technique 532

Transportation Pragmatics 539 Summary 543 Study Questions 543 Notes 545 Case 12.1: Johnson & Johnson 546 Case 12.2: Fireside Tire Company 547

Chapter 13 Sourcing Materials and Services 549 SUPPLY CHAIN PROFILE: Achieving Greater Cost Savings for Global Manufacturers Through Merger of Supply Chain Service Providers 550

Introduction 550 Types and Importance of Items and Service Purchased 552 Strategic Sourcing Methodology 555

Step 1: Project Planning and Kickoff 556 Step 2: Profile Spend 556 Step 3: Assess Supply Market 556 Step 4: Develop Sourcing Strategy 557 Step 5: Execute Sourcing Strategy 558 Step 6: Transition and Integrate 559 Step 7: Measure and Improve Performance 560

Managing Sourcing and Procurement Processes 560 Supplier Selection 561 ON THE LINE: IBM Achieves Success via Improved Purchasing and Strategic Sourcing 563

Supplier/Vendor Evaluation and Relationships 564 Certifications and Registrations 564

The Special Case of Procurement Price 565 Total Landed Cost (TLC) 569 e-Sourcing and e-Procurement 570

Which of These Solutions Should Be Considered 571 Advantages 572 Disadvantages 573

SUPPLY CHAIN TECHNOLOGY: Transportation Sourcing – Innovative Approaches to Bid Optimization 574

e-Commerce Models 574 Summary 576 Study Questions 576 Notes 577 Case 13.1: South Face 578 Case 13.2: Durable Vinyl Siding Corporation 580

xviii Contents

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Chapter 14 Operations—Producing Goods and Services 583 SUPPLY CHAIN PROFILE: Ford: Putting on the Top Hat 584

Introduction 585 The Role of Production Operations in Supply Chain

Management (SCM) 586 Production Process Functionality 586 Production Tradeoffs 587 Production Challenges 589

Operations Strategy and Planning 590 Production Strategies 590

ON THE LINE: Whirlpool’s On-Shore Production Decision 595 Production Planning 596

Production Execution Decisions 599 Assembly Processes 599

ON THE LINE: Creating Your Own Chocolate Bar 600 Production Process Layout 602 Packaging 604

SUPPLY CHAIN SUSTAINABILITY: Dell’s Three C’s Packaging Strategy 606

Production Metrics 607 Total Cost 607 Total Cycle Time 607 Delivery Performance 608 Quality 608 Safety 608

Production Technology 608 Summary 611 Study Questions 612 Notes 612 Case 14.1: Elvis Golf Ltd. 615 Case 14.2: Team HDX 617

Chapter 15 Supply Chain Sustainability 619 SUPPLY CHAIN PROFILE: Trash to Treasure Foundation: A Sequel 620

Introduction 621 Supply Chain Sustainability Framework 622 Reverse Logistics Systems 624 Importance and Magnitude of Reverse Flows 625 ON THE LINE: Staples Shows Business Value of Environmental Initiatives 627

Reverse Logistics Systems versus Closed Loops 628 Customer Returns 630 Environmental Challenges 631

ON THE LINE: Triple Bottom Line 631 Economic Value 632

Contents xix

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Achieving a Value Stream for Reverse Flows 632 Managing Reverse Flows in a Supply Chain 634 SUPPLY CHAIN TECHNOLOGY: Improving Reverse Flows with Technology 635

Summary 637 Study Questions 637 Notes 638 Case 15.1: Fitness Retreads, LLP: A Sequel 640

Part V Chapter 16 Strategic Challenges and Change for Supply Chains 645

SUPPLY CHAIN PROFILE: From Bean to Cup: How Starbucks Transformed Its Supply Chain 646

Introduction 648 Principles of Supply Chain Management 648

Principle 1: Segment Customers Based on Service Needs 648

Principle 2: Customize the Logistics Network 648 Principle 3: Listen to Signals of Market Demand and Plan

Accordingly 648 Principle 4: Differentiate Products Closer to the

Customer 649 Principle 5: Source Strategically 649 Principle 6: Develop a Supply Chainwide Technology

Strategy 650 Principle 7: Adopt Channel-Spanning Performance

Measures 650 Focus of Supply Chain Management 650

Getting to Growth: Think Beyond Cost 651 Develop World-Class Collaboration Skills 653 Grow Your Leadership Capabilities 653

ON THE LINE: Best Buy’s Supply Chain Transformation 654

Supply Chain Strategies 655 Differentiation Strategies 655

SUPPLY CHAIN TECHNOLOGY: Technology a Key Requirement for Supply Chain Success 656 Financial Strategies 658 Technology-Based Strategies 660 Relationship-Based Strategies 661 Global Strategies 664

xx Contents

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Supply Chain Transformation 666 Motorola 666

Summary 668 Study Questions 668 Notes 669 Case 16.1: Tommy Hilfiger and Li & Fung 670 Case 16.2: Peerless Products, Inc. 671

Subject Index 673 Name Index 687

Contents xxi

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Preface

Supply chain management and the closely related concept of logistics are necessary cornerstones of competitive strategy, increased market share, and shareholder value for most organizations. Now more than ever, students who are currently planning to pursue a career in business will benefit from a clear understanding of this field. Practicing man- agers will also find this text a beneficial and helpful resource because of its timeliness and the depth and breadth of the topics covered.

With this edition we have tried to cover, as comprehensively as possible, the changes in the way business is being done. In fact, the title of this edition—Supply Chain Management: A Logistics Perspective—reflects the ever-changing nature of this rapidly evolving field. The author team strives to offer you the most current, comprehensive thinking on supply chain management, combined with an authenticated, real-world logistics perspective. In keeping with the dramatic changes that have taken place in the global business environment and in the field of supply chain management, the organiza- tion of this edition again provides a logical framework for achieving a meaningful under- standing of the concepts and principles of supply chain management. Additionally, it is important to understand that a major feature of this text is that not only is the discipline of supply chain management viewed from a logistics perspective but also that logistics is positioned as a set of key processes and functions that are viewed as essential to strategic and operational success with the broader supply chain concept.

Part I provides a framework for your understanding of supply chain management and some of its important related components. Chapter 1 is devoted to a comprehensive introduction to supply chain management. Chapter 2 presents an overview of all of the important dimensions of logistics and explains the relationship of logistics to supply chain management. Finally, Chapter 3 explores global supply chains and their relevance to global trade strategy and success.

Strategic factors are the focus of Part II. Chapter 4 leads off with a discussion of supply chain relationships and the use of third-party logistics services. Chapter 5, a chapter devoted to performance measurement and financial analysis, will help you understand how to use both performance and financial metrics to gauge efficiency and effectiveness. And finally, Chapter 6 examines the role and importance of information systems in the effective management of supply chains.

Part III addresses the key process areas within supply chain fulfillment. Chapter 7 dis- cusses demand management, while Chapter 8 addresses the very closely connected topics of order management and customer service. Chapter 9 focuses on one of the most crucial assets on many companies’ balance sheets—inventory management—revealing the costs of inventory and the most effective means of managing inventory. Transportation and distribution can be viewed as the glue that holds supply chains together, and effective strategies and technologies in these areas are the subjects of Chapter 10 and Chapter 11.

With Part IV, you’ll be drawn into the world of supply chain planning, sourcing, and operations. Chapter 12 will give you the tools needed to analyze, design, and refine a supply chain network, while Chapter 13 focuses attention on key topics and issues relating to sourcing, procurement, supplier and vendor relationships, and the latest elec- tronic technologies to be used in these areas. Chapter 14 on operations and Chapter 15 on reverse flows present entirely new material created for this edition.

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The final chapter, in Part V, explores the major macro trends that will impact the future of logistics and supply chain management, as well as strategies for staying competitive in the future. Among the major types of strategies discussed are differentia- tion, financing, technology, relationships, and globalization. Last, some thoughts are included on the need for organizations of all types to transform and change their supply chains as conditions would suggest.

Features • Learning Objectives at the beginning of each chapter provide students with an overall perspective of chapter material and also serve to establish a baseline for a working knowledge of the topics that follow.

• Supply Chain Profiles are the opening vignettes at the beginning of each chapter that introduce students to the chapter’s topics through familiar, real-world companies, people, and events.

• On the Line features are applied, concrete examples that provide students with hands-on managerial experience of the chapter topics.

• Supply Chain Sustainability boxes have been added to highlight the critical role of supply chain management in conserving resources, reducing waste, and mitigating the environmental impact of fulfillment operations.

• Supply Chain Technology boxes help students relate technological developments to supply chain management concepts and logistics practices.

• End-of-chapter summaries and study questions reinforce material presented in each chapter.

• Short cases at the end of each chapter build upon what students have learned. Questions that follow the cases sharpen critical thinking skills.

Ancillaries Instructor’s Resource CD (ISBN 1-111-82299-9) contains three essential resources:

• The Instructor’s Manual includes chapter outlines, answers to end-of-chapter study questions, commentary on end-of-chapter short cases and end-of-text comprehensive cases, and teaching tips.

• A convenient Test Bank offers a variety of true/false, multiple choice, and essay questions for each chapter.

• PowerPoint slides cover the main chapter topics and contain graphics from the main text.

Student Resources A rich library of Student’s Resource are available on the companion Web site, such as:

• Suggested reading for Part 1 through Part 5

• Directory of Trade and Professional Organizations in Supply Chain Management

• Additional Cases

• A Guide of Careers in Logistics

• Glossary

• Games and more

Preface xxiii

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Acknowledgments The authors are indebted to many individuals at our respective academic institutions

as well as other individuals with whom we have had contact in a variety of venues. Our university students and our executive program students have provided an important sound- ing board for the many concepts, techniques, metrics, and strategies presented in the book. Our faculty and corporate colleagues have provided invaluable insights and appropriate criticism of our ideas. Some individuals deserve special consideration: Dr. David A. Lindsley (University of Toledo), Mark J. Basile (DuPont Corporation), Dr. Joe B. Hanna (Auburn University), Dr. Chris Norek (Chain Connectors), Ms. Jessica Volpe (Penn State University), Mr. Tim Gross (Penn State University), Mr. Sammie Markham (Penn State University), Ms. Devin Maguire (Penn State University), and especially Ms. Jean Beierlein and Ms. Tracie Shannon (Penn State University). Special thanks and appreciation to Dr. Kusumal Ruamsook, Visiting Research Associate for the Center for Supply Chain Research at The Pennsylvania State University, for her invaluable support.

The ninth edition of this text will be the first one that does not list Dr. Edward Bardi as one of the co-authors. Ed was one of the two, original co-authors of the text when it was published in 1976. It is unusual for an educational book to have a life cycle that exceeds 35 years and has gone through many editions. Ed Bardi played an important role in the success of the text by helping to keep it innovative, timely and vital. Not one to postpone or procrastinate, Ed would usually finish his chapters first, and thereby provide incentive and pressure for his fellow co-authors to be more timely in meeting deadlines. He would also volunteer to do some of the more tedious and less glamorous (but important) sections of the text, for example, subject index, author index, glossary, etc. We have missed Ed’s participation and contributions this time and hope that we have lived up to his expectations and standards. We want to express our appreciation and thanks and extend a wish for good health and joy to Ed and his wife, Carol, and their family.

We extend our appreciation to the members of our Cengage Learning team, who have been very professional and helpful with this textbook: Charles McCormick, Jr., Senior Acquisitions Editor; Daniel Noguera, Developmental Editor; Jennifer Ziegler, Content Project Manager; Rathi Thirumalai, Senior Project Manager; Gunjan Chandola, Senior Project Manager; Stacey Shirley, Art Director; Adam Marsh, Marketing Manager; and Elaine Kosta, Rights and Acquisitions Specialist.

Special thanks should be given to the following Professors who served as reviewers and who provided meaningful input for our ninth edition:

Jeffrey L. Bennett Northwood University

John A. Caltagirone Loyola University Chicago

Adam Conrad Pennsylvania State University

Eddie Davila Arizona State University

Kathryn Dobie North Carolina A&T State University

Matt Drake Duquesne University

S. Altan Erdem Edison Community College

Christopher C. Esgar Penn State University, Mont Alto Campus

Paul L. Ewell Virginia Wesleyan College

Ephrem Eyob Virginia State University

Martin Farris University of North Texas

xxiv Preface

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Lou Firenze Northwood University

Michael J. Gravier Bryant University

Joh J. Gregor Washington & Jefferson College

Joe Hanna Auburn University

Ahmad Hassan Morehead State University

Balaji Janamanchi Texas A&M International University

Jonatan Jelen Baruch College

Walter Kendall Tarleton State University

Marco Lam York College of Pennsylvania

Ian M. Langella Atkin Shippensburg University

Tenpao Lee Niagara University

Cheng Li California State University, Los Angeles

Walter Martin Wake Tech Community College

John R. Mawhinney Duquesne University

Ron Mesia Florida International University

Saeed Mohaghegh Assumption College

Martin Nunlee Delaware State University

Anthony M. Pagano University of Illinois at Chicago

Ann Rensel Niagara University

Paul Skilton Washington State University

Michael J. Stevenson Hagerstown Community College

Robert S. Trebatoski Penn State University

David Vellenga Maine Maritime Academy

Simon Veronneau Quinnipiac University

Haibo Wang Texas A&M International University

William Waxman UHCL

Jon Whitford Rio Hondo College

Linda Wright Longwood University

Rick Yokeley Forsyth Technical Community College

Preface xxv

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About the Authors

John J. Coyle is currently director of corporate relations for the Center for Supply Chain Research and professor emeritus of logistics and supply chain management in the Smeal College of Business at Penn State University. He holds a BS and MS from Penn State and earned his doctorate from Indiana University in Bloomington, Indiana, where he was a U.S. Steel Fellow. He joined the Penn State faculty in 1961 and attained the rank of full professor in 1967. In addition to his teaching responsibilities, he has served in a number of administrative positions, including department head, assistant dean, senior associate dean, special assistant for strategic planning to the university pres- ident, and executive director of the Center for Supply Chain Research. He also served as Penn State’s faculty representative to the NCAA for 30 years and to the Big Ten for 10 years. Dr. Coyle was the editor of the Journal of Business Logistics from 1990 to 1996. He has authored or coauthored 20 books or monographs and numerous articles in pro- fessional journals. He has received 14 awards at Penn State for teaching excellence and advising. In addition, he received the Council of Logistics Management’s Distinguished Service Award in 1991; the Philadelphia Traffic Club’s Person of the Year Award in 2003; and the Eccles Medal from the International Society of Logistics for his contribu- tions to the Department of Defense and the Lion’s Paw Medal from Penn State for Distinguished Service, both in 2004. Dr. Coyle currently serves on the boards of three logistics and supply chain service companies and on the Advisory Board of the NLDC and continues to be active in teaching in the Executive Education Programs at Penn State.

C. John Langley Jr. is clinical professor of supply chain management in the Smeal College of Business at Penn State University and also serves as director of development in the Center for Supply Chain Research. Previously, he served as the John H. Dove dis- tinguished professor of supply chain management at the University of Tennessee and the SCL professor of supply chain management at the Georgia Institute of Technology. Dr. Langley is a former president of the Council of Supply Chain Management Professionals and a recipient of the Council’s Distinguished Service Award. He has been recognized by the American Society of Transportation and Logistics as an honorary distinguished logistics professional for his long-term contributions and continuing commitment to the transportation logistics community, and he is a recipient of the Outstanding Alumnus Award from Penn State’s Business Logistics Program. Dr. Langley received his BS in mathematics, MBA in finance, and Ph.D. in business logistics degrees, all from Penn State University. Dr. Langley has coauthored several books, including Sup- ply Chain Management: A Logistics Perspective. Also, he is lead author of the annual Third Party Logistics Study and recently completed the 2012 16th Annual 3PL Study. His research publications have appeared in journals such as the Journal of Business Lo- gistics, International Journal of Physical Distribution and Logistics Management, Interna- tional Journal of Logistics Management, and Supply Chain Management Review. Dr. Langley serves on the Boards of Directors of UTi Worldwide, Inc., Forward Air Corpo- ration, and Averitt Express, Inc., in addition to several involvements on academic advi- sory boards to logistics organizations. He also is a member of the Program Faculty for the Kühne Logistics University in Hamburg, Germany, and of the Industrial and Profes- sional Advisory Council (IPAC) at Penn State University and currently serves as educa- tion advisor for NASSTRAC.

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Robert Novack is an associate professor of supply chain management in the Department of Supply Chain and Information Systems at Penn State University. From 1981 to 1984 he worked in operations management and planning for the Yellow Freight Corporation in Overland Park, Kansas, and from 1984 to 1986 he worked in planning and transportation at Drackett Company in Cincinnati, Ohio. Dr. Novack’s numerous articles have been published in such publications as the Journal of Business Logistics, Transportation Journal, and International Journal of Physical Distribution and Logistics Management. He also is a coauthor of Creating Logistics Value: Themes for the Future. Active in the Council of Supply Chain Management Professionals, he has served as over- all program chair for the annual conference, as a track chair, and as a session speaker as well as a member of numerous committees. Dr. Novack holds the CTL designation from AST&L and is a member of WERC. He earned a BS degree and an MBA in logistics from Penn State University and a Ph.D. in logistics from the University of Tennessee.

Brian J. Gibson holds the Wilson Family Professorship in supply chain management and is a program coordinator for the Department of Supply Chain and Information Systems Management at Auburn University. Previously, he served on the faculty of Georgia Southern University and as a logistics manager for two major retailers. He has received multiple awards for outstanding teaching, research, and outreach, most notably the Council of Supply Chain Management Professionals’ Innovative Teaching Award in 2009. Gibson’s research has been published in the Journal of Business Logistics, Supply Chain Management Review, International Journal of Logistics Management, International Journal of Physical Distribution and Logistics Management, and other leading publica- tions. He is coauthor of Transportation: A Supply Chain Perspective, author of the elec- tronic textbook Supply Chain Essentials, and lead author of the annual State of the Retail Supply Chain Report. Dr. Gibson currently serves on key committees for the Council of Supply Chain Management Professionals and the Retail Industry Leaders Association. Dr. Gibson earned a BS/BA from Central Michigan University, an MBA from Wayne State University, and a Ph.D. in logistics and transportation from the University of Tennessee.

About the Authors xxvii

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Part I

As indicated in the Preface, the authors decided to reorganize the sequence and groupings of the new and revised chapters in the ninth edition of the text to be consistent with the changes that have occurred in global supply chains. Consequently, Part I now includes a chapter on global supply chains as an important part of the discussion and expla- nation of the framework for the remaining chapters. This change was deemed necessary for the understanding of the overall complexity, mag- nitude and importance of global supply chain management for financial success in the 21st century. Today’s global economy presents chal- lenges and opportunities for all organizations: private or public; small, medium or large; products or services; and profit or non-profit. Globali- zation of the world economy is occurring with increasing speed that makes supply chain management ever more important to the competi- tive success and financial viability of most organizations.

Thomas Friedman, a staff writer for the New York Times, concludes in his bestselling book, “The World Is Flat,” that the world has been leveled by ten forces. One of these forces that he describes is supply chaining, which is essentially a collaborative approach among organiza- tions to coordinate or integrate the flow of goods, information and cash to deliver value for consumers or users and efficiency and effectiveness for organizations. The collaboration stretches vertically and horizontally on a global basis to become a cornerstone of competitive strategy and a necessary ingredient for competitive success. In keeping with that logic, Chapter 1 is focused upon the development and basic tenets of supply chain management. Chapter 2 discusses the logistics concept, which can be considered as the backbone of an effective supply chain. Chapter 3 presents the special challenges and issues of global supply chains and the relationships to the first two chapters. Overall, these chapters pro- vide a solid base for the remaining chapters in the text.

Specifically, Chapter 1 provides an introduction and overview of supply chains in the 21st century, and examines the major external or exogenous forces driving the rapid rate of change in global markets.

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The chapter explains the development and rationale for supply chains on both a domestic and global basis. It provides a thorough grounding in the fundamentals and dimensions of supply chains and discusses and demonstrates their importance to 21st century organizations. Finally, the chapter examines the major challenges and issues facing organizations and their global supply chains.

Chapter 2 is focused upon explaining the role and importance of logistics in the supply chain. As indicated above, logistics is considered by some as the backbone of the supply chain since it is so intimately involved with the flow of materials and products through the supply chain. A logistics- related process is frequently the first and last “touch” in the supply chain. Logistics provides the foundation for the material flows, forward and backward, in the supply chain. Chapter 2 also examines the relation- ship between logistics and the other functional areas in a business organization and the factors related to products and markets that impact logistics costs. A final consideration in the chapter is a review of techniques that can be used for examining logistics tradeoffs.

As indicated above, Chapter 3 adds the overall global dimension to the discussion and analysis of supply chain management. This chapter builds upon the discussions in Chapters 1 and 2 by addressing the spe- cial challenges related to global supply chains. It is not only large orga- nizations but also medium- and small-sized organizations that have been or will be impacted by globalization. Consequently, excellence in managing supply chains is a requisite for businesses and other organiza- tions to succeed. The real special challenge of globalization is that it adds time and distance to supply chains that translates usually to cost, complexity and more risk—challenges and opportunities.

2 Part I

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Chapter 1

SUPPLY CHAIN MANAGEMENT : AN OVERVIEW

Learning Objectives After reading this chapter, you should be able to do the following: • Explain the external change drivers in the global economy and their impact on

global supply chains.

• Discuss the development of supply chain management in leading organizations and understand its contributions to their financial viability.

• Appreciate the significance and role of supply chain management among private as well as public or nonprofit organizations.

• Understand the contributions of supply chain management to organizational efficiency and effectiveness for competing successfully in the global marketplace.

• Explain the benefits that can be achieved from implementing supply chain best practices.

• Understand the major challenges and issues facing organizations currently and in the future.

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Supply Chain Profile SAB Distribution: Another Sequel

When Sue Purdum, former president and CEO of SAB Distribution, “passed the baton” to her successor, Susan Weber, she had held her leadership role for over 15 years. She was credited not only with helping SAB to survive in a highly competitive economic environment but also with restoring its profitability through several strategic moves in the marketplace.

SAB was established as a classic, middle-of-the-supply-chain organization since it purchased con- sumer products from major manufacturers such as Kraft, Kimberly-Clark, Procter & Gamble (P&G), Unilever, and others and sold them to smaller distributors, wholesalers, and retailers. When Susan Weber assumed the role of CEO of SAB, she knew that its continued survival depended upon the company reexamining its role in the supply chains and making appropriate strategic and tactical changes.

COMPANY BACKGROUND SAB Distribution was established in 1949 in Harrisburg, Pennsylvania, by three World War II veterans who had served as supply officers in the U.S. Navy. They selected Harrisburg because of its central location in the mid-Atlantic region and because of its access by rail and highways. The founders of SAB—Skip, Al, and Bob—recognized the need for a consumer products whole- saling company to serve medium- and small-size retailers within a 200-mile radius of Harris- burg. Their vision proved to be correct, and the company grew and prospered in subsequent years. The company was incorporated in 1978, and a CEO, Pete Swan, was appointed in 1980 when the founders retired.

SAB’s market area expanded into nearby states, such as New York, New Jersey, and Delaware, and its product line was extended from nonperishable consumer items to include perishables and additional nonfood consumer products. Ms. Purdum took over from Pete in 1990 when the company was at a major crossroads that could have led to the sale of the company. Ms. Purdum’s career at SAB was marked by a series of competitive challenges that she navi- gated successfully. Susan Weber assumed the CEO role in 2005 with the full knowledge that significant change was necessary if SAB was to survive as a profitable organization. Essentially, SAB needed a transformation in the scope of its activities.

CURRENT SITUATION SAB was faced with a number of challenges to its future existence. First and foremost, its cus- tomers had to compete against large retailers like Walmart that could buy direct from the same consumer product manufacturers as SAB, that is, with no middleman. Walmart’s buying advan- tage had to be offset in some way to keep SAB’s customers competitive. In addition, globalization was affecting SAB’s business because of an increase in imported products for the more diverse population of the United States and the ongoing search for lower-priced alternatives. The net effect was a much more complex and competitive business environment.

When Sue Purdum assumed the role of CEO in 1990, she analyzed the competitive environment and understood the need to change SAB’s business practices. She focused initially upon effi- ciency in warehouse operations to lower the cost of doing business. She improved order fulfill- ment so that customers received their orders faster and with fewer mistakes, which lowered the customers’ cost of doing business by reducing their inventory requirements. She also developed partnerships with a core group of motor carriers to give them more volume, which led to lower rates and better service. Finally, she invested in information technology since she recognized that

4 Chapter 1

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Introduction The first decade of the twenty-first century was a period of rapid change for most

organizations, especially businesses. That rate of change has not slowed down and is actually increasing in the second decade of the twenty-first century. The forces of change require organizations to be much more nimble and responsive; that is, organizations need to be able to transform themselves quickly to survive in the intensely competitive, global environment. The SAB case is a good example of this survival mode that forces companies to transform. SAB would have been driven out of business in the 1990s if it had not changed, and it now faces an even more daunting challenge, which will necessi- tate still bigger changes.

higher-quality and more timely information would improve SAB’s forecasting, with consequent reductions in inventory costs and improved order fulfillment.

Initially, Susan Weber continued to improve warehouse efficiency, order fulfillment and carrier collaboration, but she knew that she had to transform the company by attracting larger retailers as customers. Their current customers, small- to medium-sized retailers, were losing market share to the larger retailers which, obviously, negatively impacted SAB’s profitability.

Susan Weber realized that the large retailers outsourced part of their operations to third-party logistics companies that provided them with services such as warehousing, order fulfillment, transportation, and so forth more efficiently or more effectively than the large retailers could handle those processes themselves. Given SAB’s proficiency in these areas, she believed that there were opportunities for SAB to help compress the logistics operations of existing and poten- tial customers by eliminating duplicative echelons in their supply chains. For example, between the producer’s plant and the retail store, there were often three or more distribution locations where products were stored and handled. These circumstances became the focus for Susan Weber’s strategy to change and grow SAB.

Some SAB executives left the company through early retirement or by changing companies. The remaining managers not only recognized the logic of Susan Weber’s assessment of their compet- itive market but also the opportunities associated with the changes that she outlined. Now in the fifth year of her CEO role, Susan Weber can look back and see some successful changes that have been initiated. SAB has attracted five large, regional retail chains in the Northeast and is developing a distribution park for warehousing, a transportation hub, and a call center near Scranton, Pennsylvania. The company will have access to several interstate highways and a major railroad for intermodal service.

The new distribution park will allow SAB to expand their value-added services that Susan Weber initiated when she became CEO. SAB is now providing third-party services to some of their cus- tomers (warehousing and inventory management, order fulfillment and delivery, and special packaging). Their initial venture into this area has been reasonably successful, and they expect to attract more regional chains such as Acme Markets and Wegman’s. A focus for the new dis- tribution park will be fresh fruits and vegetables and other perishable food items, commonly referred to as the cold supply chain.

As you read this chapter, consider the issues and challenges that SAB faces with these new initiatives.

Source: John J. Coyle, DBA. Used with permission.

Supply Chain Management: An Overview 5

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Several quotes cited in a previous edition of this book are still apropos:

“Change is inevitable, but growth and improvement are optional.”1

“You either change and get better or you slip and get worse; you cannot stay the same.”2

“When the rate of change outside the organization is faster than inside, the end is near.”3

Susan Weber, CEO of SAB, understands the wisdom of these comments. The ratio- nale for change can be made by using examples of the past and present giants of the retailing industry shown in Table 1.1.

Montgomery Ward, the leading mass retailer in the 1930s and 1940s, lost its leader- ship position to Sears in the 1950s because it did not have the vision to understand that the population exodus from the cities to the suburbs after World War II would cause it to lose sales volume at its large downtown stores. Sears developed a strategy to open multiple smaller stores in suburban shopping centers, providing locational convenience and free parking. In the 1970s, when the U.S. economy was struggling with inflation and unemployment, Kmart replaced Sears as the retail leader with its emphasis upon price discounts. In the 1990s, Walmart became the leading retailer with a multifaceted strategy based on discount pricing for brand-name products, location in smaller commu- nities, a “Made in America” slogan, and more customer service. A key element in Walmart’s ability to discount brand-name products was an understanding of the importance of efficiency in its logistics and supply chain system from purchasing, through delivery to its stores, to lowering cost of operations and maintaining a continual focus on improving its supply chain processes. Walmart continually makes adjustments to improve not only its store operations but also its logistics and supply chain opera- tions. The fact that two of the four retailing giants discussed above no longer exist as viable organizations is not lost upon Walmart. Walmart’s annual sales now exceed $500 billion, but some experts are questioning whether it is becoming stagnant since its “same store sales” have been declining.

One could argue that most retailers are essentially supply chain companies since they buy products produced by others and sell these same products to their customers. While other factors such as merchandising, pricing, store location, and layout are important, supply chain management and logistics are key ingredients for success in today’s highly competitive global environment. Susan Weber of SAB appears to comprehend the poten- tial role that supply chains can play in making retail organizations successful. She also seems to understand that the dynamics of today’s global environment require new think- ing and perspectives. Table 1.1 shows the historical leading retailers and clearly indicates

Table 1.1 Leading Retailers: 1930–2010

Montgomery Ward—1930s and 1940s

Sears and Roebuck—1950s and 1960s

Kmart—1970s and 1980s

Walmart—1990s and 2000s

????—2010s

Source: Center for Supply Chain Research, Penn State University.

6 Chapter 1

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that change is necessary to maintain or gain market share. Table 1.2 demonstrates even more dramatically the forces of change and the need to transform the organization, espe- cially the supply chain, since only three of the top 10 retailers from 1996 are in the top 10 in 2010 (note also the number of global companies on the 2010 list).

At this juncture, an examination of the major external forces or change drivers shaping the economic and political environment is appropriate. We need to understand the impact of these forces of change on businesses and other organizations.

What Forces Are Driving the Rate of Change We know that supply chain management (SCM) became a part of the vocabularies

of CEOs, CFOs, COOs, and CIOs during the 1990s. The dynamics of the global environ- ment changed dramatically during that decade, and organizations had to adapt to these changes or perish. Unfortunately, there were a number of casualties like some of the retailers previously mentioned.

Five major external forces appear to be driving the rate of change and shaping our economic and political landscape: globalization, technology, organizational consolida- tion, the empowered consumer, and government policy and regulation. The impact of these factors varies from sector to sector, but they are all important. Additional exter- nal forces may also influence some organizations, particularly in the public and non- profit sectors.

Globalization Arguably, globalization is the most frequently cited change factor by business leaders,

and it has replaced the post–World War II Cold War as the dominant driving force in world economics. The concept of the global marketplace or the global economy has taken on new meaning for all enterprises (profit and nonprofit; small, medium, and large; products or services) and for individual consumers during the last two decades.

Table 1.2 Leading Retailers

1996 2010

1. Walmart 1. Walmart

2. Sears Roebuck 2. Carrefour

3. Metro 3. Metro

4. Tangelmann 4. Tesco

5. Kmart 5. Schwarz

6. Carrefour 6. Kroger

7. Rewe Zentrale 7. Home Depot

8. Edeka Zentrale 8. Costco

9. Auchan 9. Aldi

10. Dayton Hudson 10. Target

Source: Center for Supply Chain Research, Penn State University.

Supply Chain Management: An Overview 7

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Overall, globalization has led to a more competitively intense economic and geopolit- ical environment. This environment manifests itself in opportunities and threats both economic and political. Some individuals have implied that there is no “geography” in the current global environment (figuratively speaking) or, perhaps more aptly, that time and distance have been compressed. So, for example, companies seeking to rationalize their global networks frequently ask such questions as the following:

• Where in the world should we source our materials or services?

• Where in the world should we manufacture or produce our products or services?

• Where in the world should we market and sell our products or services?

• Where in the world should we warehouse and distribute our products?

• What global transportation alternatives should we consider?

Some important issues or challenges for supply chains in the global economy are (1) more economic and political risk; (2) shorter product life cycles, and (3) the blurring of traditional organizational boundaries. All three deserve some discussion.

Supply and demand have become more volatile for a number of reasons. Acts of ter- rorism, for example, can have serious implications for the flow of commerce. Companies have put in place security measures to protect their global supply chains and are pre- pared to act quickly to offset challenges to the flow of materials through their supply chains, but the risk is ever present. One such challenge has been the contamination of food products and supplies from countries such as China. An interruption in the flow of products from China can cause serious shortages in the supply of food and other pro- ducts. Natural catastrophes such as hurricanes, floods, and earthquakes have become more problematic because of the scope and extent of global trade; therefore, they pose a significant potential problem for global supply chains. The natural catastrophes that occurred in Japan in 2011 interrupted or disrupted supply chains worldwide in auto and technology companies. Other examples could be offered, but suffice it to say that challenges to supply and demand can be exacerbated in number and severity by the dis- tances involved, which necessitates risk mitigation strategies.

Longer-run issues of supply and demand also arise with the global competition for sources of supply and markets. The growth in steel production and automobile manufactur- ing in China and information technology in India has caused significant changes in U.S. manufacturing of parts and finished goods. The global supply chains of the best companies must be adaptive and resilient to meet the challenges of the global marketplace.

Shorter product life cycles are a manifestation of the ability of products and services to be duplicated quickly. Technology companies are particularly vulnerable to the threat of their new products being reengineered. However, almost all products in our highly competitive global environment are faced with this issue. From a supply chain perspec- tive, shorter product life cycles present a challenge for inventory management. Products that are duplicated will most likely face a faster reduction in demand and new pricing policies, both of which present challenges to effective inventory management. The risk of obsolescence in certain sectors of the economy as new products are developed is another challenge for inventory management. It also means continually developing new products or reconfiguring old products. Both are a challenge for supply chains. Technol- ogy companies are particularly vulnerable to product obsolescence.

The blurring of traditional organizational boundaries is the result of companies having to adjust or transform their business model or the way that they do business in

8 Chapter 1

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a competitive global economy. To maintain their financial viability (read profitability), companies may have to outsource some parts of their operation to another domestic or global company that can provide what they need more efficiently and, hopefully, maintain the same quality. They may also add to their current operations or services to add value for customers. SAB is considering this strategy in an effort to retain and add customers.

Outsourcing is not new. It has been going on for many decades. No organization is completely independent. The competitiveness of the global environment, however, has increased the scope of outsourcing both domestically and globally. As previously men- tioned, companies need to analyze how they do business in order to stay competitive and financially viable. Nike, for example, outsources all of its manufacturing and has done so for many years. Airlines and hotels have outsourced their call centers. Many automobile and computer manufacturers outsource components or parts that they need for finished products. There are many examples of outsourcing for materials and ser- vices. From a supply chain and logistics perspective, the growth in outsourcing is note- worthy because it increases the importance of effective and efficient global chains because they become longer and more complex.

Before discussing technology, mention should be made of the “BRIC factor” in the analysis of globalization and supply chains. BRIC is an acronym for the four countries of Brazil, Russia, India, and China. These four countries have a total population of well over 3.0 billion, with China accounting for about 1.3 billion of that total. These four countries, especially China and India, have been a leading force in the changing world marketplace in this era of globalization. They not only produce products and services for export, but they have also become major consumers of energy, basic materials, and finished products. For example, General Motors sells more cars in China than in the United States; the Buick is the largest seller. The supply chains of most, if not all, com- panies have been affected by the emergence of the BRIC countries. Walmart, for exam- ple, is by far the largest buyer of products produced in China, which is in sharp contrast to its 1970s slogan of “Made in America.” It is estimated that if Walmart were a country, it would be China’s seventh- or eighth-largest trading partner.

Currently, there is growing discussion about a new group of developing, low-cost countries. The so-called VISTA Countries—Vietnam, Indonesia, South Africa, Turkey, and Argentina. It is expected that some or all of these countries will replace the BRIC countries as low-cost producers of various products and services. However, the BRIC countries with their developing middle class will become a growing market area for local and imported products.

SAB Distribution has been impacted by globalization because a growing number of products that it buys and distributes are being produced in whole or in part in other countries even though a U.S. company is their destination. SAB also needs to evaluate buying products directly from global producers. While this will add to the complexity of its supply chains, it may enable SAB to provide more competitively priced products. Also, SAB will be able to satisfy the needs of its more diverse customers. Similar to other U.S. companies, SAB is faced with both an opportunity and a threat by globalization.

A strong complement to the growth in the global economy has been the growth and development in the technology related to supply chains. Mention has been made of time and distance being compressed, and technology has certainly played a major role in making this happen. Technology will be discussed as the next external change factor.

Supply Chain Management: An Overview 9

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Technology Technology has had a major impact on supply chains as a facilitator of change as

companies have transformed their processes. However, it is also a major force in chang- ing the dynamics of the marketplace. Individuals and organizations are connected 24/7 and have access to information on the same basis via the Internet. Search engines such as Google have made it possible to gather timely information quickly. We have become what some individuals describe as the “click here” generation. We no longer have to wait for information to be “pushed” to us via the media on their schedule; we can “pull” information as we need it. Vast stores of data and information are virtually at our fingertips. Social networks such as Facebook and Twitter are playing an ever increas- ing role in business organizations and will influence supply chains because of their impact on customer demand and the speed of information transfers. Many companies see opportunities to “data mine” the tweets to uncover demand-related information for improved forecasting.

It has been argued that technology has allowed individuals and smaller organizations to connect to the world’s “knowledge pools” to create an unbelievable set of opportu- nities for collaboration in supply chains. A corollary of this phenomenon is that the world has become “flat.” In other words, traditionally underdeveloped countries such as China and India have become enabled and can participate in the global economy much more readily. The world is no longer tilted toward the developed countries such as the United States and European countries in terms of an economic advantage. Outsourcing to the less-developed countries has been enhanced by technology. Collaboration oppor- tunities with individuals and companies throughout the globe have increased. The flip side is that these economic advances have also created market opportunities for U.S. companies. Consequently, the flow of commerce has become multidirectional. This factor also increases the need for efficient and effective supply chains.

Susan Weber, as SAB’s new CEO, will have to more fully exploit the opportunities presented by technology both on the procurement side of business and in marketing pro- ducts to customers. Her predecessor used technology to improve internal processes, for instance through warehouse operations and order fulfillment as well as transportation carrier collaboration. Susan will need to focus more externally to improve overall supply chain efficiency and effectiveness.

Organizational Consolidation and Power Shifts After World War II, product manufacturers became the driving force in supply

chains. They developed, designed, produced, promoted, and distributed their products. Frequently, they were the largest organizations in the supply chain in terms of sales vol- ume, employees, buying power, locations, and other factors. They typically exerted their influence throughout the supply chain to their specific economic advantage, especially in the distribution of their products.

During the 1980s and especially the 1990s, a significant change occurred in the rela- tive economic power in a growing number of supply chains as mass retailers became increasingly larger. Retail giants such as Walmart, Sears, Kmart, Home Depot, Target, Kroger, and McDonald’s became powerful market leaders and engines for change. Walmart, for example, was number one on the Fortune 500 list by the middle of the first decade of the twenty-first century. It had surpassed Ford, General Motors, and ExxonMobil with more than $500 billion of annual sales and was the number one employer in many states.

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While other retailers are not as large as Walmart, their size and economic buying power have also increased significantly. An important aspect of the economic power shift toward the retail end of the supply chain is that many consumer product companies find that 15 to 20 percent of their customers account for 70 to 80 percent of their total sales. Walmart alone may account for over 10 percent of their total sales. As noted pre- viously, if Walmart were a country, it would be China’s eighth largest trading partner.4

This phenomenon is not unique to the United States. For example, a list of the top 10 global retailers would include Carrefour, Metro, Ahold, and Tesco, all of which are head- quartered in other countries. (See Table 1.2.)

As you would expect, the large retailers are accorded special consideration from con- sumer product companies. For example, customized distribution services are provided such as scheduled deliveries, “rainbow” pallets [mixed arrays of products or stock- keeping units (SKUs)], advance shipment notices (ASNs), shrink-wrapped pallets, and so forth. These services allow retailers to operate more efficiently and often more effec- tively. The scale of the retailers can also provide scale economies (read cost savings) to the producers of the products. It can be a win-win arrangement for both sides, with sav- ings passed on to the ultimate customer—the consumer.

In addition to customization, the retailer may be provided value-added services such as vendor-managed inventory (VMI). Essentially, this service usually means that the manufacturer will manage the inventory of its products (and possibly related products) at the retailer’s warehouse(s) and reorder as appropriate for customer fulfillment. The manufacturer may also have a representative at the designated retail warehouse locations to assure accurate and timely delivery. The retailer should experience lower costs associ- ated with inbound logistics, and the manufacturer should be able to offset its additional cost with increased sales (fewer stockouts, more complete orders, etc.) because of the more accurate and timely information of product orders at the store level.

Finally, more collaboration is being practiced between organizations in the supply chains to gain mutual cost savings and improved customer service. For example, sharing point-of-sale data is a powerful collaborative tool for mitigating the so-called bullwhip effect in the supply chain, which has multiple benefits to supply chain collaborators. Collaborative planning and forecasting for replenishment among members of the supply chain can be used for reducing stockouts and mitigating overreaction to swings in demand levels. Companies can frequently make simple changes at no extra cost to them- selves by collaborating, which will allow their vendors and their customers to reduce expenses. The power of information sharing cannot be overstated. This is a key area for SAB to exploit as it tries to adapt to its competitive environment and increase sales with existing and new customers. Data sharing will help SAB to lower stockouts and improve on-shelf availability of their products.

The Empowered Consumer Understanding consumer behavior has been a focus of marketing analysis and strat-

egy development for many years. Typically, such analyses examine consumers in total or in major groupings or segments to understand their needs and to respond to them with appropriate products and services. Such analyses have implications for logistics and sup- ply chain management, but they have been viewed in the past by logisticians as having somewhat indirect impacts. Today, the impact of the consumer is much more direct for supply chains because the consumer has placed increased demands at the retail level for an expanded variety of products and services. For example, year-round availability of fresh

Supply Chain Management: An Overview 11

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fruits and vegetables that are frequently imported, a selection of many different variations of the same basic product, stores being open 24/7, and similar demands are all extras pro- vided with very low margins on products. The supply chains have to perform very effi- ciently to enable the retailer and other organizations in the supply chain to make a profit.

Today’s consumers are more enlightened and educated, and they are empowered more than ever by the information that they have at their disposal from the Internet and other sources. Their access to supply sources has expanded dramatically beyond their immediate locale by virtue of catalogs, the Internet, and other media. They have the opportunity to compare prices, quality, and service. Consequently, they demand competi- tive prices, high quality, tailored or customized products, convenience, flexibility, and responsiveness. They tend to have a low tolerance level for poor quality in products and services. Consumers also have increased buying power due to higher income levels. They demand the best quality at the best price and with the best service. These demands place increased challenges and pressure on the various supply chains for consumer products.

The demographics of our society with the increase in two-career families and single- parent households have made time a critical factor for many households. Consumers want and demand quicker response times and more convenient offerings according to their sche- dules. The five-day services week from 9 AM to 6 PM for customers is no longer acceptable. The expectation for service is frequently 24/7 availability with a minimum of wait time. The age old axiom of “let the buyer beware” should probably be changed to “let the seller beware.” Today’s consumers may not have the loyalty of previous periods or much patience with inferior quality in any area. The Internet enables them to expand their buying alterna- tives and quickly make comparisons before they purchase. The associated transportation delivery service is usually expected to be provided quickly and conveniently.

Why is this consumer revolution so important in a supply chain and logistics context? The reason is that the supply chain and logistics requirements have dramatically increased. For example, if retail establishments have to be open for 24 hours a day, seven days a week, their resulting tendency to order more frequently in smaller quantities places greater demands on the supply chains that serve them. Also, the pressure from consumers related to price puts pressure in turn on the supply chain to operate as efficiently as possible. The power of the consumer has caused much change in how supply chains function. Supply chains have felt the pressure to keep prices stable even during inflationary periods. Collaboration has frequently been the basis for efficiencies to offset increased costs.

Government Policy and Regulation The fifth external change factor is the various levels of government (federal, state, and

local) that establish and administer policies, regulations, and taxes that impact individual businesses and their supply chains. The deregulation of several important sectors of our economy that occurred in the 1980s and 1990s is a good example. These deregulated sectors include transportation, communications, and financial institutions, which are cornerstones of the infrastructure for most organizations.

Beginning in the late 1970s and into the 1980s, the U.S. transportation industry was deregulated at the federal level in terms of economic controls such as rates and areas of service. The net effect was that it became possible for transportation services to be pur- chased and sold in a much more competitive environment. The results frequently were lower prices to users and improved service. It became possible for carriers and shippers to negotiate and to make changes in their respective operations to allow carriers to oper- ate more efficiently and lower their prices. New carriers entered the marketplace,

12 Chapter 1

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particularly in the motor carrier industry, which increased competition. Certain sectors of transportation underwent consolidation through mergers and acquisition; most nota- ble were the railroads and airlines. Transportation companies have also been allowed to offer more than just transportation services. Many motor carriers, for example, have declared themselves to be logistics services companies and offer an array of related ser- vices that can include order fulfillment, inventory management, and warehousing. They have moved aggressively ahead in the new business environment where companies view outsourcing and partnerships as potential strategic advantages.

The financial sector was also deregulated at the federal level. The distinctions between commercial banks, savings and loan associations, and credit unions, for example, have blurred as these institutions have been allowed to broaden their array of services. Finan- cial markets have become more competitive and, like the transportation sector, more responsive to customer needs. Brokerage and insurance companies have also been affected by the deregulation of the broad financial industry, and some offer services sim- ilar to banks and vice versa.

The deregulation of financial institutions has fostered changes in how businesses can operate. For example, the opportunity to invest cash at the end of the day in the global overnight money market for periods of 6 to 10 hours made many companies more cog- nizant of the value of asset liquidity and asset reduction, especially inventory. Payment transactions for buyers and sellers have also changed dramatically with the alternatives in financial practices made possible by deregulation. The purchase cards used by many pro- curement departments for maintenance, repair, and operating (MRO) items are examples of the efficiencies that were made possible by deregulation. All of the above have contrib- uted to the focus on cash flow previously discussed. It should be noted that there have been some negative aspects associated with the financial deregulation, which contributed, for example, to the Great Recession of 2008–2010.

The communications industry was also made more competitive. This scenario was differ- ent since the major cause of change was a Supreme Court decision that split up the AT&T/ Bell telephone system into regional companies, separated the “long-lines” system of AT&T, and made it accessible to other companies such as Sprint that wanted to sell telephone ser- vices. Like the other two industries discussed earlier, the communications industry has under- gone dramatic change, and more is coming with the integration of related services such as cable, telephone, computers, and wireless access. The communications industry is at the cen- ter of the technology revolution that is changing individual and business interface practices.

Businesses and the general consumer population are all being impacted by the many changes in this industry from cell phones and pagers to e-mail, text messaging, tweets, and the Internet. Communications efficiency and effectiveness have led to dramatic improvements and opportunities in logistics and supply chains. Examples include asset visibility, quick response replenishment, improved transportation scheduling, rapid order entry, and so on. Supply chain practices have been improved, leading to lower cost and better customer service. Some people argue that the best is yet to come with radio-frequency identification (RFID) and other related supply chain technology.

SAB Distribution is being buffeted by all of these change drivers. The marketplace is much more competitive; consumers are much more demanding and knowledgeable. Globalization and deregulation have made SAB much more vulnerable in its regional marketplace and much less insulated against larger competitors. These change drivers represent both opportunities and threats for SAB, as well as for other businesses both large and small. SAB needs to use technology to improve its supply chain operations.

Supply Chain Management: An Overview 13

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14 Chapter 1

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On the Line Malt-O-Meal Company: Going National

Malt-O-Meal Company (MOM) is a medium-sized, family-owned manufacturer (over $500 million per year) headquartered in Minneapolis, Minnesota. MOM has been an industry leader in provid- ing quality, value-priced breakfast cereals to U.S. consumers since 1919. The company markets hot and ready-to-eat cereals under its own brand as well as private labels.

In recent years, Malt-O-Meal cereal sales have grown over 40 percent based upon total pounds sold through traditional grocery store formats. This growth represents a market share change of approximately two points (on a total weight basis), from 3.2 percent to 5 percent of the $9 billion U.S. breakfast cereal market.

One driver of this growth has been the expanded distribution of the Malt-O-Meal brand. SKUs have increased due to the addition of flavors, package types, and case configurations for new outlets like foodservice, mass merchants, and drug and dollar-store formats. But the proliferation of SKUs and the unique requirements of nontraditional channels have added complexity to the existing business processes and challenged supporting systems. The company looked to its sup- ply chain to deliver the sales results for these growth initiatives while maintaining or reducing delivered cost and meeting service-level targets.

The supply chain organization at Malt-O-Meal is centralized and covers multiple production sites and distribution centers. It includes customer service, customer logistics, inventory planning, pro- duction planning, materials planning, procurement, distribution, and transportation. With this broad functional coverage, prioritization of supply chain initiatives is essential to success. MOM established its supply chain priorities based on three categories: customer focus (service), opera- tional efficiency (cost/return on invested capital), and company culture (values).

SUPPLY CHAIN ORGANIZATION AND DEVELOPMENT The supply chain organization has evolved to enable MOM to increase distribution of its brand. MOM has expanded the breadth of its supply chain by adding procurement to its responsibilities for end-to-end accountability. Packaging, commodities, and ingredients, for example, all have significant impact on the cost of goods sold and the delivered cost to the customer. For this rea- son, dollars conserved in these areas have been invested in growth opportunities. In addition, MOM established a successful Customer Logistics Team to serve as a point of contact to solve key customer supply chain issues. This has helped revenue growth and branding by enabling effective customer collaboration and demonstrating service-level improvement. The Customer Logistics Team increased sales and reduced cost through their efforts.

MOM also restructured both its Supply Chain Planning and Execution (SCPE) Group and the Procurement Group to focus efforts on creating executable operating plans that deliver desired results. SCPE was restructured to also interface with internal customers: demand planning with sales, inventory planning with distribution, and production scheduling and materials manage- ment with manufacturing. Procurement was restructured to put an emphasis on strategic sourc- ing as well as transactional processes. Finally, to help ensure that it has future supply chain leaders, MOM has established successful leadership development program. The integration of the functions, listed above, has played an integral role in improving supply chain efficiency and effectiveness.

Source: Chris Norek, Wesley Gass, and Thomas Jorgenson, “You Can Transform Your Supply Chain, Too,” Supply Chain Management Review (March 2007): 38. (Updated 2011) Copyright © 2007 Reed Business Information, a division of Reed Elsevier. Reproduced by permission.

The rate of change has accelerated, as previously noted, with consequent negative impacts if organizations do not change accordingly. MOM is an excellent example of a company that has been changing in response to its more competitive market by adding new channels of distribution and expanding its product offerings. However, these market- oriented changes added to the complexity of supply chain requirements. This in turn necessitated organizational changes to accommodate the scope and challenges of MOM’s supply chain initiatives. They had to develop plans and strategies to accommodate their internal customers as well as their external challenges. Their supply chains have become much more important to their market competitiveness and their overall financial viability. Their investment in process change, people, and technology was critical to their efforts.

The Supply Chain Concept While references to supply chain management can be traced to the 1980s, it was not

until the 1990s that SCM captured the attention of senior-level executives in major com- panies. They began to recognize the power and potential impact of SCM in making orga- nizations more globally competitive and enabling their companies to increase their market share with consequent improvement in shareholder value.

Development of the Concept It can be argued that supply chain management was not a brand-new concept. Rather,

supply chain management represents the third phase of an evolution that started in the 1960s with the development of the physical distribution concept that focused on the outbound side of a firm’s logistics system. (See Figure 1.1.) The system relationships

Figure 1.1 A View of Business Logistics in a Company

Storage

Storage

Storage

Warehouse

Warehouse

Warehouse

Plant 1

Plant 2

Plant 3

A

B

C

Raw Materials Supply Points

Raw Materials Storage

Manufacturing Finished Goods Storage

Markets

Movement/ Transportation

Movement/ Transportation

Movement/ Transportation

Movement/ Transportation

Physical supply materials management

inbound logistics

Physical distribution outbound logistics

Source: Center for Supply Chain Research, Penn State University.

Supply Chain Management: An Overview 15

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among transportation, inventory requirements, warehousing, exterior packaging, materi- als handling, and some other activities or cost centers were recognized. For example, the selection and use of a mode of transportation, such as rail, affects inventory, warehousing, packaging, customer service, and materials-handling costs, whereas motor carrier service would probably have a different impact on the same cost centers. The type of product, volume of movement, ship distances, and other factors influence which mode would have the lower total system cost. (This concept will be discussed more in Chapter 2.)

The initial focus on physical distribution or outbound logistics was logical since fin- ished goods were usually higher in value, which meant that their inventory, warehousing, materials-handling, and packaging costs were relatively higher than their raw materials inputs. The impact of transportation selection was, therefore, usually more significant. Managers in certain industries such as consumer packaged and grocery products, high-tech companies, and other consumer product companies—as well as some academicians—became very interested in physical distribution management. A national organization, the National Council of Physical Distribution Management (NCPDM), was organized to foster leadership, education, research, and interest in this area.

The 1980s, as noted earlier, was a decade of change with the deregulation of transpor- tation and financial institutions. The technology revolution was also well under way. During the 1980s, the logistics or integrated logistics management concept developed in a growing number of organizations. Logistics, in its basic form, added inbound logis- tics to the outbound logistics of physical distribution (see Figures 1.1 and 1.2). This was a very logical addition since deregulation of transportation provided an opportunity to coordinate inbound and outbound transportation movements of large shippers, which

Figure 1.2 Integrated Logistics Management

1960 1990

Inbound logistics

Logistics supply chain

Outbound logistics

Demand forecasting Purchasing

Requirements planning Production planning

Manufacturing inventory Warehousing

Materials handling Industrial packaging

Finished goods inventory Distribution planning

Order processing Transportation

Customer service

FRAGMENTATION 1960

EVOLVING INTEGRATION

1980

TOTAL INTEGRATION

2000

Source: Center for Supply Chain Research, Penn State University.

16 Chapter 1

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could positively impact a carrier’s operating cost by minimizing empty backhauls, lead- ing to lower rates for the shipper. Also, international or global sourcing of materials and supplies for inbound systems was growing in importance. Global transportation pre- sented some special challenges for production scheduling. Therefore, it became increas- ingly apparent that coordination between the outbound and inbound logistics systems provided opportunities for increased efficiency and improved customer service.

The underlying logic of the systems or total cost concept was also the rationale for logistics management. In addition, the value chain concept was also developed as a tool for competitive analysis and strategy. As can be seen in the value chain illustration in Figure 1.3, inbound and outbound logistics are important, primary components of the value chain; that is, they can contribute value to the firm’s customers and make the com- pany financially viable to increase sales and improve cash flow. The more integrated nature of marketing, sales, and manufacturing with logistics is also an important dimen- sion of the value chain. Logistics authors would usually include procurement as an ele- ment of logistics, as indicated in Chapter 2, but the value chain depicts it as a support activity for all the primary activities since they all may do some purchasing of services and materials. The rationale for the former is the opportunity for tradeoff analysis between procurement quantities, transportation volumes, inventory levels, and other related costs across the value chain, as explained in the MOM example.

As already stated, supply chain management came into vogue during the 1990s and continues to be a focal point for making organizations more competitive in the global marketplace. Supply chain management can be viewed as a pipeline or conduit for the efficient and effective flow of products, materials, services, information, and financials from the supplier’s suppliers through the various intermediate organizations or compa- nies out to the customer’s customers (see Figure 1.4), or a system of connected networks between the original vendors and the ultimate final consumer. The extended enterprise perspective of supply chain management represents a logical extension of the logistics concept, providing an opportunity to view the total system of interrelated companies for increased efficiency and effectiveness.

Figure 1.3 Generic Value Chain

Firm infrastructure

Human resource management

Technology development

Procurement

Inbound logistics

Operations Outbound logistics

Marketing and sales

Service M

argin M

argin

Primary activities

Support activities

Source: Michael Porfun, Competitive Advantage (New York: The Free Press, 1985): 37.

Supply Chain Management: An Overview 17

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Before discussing and analyzing the supply chain concept in more detail, it is worth noting that a growing number of terms used by individuals and organizations are pre- sented as being more appropriate, comprehensive, or advanced than supply chain man- agement. Such terms include demand chain management, demand flow management, value chain management, value networks, and synchronization management. Supply chain management is viewed by some individuals to be narrowly focused upon supplies and materials, not demand for finished products.

The definition of supply chain management proposed in this book is broad and com- prehensive; therefore, demand and value are relevant as well as synchronization of flows through the pipeline or supply chain. Thus, it could be argued that supply chain, demand chain, value network, value chains, and other terms can be used as synonyms. Also, there appears to be a more widespread use and acceptance of the term supply chain manage- ment and the comprehensive viewpoint of supply chain management espoused in this chapter and throughout the book.

A logical question to be asked is why supply chain management attracted attention among CEOs, CFOs, COOs, CIOs, and other senior executives. A myriad of reasons can be given, but the business case for supply chain management was initially demon- strated by two well-known studies.

In the early 1990s, the Grocery Manufacturer’s Association (GMA) commissioned a study by one of the large supply chain consulting organizations to research and analyze the supply chains of grocery manufacturers. Figure 1.5 illustrates one of the major find- ings of the study: on average, the industry had 104 days of inventory in its outbound supply chains. The consulting company recommended a set of initiatives that would lead to reducing that to 61 days of inventory. There are two important points here. First, it was estimated that at least $30 billion per year would be saved by reducing pipe- line inventory to 61 days. Such savings had the potential of having a significant impact upon consumer prices, or what might be called “landed prices.” Second, this study only considered part of the supply chain, and therefore understated the total potential. The potential savings of $30 billion demonstrated the power of optimizing the supply chain

Figure 1.4 Integrated Supply Chain

SCM is the art and science of integrating the flows of products, information, and financials through the entire supply pipeline from the supplier’s supplier to the customer’s customer.

VendorsSuppliers DistributorsDistributors ManufacturersManufacturers WholesalersWholesalers Customers Retailers/Retailers/ Customers

Product/services Information

Finances

Source: Center for Supply Chain Research, Penn State University.

18 Chapter 1

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as opposed to just one individual company or one segment of the supply chain. The lat- ter perspective often results in suboptimization of the whole supply chain with subse- quent higher overall costs.

The other example of the importance of focusing upon the supply chain came from the Supply Chain Council, which published a comparison for 1996 and 1997 of the “best-in-class” companies (top 10 percent) and the median companies that were report- ing their metrics to the council. As can be seen from Figure 1.6, in 1996, the supply chain–related costs of the best-in-class (BIC) companies were 7.0 percent of total sales, while the median company experienced 13.1 percent. In other words, the best-in-class companies spent 7.0 cents of every sales or revenue dollar for supply chain–related costs, while the median company spent 13.1 cents of every sales dollar on supply chain–related costs. In 1997, the respective numbers were 6.3 percent and 11.6 percent for best-in-class companies versus median companies. If we take a simple application of these numbers for a hypothetical company with $100 million in sales in 1997, being best in class would mean an additional $5.3 million of gross profit to an organization, which frequently would be the equivalent profit from an additional $80 to $100 million of sales.

At this point, a more detailed analysis and discussion of the supply chain is appropri- ate. Figure 1.7 presents a simplified, linear example of a hypothetical supply chain. Real-world supply chains are usually more complex than this example because they may be nonlinear or have more supply chain participants. Also, this supply chain does not adequately portray the importance of transportation in the supply chain. In addition, some companies may be part of several supply chains. For example, chemical companies provide the ingredients for many different products manufactured by different companies.

Figure 1.5 Comparison of Average Throughput Time of Dry Grocery Chain Before and After ECR Implementation

38 Days

Supplier Warehouse

40 Days

Current Dry Grocery Chain

Distributor Warehouse

26 Days

Retail Store

Packing Line

Consumer Purchase

104 Days

27 Days

Supplier Warehouse

12 Days

ECR Dry Grocery Chain

Distributor Warehouse

22 Days

Retail Store

Packing Line

Consumer Purchase

61 Days

Source: “Efficient Consumer Response Enhancing Consumer Value in the Grocery Industry” by Kurt Salmon Associates, Inc. (January 1993).

Supply Chain Management: An Overview 19

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Figure 1.6 Total Supply Chain Management Cost—All Sectors

14

12

10

8

6

4

2

0

16

Re ve

nu e %

1996 1997

7.0

13.1

6.3

11.6

BIC Median

Source: Supply Chain Council.

Figure 1.7 Integrated Supply Chain—Basics

Vendors ManufacturersContractedManufacturers Wholesalers/ Distributors

Retailers/ Customers

SCM is the art and science of integrating the flows of products, information, and financials through the entire supply pipeline from the vendor’s vendor to the customer’s customer.

Product/Services Flow

Information Flow

Cash Flow

Demand Flow

Source: Center for Supply Chain Research, Penn State University.

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Figure 1.7, however, does provide sufficient perspective to understand the basics of a supply chain. The definition that is a part of the illustration indicates several important points. A supply chain is an extended enterprise that crosses the boundaries of individ- ual firms to span the related activities of all the companies involved in the total supply chain. This extended enterprise should attempt to execute or implement a coordinated, two-way flow of goods and services, information, cash, and demand. The four flows enu- merated at the bottom of the illustration are important to the success of supply chain management (see Figure 1.8). Integration across the boundaries of several organizations in essence means that the supply chain needs to function similar to a single organization in satisfying the ultimate customer.

The top flow—products and related services—has traditionally been an important focus of logisticians and is still an important element in supply chain management. Customers expect their orders to be delivered in a timely, reliable, and damage-free man- ner, and transportation is critical to this outcome. Figure 1.7 also indicates that product flow is a two-way flow in today’s environment because of the growing importance of reverse logistics systems for returning products that are unacceptable to the buyer because they are damaged, obsolete, or worn out. There are numerous reasons for this growth in reverse systems, which are explored in Chapter 15, but there is no question that it is a growing phenomenon of supply chains. Note also that networks for reverse systems usually have to be designed differently than forward systems. The location, size,

Figure 1.8 Supply Chain Flows

INFORMATION FLOW • Enabling physical flow of products • Decision making • Supply chain collaborations

CASH FLOW • Management of working capital

DEMAND FLOW • Detect and understand demand signals • Synchronize demand vs. supply

PRODUCT FLOW • Physical movement of goods and materials

Source: Center for Supply Chain Research, Penn State University.

Supply Chain Management: An Overview 21

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and layout of facilities are frequently different, and the transportation carriers need to be utilized differently. Consequently, third-party logistics companies that specialize in offer- ing reverse flow systems have developed. They can provide a valuable service in appro- priate situations.

The second flow indicated is the information flow, which has become an extremely important factor for success in supply chain management. Traditionally, we have viewed information as flowing in the opposite direction of products, that is, from the market or customer back to the wholesalers, manufacturers, and vendors. The information was pri- marily demand or sales data, which were the trigger for replenishment and the basis for forecasting. Note that, other than the retailer or final seller, the other members of the supply chain traditionally reacted to replenishment orders. If there were long time inter- vals between orders, the members of the supply chain were faced with much uncertainty about the level and pattern of the demand, which usually resulted in higher inventory or stockout costs, a phenomenon known as the bullwhip effect.

One of the realizable outcomes of supply chain management is the sharing of sales information on a more real-time basis, which leads to less uncertainty and, therefore, less safety stock. In a sense, the supply chain is being compressed or shortened through timely information flows back from the marketplace, which leads to a type of supply chain compression or inventory compression. In other words, inventory can be elimi- nated from the supply chain by timely, accurate information about demand. Simply stated, information can be a substitute for inventory. If point-of-sale (POS) data is avail- able from the retail level on a real-time basis, it helps to mitigate the bullwhip effect associated with supply chain inventories and can significantly reduce cost.

Note that the illustration also indicates a two-way flow for information. In a supply chain environment, information flowing forward in the supply chain has taken on increased significance and importance. Forward information flow can take many forms such as advance shipment notices, order status information, inventory availabil- ity information, and so on. The overall impact has been to reduce uncertainty with respect to order replenishment, which also contributes to lowering inventory and improving replenishment time. A related aspect of forward information flow has been the increased utilization of barcodes and radio-frequency tags, which can increase inventory visibility and help reduce uncertainty and safety stock. The improved visibil- ity of pipeline inventory also makes possible many opportunities for improved efficiency such as transportation consolidation and merge-in-transit strategies. The combined two-way flow of timely, accurate information lowers supply chain–related costs while also improving effectiveness and customer service; but much more improvement can be made.

The third flow is financials, or, more specifically, cash. Traditionally, financial flow has been viewed as one-directional—backward—in the supply chain or, in other words, as payment for goods, services, and orders received. A major impact of supply chain compression and faster order cycle times has been faster cash flow. Customers receive orders faster, they are billed sooner, and companies can collect sooner. The faster cash- to-cash cycle or order-to-cash cycle has been a bonanza for companies because of the impact on working capital. Shorter cash flow cycles mean less working capital is needed, which usually increases the return on assets (ROA) for the company. In fact, some com- panies have negative working capital or what financial organizations refer to as “free” cash flow. They actually collect from their customers before they have to pay their ven- dors or suppliers. In companies such as Dell, where this period between collection and payment may be 30 to 45 days, the cash can be used for financial investment purposes or

22 Chapter 1

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as another source of funding for product development or other improvements. Cash flow measures have become an important metric of the financial markets to gauge the viabil- ity or vulnerability of companies. Most companies recognize the importance of acceler- ated cash flow or free cash flow and that supply chain management plays an important role in improved cash flow.

The fourth and final flow is demand flow, which is a new addition to this figure since the previous edition of this book. Demand flow was discussed in previous editions, but in recent years this flow has received increased attention from supply chain managers with the emphasis on demand-driven systems. This is not a new concept for supply chain management but rather reflects the growth in technology, which provides organi- zations the ability to better synchronize supply and demand by detecting and under- standing demand “signals” and making appropriate adjustments to demand changes more effectively. For example, consumer product companies usually had a 30-day pro- duction schedule “locked in” based upon a demand forecasted by SKU. Consequently, these products rolled out to distribution centers regardless of what was actually being sold at the retail level. Production runs were rigid until the next period. A number of the best-in-class consumer product companies have developed a much more flexible produc- tion schedule that can make adjustments in 24 hours. Production costs are higher with the change, but the trade-off is the ability to meet spikes in demand or to slow down production of some SKUs that may not be selling at the level anticipated. It should be noted that some companies cannot make adjustments on such a short-term basis. Global supply chains present a special challenge because of the longer lead times, but technology has enabled most companies to detect demand signals or market changes and make appropriate adjustments, as will be discussed in subsequent chapters. Figure 1.9 offers a more realistic view of a supply chain.

SAB Distribution is obviously part of a supply chain with an intermediate position between manufacturers and retailers. Wholesalers had a traditional role, which was

Figure 1.9 Supply Chain Network

Raw Material Supplier

Retailer’s Warehouse Retailer’s Store

Co-Packer Warehouse

Manufacturing Plant (In-house or Outsourced)

Manufacturing Warehouse

( Multitiered)

Source: Center for Supply Chain Research, Penn State University.

Supply Chain Management: An Overview 23

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buying products in volume quantities at volume prices and selling a mix of products in smaller quantities at higher prices to retailers. They frequently played a role in promot- ing and financing product sales in addition to distributing the item. Manufacturers and retailers depended upon them for efficiency in their operations. Large-scale retailers and manufacturers willing and able to provide more tailored, customized services have put wholesalers in jeopardy. SAB has felt this changing environment. It needs to reevaluate its role in relation to its retailers and to add “value” services to help reduce costs for its customers or help improve their sales revenue.

Supply chain management provides organizations with an opportunity to reduce cost (improve efficiency) and improve customer service (effectiveness). However, certain issues or challenges must be addressed before SCM will be successful.

Major Supply Chain Issues The challenge to develop and sustain an efficient and effective supply chain(s)

requires organizations to address a number of issues. We will discuss these issues briefly here, but they will be explored in much more depth in later chapters.

Supply Chain Networks Network facilities (plants, distribution centers, terminals, etc.) and the supporting

transportation services have always been considered important. However, the network system in a dynamic, global environment is critical. One of the challenges is the rapid changes that can take place. Companies and other organizations need a network system that is capable and flexible to respond and change with the dynamics of the marketplace whether in the short run or the long run.

Technology companies, for example, may have to move manufacturing operations to a different country in six to nine months because of changes that affect their cost or customer service. The need for flexibility frequently means leasing facilities, equipment, and maybe supporting services. At times, the flexibility may be required for a shorter duration—for example, to respond to port strikes, floods, hurricanes, political uprisings, terrorist attacks, and other disruptions. Flexibility is requisite for success in global opera- tions and markets. The catastrophe in Japan in 2011 is an excellent example of major disruptions of supply chains.

Walmart and Home Depot received accolades for their ability to respond in 2005 to Hurricane Katrina and the flood disasters that occurred in New Orleans and the sur- rounding Gulf Coast area. Their respective supply chains distributed products when the Federal Emergency Management Agency (FEMA) was incapable. These same organiza- tions analyze and change their networks in response to longer-run phenomena in the marketplace.

Complexity The globalization and consolidation in supply chains that were previously discussed

have caused an increased complexity for organizations in terms of SKUs, customer and supplier locations, transportation requirements, trade regulations, taxes, and so forth. Companies need to take steps to simplify, as much as possible, the various aspects of their supply chains. For example, the number of SKUs has expanded for

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many companies, which exacerbates problems for inventory management and order fulfillment. Consequently, companies have been rationalizing SKUs to eliminate the slow movers and items that do not contribute to profitability. Locations also need to be analyzed to eliminate high-cost or duplicative operations. Customer service levels need to be rationalized, as do vendors or supplier alternatives. Layers of com- plexity develop and may seem necessary, but organizations need to continually evaluate those areas of complexity by evaluating processes, training people, and exploiting technology.

Inventory Deployment Two interesting characteristics of supply chains are inventory often being duplicated

along the chain and the bullwhip effect. Effective SCM usually provides an opportunity to reduce inventory levels. The GMA study previously discussed is a good example. Coordination or integration can help reduce inventory levels on horizontal (single-firm) and vertical (multiple-firm) levels in the supply chain. Strategies such as compression and postponement can also have a positive impact. Inventory deployment is an impor- tant issue for supply chains because of the associated cost and related opportunities for increased efficiency. However, it is important to remember that inventory is a necessary ingredient for successful supply chains, but inventory levels must be managed carefully to reduce working capital.

Information The technology and communication systems that are available to organizations today

lead to the collection and storage of vast amounts of data, but interestingly enough, orga- nizations may not be taking advantage of the abundant data to develop information sys- tems to improve decision making. The accumulation and storage of data are almost useless unless the data are shared horizontally and vertically in the supply chain and used to make better decisions about inventory, customer service, transportation, and so forth. Information can be a powerful tool if it is timely, accurate, managed, and shared. It can be a substitute for inventory because it can reduce uncertainty. The latter is one of the major causes of higher inventory levels because it leads to the accumulation of safety stock. The challenge, frequently, is the sharing of information along the supply chain and the discipline to ensure the integrity of the data collected—a big challenge, but one with much potential.

Cost and Value Frequent reference has been made in this chapter to efficiency (cost) and effectiveness

(value). A challenge for supply chains is the prevention of suboptimization. In today’s environment, global supply chains compete against global supply chains, which means that the cost and value at the very end of the supply chain are what is important. If a competing supply chain is offering a comparable product at a lower cost and higher value, it does not matter if a company is effective and efficient but in the middle of another supply chain.

Consider SAB’s situation. It has to be cognizant of the cost and value being offered by the large retailers who compete against its customers. It must think in terms of making its customers more competitive or attracting different customers where the synergies will lead to better outcomes. SAB’s expertise in warehousing, distribution, and inventory

Supply Chain Management: An Overview 25

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management might be capitalized on for a new but related type of business. The supply chain perspective with vertical and horizontal views provides an opportunity to “think outside the box.”

Organizational Relationships Supply chain management emphasizes a horizontal process orientation that cuts

across traditional functional silos within organizations and necessitates collaboration with external vendors, customers, transportation companies, 3PLs, and others in the sup- ply chain. In other words, internal collaboration or cooperation with marketing, sales, operations or manufacturing, and accounting or finance are very important as well as collaboration or cooperation with external organizations. Communication is critical to explain the opportunities for system tradeoffs that will make the supply chain more

On the Line Auto Parts Distributor LKQ Discovers the Key to Effective Carrier Management

With the 2007 acquisition of Keystone Automotive, LKQ became the nation’s largest distributor of what it calls “alternative collision replacement” auto parts. Today, it distributes large quantities of remanufactured or recycled engines, bumpers, headlights and taillights, among other items. Customers are mostly dealerships, body shops and repair sites.

Few businesses have a more demanding customer base than automotive repair. The longer a vehicle stays in the shop, the angrier its owner is likely to get. For all the complexity involved in getting physical parts through a complex supply chain, it’s still a service-intensive industry.

Not surprisingly, LKQ places a high premium on the quality of its logistics operation. Picking the right carrier for a given shipment is of paramount importance. With more than 325 locations around the country, the selection process can be hugely complex.

Rapid growth in the business meant more time spent dealing with carriers. Individual sites were striking their own transportation deals, which didn’t always result in the best mix of cost and service. LKQ hired its first logistics partner to centralize the negotiating of contracts and bring some order to the process. Five years ago, it was lured to a second provider by the promise of a Web-based system that could match load requirements with the right carrier. The problem was that the selection was usually based on the cheapest option, whether or not that vendor was right from the standpoint of service.

LKQ liked what it saw, but wasn’t about to commit to a full-fledged relationship without a dem- onstration of Echo’s abilities.

Echo quickly proved its ability to handle the business. The company’s software platform, called Evolved Transportation Management (ETM), allowed LKQ’s facility managers to select from a list of pre-screened carriers, based on data inputted by customers or company employees. For the first time, says Lahr, buyers could choose a vendor for reasons other than pure cost. Carriers were displayed from the least to most expensive, with the number of days in transit shown alongside each option. In addition, LKQ’s plants were given the leeway to hire carriers with whom they had a positive history, even if the rate wasn’t the lowest.

Source: Robert J. Bowman, Supply Chain Brain, March/April 2011, p. 62.

26 Chapter 1

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competitive. For example, the vice president of manufacturing may present a rationale for operating plants on a 24/7 basis to lower production costs, but what about the cost of warehousing and inventory of goods that have to be stored until sales are finalized? Looking at manufacturing cost in isolation could lead to higher overall system costs. In Chapter 2, we will explore the concept of systems analysis in more detail, and the importance of sales and operations planning (S&OP) will be explored in a later chapter.

Performance Measurement Most organizations have measures of performance or metrics in place to analyze and

evaluate their efficiency and progress over different time periods. Sometimes, such mea- sures are used for setting baseline performance objectives or expected outcomes, for instance, orders filled and shipped per day. Measurement is important, and more atten- tion will be devoted to this topic in Chapter 5. At this juncture, it is important to recog- nize that lower-level metrics in an organization must connect directly to the high-level performance measures of the organization and the supply chain, which are usually net profit, return on investment, or assets and cash flow. In some instances, metrics are set that appear logical for the subunit of the organization but are suboptimal for the overall organization or supply chain. The previous example of the vice president running the plants 24/7 to achieve the lowest possible unit cost of products could be saving 3 cents per unit on manufacturing, but the extra expense of holding excess inventory could cost 4 to 5 cents per unit, thus lowering the company’s net profit margin. The warehouse manager who is measured by the cost per cubic foot of units stored will be motivated to fill the warehouse to the ceiling (what is the tradeoff cost?).

Technology Technology, as indicated previously, can be viewed as a change driver, but it is also

important as a facilitator of change that will lead to improved efficiency and effective- ness. The challenge is to evaluate and successfully implement the technology to make the improvements desired. Sometimes technology is, figuratively speaking, thrown at a problem, which usually leads to frustration and then failure. The approach necessary is to analyze and adjust or change processes, educate the people involved, and then select and implement the technology to facilitate the changes in the processes. Skipping the first two steps is analogous to the frequently cited bad approach to strategic planning— ready, fire, aim. The technology available today is almost overwhelming, but analysis and planning are necessary to achieve the expected outcomes.

Transportation Management Transportation can be viewed as the glue that makes the supply chain model function.

The critical outcomes of the supply chain are to deliver the right product, at the right time, in the right quantity and quality, at the right cost, and to the right destination. Transportation plays an important role in making these “rights” happen. Another aspect of the importance of transportation is related to some of the strategies that are being used by companies to remain competitive in today’s economy—for example, just- in-time inventory, lean logistics and manufacturing, and scheduled deliveries. The chal- lenge has been exacerbated by economic changes among transportation providers; shortages of drivers, higher fuel costs, and changes in driver hours regulations have led to what some individuals have called a transportation crisis or the “perfect storm.” Transportation has gone from being a readily available commodity to potential users, especially in the 1990s, to today where transportation is scarce in some market areas.

Supply Chain Management: An Overview 27

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The increases in fuel cost because of the political unrest in the Middle East countries in 2011 had a dramatic impact upon transportation cost. An additional challenge is the level of maintenance for the existing transportation infrastructure (roads, bridges, ports, waterways, tracks, and airports) and the need to increase capacity to meet the growth in demand.

Supply Chain Security Safe, reliable delivery of products to customers is expected of the supply chain. In the

past, this was often accepted as a given, but today it is a concern and potential challenge since 9/11. Globalization has obviously increased the risk of interruptions or shutdowns of supply chains. Consequently, organizations must be prepared in case of a terrorist attack. Such threats have changed some of the planning and preparation for supply chains that often include some type of scenario analysis that can consider possible threats, assess probabilities, and plan for alternatives.

Supply Chain Technology

Trends in Retail Distribution

A number of retailers are reducing the number of SKUs they sell, but you wouldn’t necessarily know that in the warehouse or distribution center where proliferation seems to be the order of the day. And with that comes different levels of movement and varying degrees of complexity. At the same time, multiple-store orders pose their own challenges, not least of which is that the SKU base varies depending on the neighborhood they go to. What retailers demand is deliv- eries that are deemed “store friendly” and “aisle friendly.”

All of this boils down ultimately to cost. Every touch has expense associated with it, which means labor both in the distribution center and in the store has to be kept to a minimum, and the distribution network must be as simple as possible.

In the past, retailers have focused primarily inside the distribution center, and they have a fairly good handle on the cost of labor there. In today’s environment that is not where most such costs are. After all, sortation inside the DC and picking systems have all contributed to making the DC more effective and less labor-intensive. And even greater efficiencies are available through goods-go-person picking systems.

These and others automated systems have reduced the workforce in some DCs by as much as 40 percent. That’s had a corresponding benefit in damage reduction and greater accuracy.

Smaller workforces have also allowed the footprint of such facilities to shrink. The savings are even greater in Greenfield construction because a warehouse can be built taller and smaller from the get-go. That has significant benefits in terms of sustainability savings.

Obviously, each facility has a different ROI calculation, but savings are there.

Source: Mike Khodl, Supply Chain Brain, May 2010, p. 34.

28 Chapter 1

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SUMMARY • Cash flow has become one of the most important measures of financial viability

for business organizations in today’s global markets. Supply chains are an important determinant of improved cash flow since they directly impact customers’ costs, revenues, and asset requirements.

• Supply chains are an important determinant of working capital consumption: they impact, inventory, accounts receivable, and cash.

• Efficient and effective supply chains can free up valuable resources and improve customer fulfillment so as to increase return on investment or assets and improve shareholder value.

• The accelerated rate of change in the global economy has increased the necessity of continual changes in supply chains or even transformation of the organization to remain competitive.

• The rate of change has been driven by a set of external forces including, but not limited to, globalization, technology, organizational consolidation and shifts in power in supply chains, empowered consumers, and government policy and regulations.

• The conceptual basis of the supply chain is not new. In fact, organizations have evolved from physical distribution management to logistics management to supply chain management, which are all based upon effective systems analysis.

• Supply chains are boundary spanning and require managing four flows—products, information, financials (cash), and demand.

• Supply chain management is a journey, not a goal, and there are no “silver bullets” since all supply chains are unique.

• Information is power, and collaborative relationships internally and externally are a necessary ingredient for success.

• The performance of supply chains must be measured in terms of overall corporate goals for success, and supply chain strategies must be consistent with organizational strategies.

• Supply chains need to focus on the customers at the end of the supply chain and be flexible and responsive.

• Technology is important to facilitate change, but it must follow process change employee education to address problems and issues appropriately.

• Transportation management, security, and sustainability have become increasingly important in the twenty-first century because of the political and economic changes that have occurred.

• Change with the changes, or you will be changed by the changes!

STUDY QUESTIONS 1. Globalization and technology developments have led to what some individuals have

described as a “flat world.” What is the significance of the flat world concept? What is the impact of the flat world on supply chain requirements and strategies?

2. The consolidation that has developed at the retail end of many supply chains has been described as the “Walmart effect.” Why? What changes have occurred in supply chain management because of retail consolidation and the related power shift?

Supply Chain Management: An Overview 29

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3. Consumers have much more influence in the marketplace today. What factors have lead to this “empowered consumer” situation? How has this factor changed supply chains in the last 10 to 15 years? Will this influence continue, and what will be the impact on supply chains?

4. The influence and impact of federal, state, and local governments seems to be increasing in importance for supply chains. Why? What are the most important dimensions of governmental control for supply chains for the future?

5. Why should CEOs, COOs, CFOs, and CMOs be concerned about supply chain management in their organizations? How can effective supply chain management improve the financial viability of their companies?

6. Supply chain managers should be concerned about four flows in their organizations. Describe these four flows and why they are important. How are they related to each other?

7. During the 1980s and 1990s, managing the transportation function in supply chains was recognized as being important but not critical. Has this perspective changed, and, if so, how and why? What special challenges does transportation face in the future?

8. Collaboration is a critical ingredient for successful supply chains. Why? What types of collaboration are important? What are some of the challenges and issues that need to be addressed?

9. Why is information so important in supply chains? What are the challenges to the successful development and implementation of effective information? What is the role of technology and information management?

10. What special role do networks play in supply chains? What are some of the chal- lenges and issues for efficient and effective networks? How can companies address these challenges and issues?

NOTES 1. James Tompkins, speech presented at the Warehouse of the Future Conference (Atlanta, GA: May 2000).

2. Joe Paterno, football coach, speech presented at Penn State University (September 1998).

3. Anonymous, Logistics (July/August 2000): 43.

4. Charles Fishman, The Wal-Mart Effect (New York: Penguin Press, 2006): 5–7.

30 Chapter 1

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CASE 1 .1

Central Transport, Inc. Jean Beierlein, president and CEO of Central Transport, has just met with Susan

Weber, the current president and CEO of SAB Distribution. Jean was promoted from COO at Central Transport to CEO. Her predecessor had worked closely with the former CEO of SAB Distribution when SAB transformed its operations about 10 years earlier to respond to changes in its competitive marketplace. Now, Ms. Weber is faced with new challenges and wants the collaboration of Jean and Central Transport to transform again.

Susan has met extensively with the old and new members of her executive team (several old timers left the organization when Susan had announced her planned changes) and has developed a tentative plan for modifying the strategic direction of SAB. Susan is convinced that SAB can attract some larger retailers in the mid-Atlantic states if it changes its business model to add services similar to third-party logistics com- panies, namely, warehousing, transportation delivery, and inventory management. How- ever, Susan feels that she needs a major collaborator with experience in these areas. She also feels that it would be better if the collaborator is a company SAB has worked with previously on a successful basis and that is willing to take on some new challenges.

Susan has decided to approach Wegman’s Food Markets, Inc. as a customer for these new services. Wegman’s is a very successful company in the Northeast that is privately owned and has expanded carefully into new market areas over the last 15 years. It offers more value services to its customers, including an in-store bakery, a restaurant and deli, more take-out options, and in-store cooking demonstrations.

Wegman’s primary distribution point for its stores is located in a distribution park in Rochester, New York, near its corporate headquarters. With its store expansion into the Washington, D.C., area and points further south into Virginia, Wegman’s is developing a new distribution park in northwestern Pennsylvania to lower its cost and improve its service. With the state of the economy, Wegman’s is feeling the pressure to be more competitive on a price basis.

Susan is also convinced that Wegman’s has to be price competitive to continue to grow in-store sales and expand its market opportunities. She feels that Wegman’s will listen to her proposal to offer expanded services to help it be more competitive. Now, she wants Central to join with SAB in making Wegman’s a proposal.

Jean wants your help in developing a positive response to Susan.

CASE QUESTIONS 1. Why and how has the competitive market place for SAB changed in the last five

to seven years?

2. What advantages might Central experience in the proposed new venture?

3. What issues would SAB and Central face in the proposed new approach?

Source: John J. Coyle, DBA. Used with permission.

Supply Chain Management: An Overview 31

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Chapter 2

ROLE OF LOGIST ICS IN SUPPLY CHAINS

Learning Objectives After reading this chapter, you should be able to do the following: • Appreciate the role and importance of logistics in improving organizational

supply chains.

• Discuss the impact of logistics on the economy and how efficient and effective logistics management contributes to the vitality of the economy.

• Understand the value-added roles of logistics on both a macro and micro level.

• Explain the relationships between logistics and other important functional areas in an organization, including manufacturing, marketing, and finance.

• Discuss the importance of management activities in the logistics function.

• Analyze logistics systems from several different perspectives to meet different objectives.

• Determine the total costs and understand the cost tradeoffs in a logistics system.

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Supply Chain Profile Jordano Foods: The Sequel

Tracie Shannon, vice president for logistics at Jordano Foods (Jordano), has just sent the following e-mail to members of the executive committee of the company:

I just returned from a lengthy meeting with Susan Weber, CEO of SAB Distribution. She is under great pressure from her board of directors to continue to grow market share and improve profitability. SAB has received a recent tender offer from another, larger food distributor to buy the company, and several members of their board have recommended that the offer be seriously considered. Susan feels that SAB can continue to improve its bottom line with additional changes in service offerings. Ms. Weber is meeting with all of SAB’s major suppliers and customers to discuss new services that SAB can offer to enhance the competitive- ness of the SAB supply chain.

I understand the competitive dimensions of supply chain management, and Susan’s ideas make sense to me. She feels that if they can work more closely with major suppliers (we are SAB’s second-largest supplier) and major customers, a significant supply chain transformation can be achieved. She is also convinced that these changes would not be at the expense of service. In fact, she gave examples of where organizations in a supply chain made similar changes. I was concerned about how the sales and revenue growth would be shared. Susan assured me that it would be a win-win approach. She feels that most of the changes should be directed to lowering product prices on the shelf for the consumer, making both us and SAB more competitive. This improved competitive position would result in increased revenue for all members of our supply chain, which should result in increased sales and higher profits for all.

One way to look at Susan’s message is that the major supply chain members must not only improve their internal logistics operations but also coordi- nate their logistics activities with other supply chain members by collaborating and sharing information. I am going to ask Sharon Cox, warehouse manager; Jane Jones, transportation manager; Beth Bower, inventory manager; and Teresa Lehman, customer service manager, to serve as a facilitating group for our interactions with SAB. We will be holding weekly meetings and will update all directors and managers on our progress.

BACKGROUND ON JORDANO FOODS Jordano Foods was founded in 1950 in Lewistown, Pennsylvania, by two brothers, Luigi and Mario Jordano. Their parents operated a restaurant in Burnham, Pennsylvania, featuring Italian cuisine. Marie Jordano was famous for her culinary skills. She developed her own recipes for pasta sauce, meatballs, fresh and dry pasta, and other Italian food items. Luigi and Mario worked in a restau- rant prior to establishing Jordano Foods. The brothers felt that they could capitalize on the family recipes by selling pasta, sauces, and related Italian food products to other restaurants in nearby communities in central Pennsylvania.

Their initial venture was so successful that they expanded their product line and began selling their products to small- to medium-sized wholesalers and distributors throughout Pennsylvania. They built a plant in Lewistown to produce their food products and subsequently built another plant in Elizabethtown, Pennsylvania, and a warehouse in Mechanicsburg, Pennsylvania.

34 Chapter 2

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Introduction As previously mentioned, supply chain management has captured the attention and inter-

est of many organizations. Logistics is perhaps misunderstood or even overlooked with the excitement surrounding supply chain management and all of the related technology that has been developed to support supply chains. The glamour associated with the e-supply chain, e-tailing, e-business, and so on seems to overshadow the importance of logistics in some organizations and the need for efficient and effective logistics support in a supply chain. Logistics might be regarded by some individuals as mundane and staid when compared to supply chain challenges and initiatives such as globalization and demand management.

Logistics professionals and other knowledgeable managers realize, however, that in spite of all the hype about the Internet, successful organizations must manage order fulfillment to their customers effectively and efficiently to build and sustain competitive advantage and profitability. The much-noted e-tailing problems of the 1999 Christmas season provide ample proof of the need for good, basic logistics systems and processes.

CURRENT SITUATION The 1990s and 2000s were times of significant growth for Jordano. Mario and Luigi were still active in the company as president/CEO and chairman of the board, respectively. Revenue now exceeded $600 million per year, and a third plant was built in the western part of Pennsylvania near Uniontown. A group of professional managers has been developed in the company to head up the major functional areas. Tracie Shannon was hired in 2005 to manage the logistics area, which had not received much attention prior to Tracie being hired. Her experi- ence with systems planning made her attractive to Mario Jordano when she was interviewed.

Under Ms. Shannon’s leadership, a number of initiatives in inbound transportation and inventory control have been implemented. She is very supportive of SAB’s collaborative approach. She had been involved previously with collaborative efforts with suppliers. She was successful in initiating improvements in inbound and outbound logistics systems not only to operate more efficiently but also to provide better service to Jordano’s plants (inbound) and customers (outbound), such as SAB. She sees increased opportunities for Jordano’s products with the expanded services that SAB is planning in the second decade of the twenty-first century.

Tracie realizes that the functional team she has appointed will need to operate with a systems perspective but also that the entire team will have to coordinate not only with their internal functions but also with SAB’s management team. Under Ms. Shannon’s leadership, Jordano’s internal manufacturing and marketing coordinate closely with logistics to consider proposals and discuss tradeoffs among the areas.

Tracie realizes that the Jordano brothers managed and developed the manufacturing and market- ing functions during the formative years, and these two areas had been considered as corner- stones of the company’s success. Logistics is a relatively new functional area for Jordano, but skeptics within the company no longer question logistics’ added value to the profitability and competitive position of Jordano. They now realize the potential of logistics within a dynamic supply chain strategy.

Tracie’s “plate” is indeed “full” with both internal and external challenges and pressures. The new vision of Susan Weber for SAB has tremendous potential for all members of its supply chain. Now, Tracie has to help orchestrate the transformation of Jordano.

Source: John J. Coyle, DBA. Used with permission.

Role of Logistics in Supply Chains 35

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Sophisticated front-end systems cannot stand alone in the competitive global market- place of today—“back office” execution is critical for customer satisfaction. In fact, the speed of ordering via the Internet and other technologies exacerbates the need for an efficient and effective logistics system that can deploy appropriate levels of inventory, expedite completed orders to customers, and manage any returns. The often-quoted adage “Good logistics is business power” is appropriate because logistics helps build competitive advantage. If an organization cannot get its products to customers in a timely manner, it will not stay in business very long. This is not to say that quality products and effective marketing are not important, but they must be combined with effective and efficient logistics systems for long-run success and financial viability.

The challenge is to manage the entire logistics system in such a way that order fulfill- ment meets and perhaps exceeds customer expectations. At the same time, the competi- tive marketplace demands efficiency—controlling transportation, inventory, and other logistics-related costs. As will be discussed, cost and service tradeoffs must be considered when evaluating customer service levels and the associated total cost of logistics, but both goals—efficiency and effectiveness—are important to an organization in today’s competitive environment.

At this point, it is important to delineate more explicitly the relationship between logistics management and supply chain management. In the preceding chapter, supply chain management was defined using a pipeline analogy, with the start of the pipeline representing the initial supplier and the end of the pipeline representing the ultimate customer (see Figure 2.1). In other words, it is an extended set of enterprises from the supplier’s supplier to the customer’s customer.

Another perspective on supply chain management views it as a connecting network of the logistics systems and related activities of all the individual organizations that are a part of a particular supply chain. The collective logistics systems play a role in the success of the overall supply chain. The coordination or integration of the logistics systems in a supply chain is a challenge. The focus in this chapter is on the dimensions and roles of the individual logistics system, but we recognize that no logistics system operates in a vacuum. For example, the inbound part of a manufacturer’s logistics system interfaces with the outbound side of the supplier’s logistics system, and the outbound portion of the manufacturer’s logistics system interfaces with the inbound side of its customer’s logistics system. Supply chain management encompasses logistics as well as the other activities discussed in Chapter 1.

Having introduced the concept of logistics and its relationship to the supply chain, the next section will discuss definitions of logistics and the value-adding roles of logistics.

Figure 2.1 Contemporary Supply Chain Profile

Supplier Manufacturer Wholesaler Retailer Customer

Source: Center for Supply Chain Research, Penn State University.

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What Is Logistics? The term logistics has become much more widely recognized by the general public in

the last 20 years. Television, radio, and print advertising have lauded the importance of logistics. Transportation firms, such as UPS, DHL, and FedEx, frequently refer to their organizations as logistics companies and stress the importance of their service to overall logistics success. The Persian Gulf War of the 1990s also contributed to increased recognition of logistics because of CNN news commentators’ frequent mention of the logistics challenges associated with the 7,000-mile long supply pipeline to support the war effort in the Persian Gulf countries. Another factor contributing to the recognition of logistics has been increased customer sensitivity not only to product quality but also to the logistics service quality.

Logistics management, as defined in this text, encompasses logistics systems not only in the private business sector but also in the public/government and nonprofit sectors. In addition, service organizations such as banks, hospitals, restaurants, and hotels have logistics challenges and issues, and logistics management is an appropriate and growing activity for service organizations. Consequently, there are a number of different defini- tions of logistics because of the different perspectives (see Table 2.1).

For the purposes of this text, the definition offered by the Council of Supply Chain Management Professionals (formerly the Council of Logistics Management) is the most appropriate. However, it is important to recognize that logistics owes its origins to the mil- itary, which has long recognized the importance of logistics activities for national defense.

The military definition of logistics encompasses supply items (food, fuel, spare parts) as well as personnel. The term logistics apparently became a part of the military lexicon in the eighteenth century in Europe. The logistics officer was responsible for encamping and quartering the troops as well as for stocking supply depots.1

Table 2.1 Logistics Definitions

PERSPECTIVE DEFINITION

Inventory Management of materials in motion and at rest

Customer Getting the right product to the right customer, in the right quantity, in the right condition, at the right place, at the right time, and at the right cost (called the “seven Rs of logistics”)

Dictionary The branch of military science having to do with procuring, maintaining, and transporting material, personnel, and facilities

International Society of Logistics The art and science of management, engineering, and technical activities concerned with requirements, design, and supplying and maintaining resources to support objectives, plans, and operations

Utility/Value Providing time and place utility or value of materials and products in support of organization objectives

Council of Supply Chain Management Professionals

That part of the supply chain process that plans, implements, and controls the efficient, effective flow and storage of goods, services, and related information from point of origin to point of consumption in order to meet customer requirements

Component support Supply management for the plant (inbound logistics) and distribution management for the firm’s customers (outbound logistics)

Source: Adapted from Stephen H. Russell, “A General Theory of Logistics Practices,” Air Force Journal of Logistics 24, no. 4 (2000): 15. Reproduced by permission.

Role of Logistics in Supply Chains 37

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The logistics concept began to appear in the business-related literature in the 1960s under the label of physical distribution, which had a focus on the outbound side of the logistics system (plant to market). During the 1960s, military logistics began to focus on engineering dimensions of logistics—reliability, maintainability, configuration management, life cycle management, and so on—with increased emphasis on modeling and quantitative analysis.2 In contrast, the business or commercial applications were usually more focused on consumer nondurable goods related to marketing and physical distribution of finished products. The engineering-related logistics, as practiced by the military, attracted attention among businesses that produced industrial products that had to be maintained with repair parts over the life cycle of the product. For example, heavy machinery manufacturers, such as Komatsu, have developed world-renowned logistics systems for delivering spare parts to repair and maintain their vehicles. In fact, engineers developed a separate professional organization called the Society of Logistics Engineers (SOLE), which has had active participation from both military and commercial enterprises.

As indicated in the previous chapter, the business sector approach to logistics developed into inbound logistics (materials management to support manufacturing) and outbound logistics (physical distribution to support marketing) during the 1970s and 1980s. Then, in the 1990s, the business sector began to view logistics in the context of a supply or demand chain that linked all of the organizations from the supplier’s supplier to the customer’s customer. Supply chain management requires a more collaborative, coordinated flow of materials and goods through the logistics systems of all the organiza- tions in the network, as indicated in Chapter 1.

In the twenty-first century, logistics should be viewed as a part of organizational management and has four subdivisions3:

• Business logistics—That part of the supply chain process that plans, imple- ments, and controls the efficient, effective flow and storage of goods, service, and related information from point of origin to point of consumption in order to meet customer requirements.

• Military logistics—The design and integration of all aspects of support for the operational capability of the military forces (deployed or in garrison) and their equipment to ensure readiness, reliability, and efficiency.

• Event logistics—The network of activities, facilities, and personnel required to organize, schedule, and deploy the resources for an event to take place and to efficiently withdraw after the event.

• Service logistics—The acquisition, scheduling, and management of the facilities, assets, personnel, and materials to support and sustain a service operation or business.

All four subdivisions have some common characteristics and requirements such as fore- casting, scheduling, and transportation, but they also have some differences in their primary purpose. All four, however, can be viewed in a supply chain context; that is, upstream and downstream other organizations play a role in their overall success and long-run viability. The focus of this text is on logistics management in the business sector.

A general definition of logistics that could be used that appears to encompass all four subdivisions is as follows:

Logistics is the process of anticipating customer needs and wants; acquiring the capital, materials, people, technologies, and information necessary to meet

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those needs and wants; optimizing the goods or service-producing network to fulfill customer requests; and utilizing the network to fulfill customer requests in a timely manner.

Having offered a definition of logistics, it is now appropriate to discuss how logistics adds value to an organization’s products.

Value-Added Roles of Logistics As Figure 2.2 illustrates, there are five principal types of economic utility that

add value to a product or service: form, time, place, quantity, and possession. Generally, production activities are credited with providing form utility; logistics activities with time, place, and quantity utilities; and marketing activities with possession utility. Each will be discussed briefly.

Form Utility Form utility refers to the value added to goods through a manufacturing or assembly

process. For example, form utility results when raw materials or components are combined in some predetermined manner to make a finished product. This is the case, for example, when Dell combines components along with software to produce a computer to a customer’s specifications. The process of combining these different components represents a change in the product form that adds value to a product.

In today’s business environment, certain logistics activities can also provide form utility. For example, breaking bulk and mixing products, which typically take place at distribution centers, change a product’s form by changing its shipment size and packag- ing characteristics. Thus, unpacking a pallet of Kraft macaroni and cheese into individual

Figure 2.2 Fundamental Utility Creation in the Economy

Production Form utility

Logistics Place utility Time utility

Quantity utility

Marketing Possession utility

Source: Center for Supply Chain Research, Penn State University.

Role of Logistics in Supply Chains 39

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consumer-size boxes adds form utility to the product. However, the three principal ways in which logistics adds value are place, time, and quantity utilities.

Place Utility Logistics provides place utility by moving goods from production points to market

points where demand exists. Logistics extends the physical boundaries of the market area, thus adding economic value to the goods. Logistics creates place utility primarily through transportation. For example, moving Huggies diapers from a Kimberly-Clark manufacturing facility by motor carrier to markets where consumers need these diapers creates place utility. The same is true when steel is moved by rail to an automotive sup- plier to stamp automobile parts. The market boundary extension added by place utility increases competition, which usually leads to lower prices and increased product availability.

Time Utility Not only must goods and services be available where customers need them but also at

the point when customers demand them. This is called time utility, or the economic value added to a good or service by having it at a demand point at a specific time when it is needed. Logistics creates time utility through proper inventory maintenance, the strategic location of goods and services, and transportation. For example, logistics creates time utility by having heavily advertised products and sale merchandise available in retail stores at the time promised in the advertisement. This can be done by having the right products in inventory, having them stored close to the point of demand, or using a premium (faster) mode of transportation. Time utility is much more important today because of the emphasis on reducing lead time and minimizing inventory levels through logistics-related strategies such as just-in-time (JIT) inventory control to improve cash flow.

Quantity Utility Today’s business environment requires that products not only be delivered on time to

the correct destination but also be delivered in the correct quantities to minimize inven- tory cost and prevent stockouts. So, the utilities of when and where must be accompanied by how much. Delivering the proper quantities of an item to where it is demanded is creating quantity utility. Logistics creates quantity utility through production forecast- ing, production scheduling, and inventory control. Take for example the importance of quantity utility in the automobile industry. Assume that General Motors will be assem- bling 1,000 automobiles in one day and is using a JIT inventory strategy. This will require that 4,000 tires be delivered to support the automobile production schedule. Assume that tire supplier delivers 1,900 tires in time at the correct location. Even though the when and where utilities are created, the how much utility is not. Thus, GM will not be able to assemble the 1,000 cars as planned. So, logistics must deliver products at the right time, to the right place, and in the right quantities to add utility and economic value to a product.

Possession Utility Possession utility is primarily created through the basic marketing activities related to

the promotion and sale of products and services. Promotion can be defined as the effort, through direct and indirect contact with the customer, to increase the desire to possess a

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good or to benefit from a service. The role of logistics in the economy depends on the existence of possession utility, for time, place, and quantity utilities make sense only if demand for the product or service exists. Marketing also depends on logistics, since pos- session utility cannot be accomplished unless time, place, and quantity utilities are provided.

Logistics Activities The logistics definition discussed previously indicates activities for which the logistics

manager could be responsible:

• Transportation

• Warehousing and storage

On the Line Building India: Transforming the Nation’s Logistics Infrastructure

Logistics infrastructure is a critical enabler of India’s economic development. Recognizing this piv- otal role, logistics infrastructure spending has been tripled from around USD 10 billion in 2003 to a planned amount of around USD 30 billion in 2010. Despite this increase, the country’s network of roads, rail and waterways will be insufficient as freight movement increases about three-fold in the coming decade. This shortfall in logistics infrastructure will put India’s growth at risk.

Since a large part of India’s future logistics network is still to be built, the country has a chance to build infrastructure optimally, to meet the growing demand. Doing so requires an integrated and coordinated approach in which the development of each mode—railways, waterways and roads—is matched to the needs and existing assets are better utilized.

In particular, India needs to increase its use of rail, and realize the potential of its waterways. For example, in the normal course, India’s rail share in freight would decline to 25 percent from the current 36 percent. This is relative to almost 50 percent rail share in China and the US, sim- ilar continental-sized nations. The concerted approach suggested in this report can increase India’s rail share to 46 percent.

If India fails to achieve this, waste caused by poor logistics infrastructure will increase from the current USD 45 billion equivalent to 4.3 percent of today’s GDP, to USD 140 billion or more than 5 percent of the GDP in 2020. If tackled in an integrated and coordinated manner, this can be reduced by half and India’s transport fuel requirement reduced by 15 to 20 percent.

Achieving this will require four major shifts:

• Building the right network and ensuring flows on the right mode.

• Creating logistics facilities to maximize the efficient use of the network.

• Extracting more from existing assets.

• Allocating more investment to rail and reallocating within roads and rail.

Source: Rajat Gupta, Hemarig Mehta, and Thomas Netzer, McKinsey Quarterly (www.mckinseyquarterly.com), September 2010.

Role of Logistics in Supply Chains 41

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• Industrial packaging

• Materials handling

• Inventory control

• Order fulfillment

• Inventory forecasting

• Production planning and scheduling

• Procurement

• Customer service

• Facility location

• Return goods handling

• Parts and service support

• Salvage and scrap disposal

This list is quite comprehensive; some organizations with well-developed logistics departments might not place responsibility for all of these activities within the logistics area. However, decisions regarding these areas should utilize the systems view that is critical to logistics management to evaluate the costs and benefits to the logistics system when any changes are made in one or more of the aforementioned activities.

The development of interest in logistics after World War II contributed to the growth in activities associated with logistics. Given the scope of this growth, it is worthwhile to briefly discuss these activities and their relationship to logistics and to the overall supply chain where appropriate.

Transportation Transportation is a very important activity in the logistics system and is often the larg-

est variable logistics cost. A major focus in logistics is on the physical movement or flow of goods and on the network that moves the product. The network is usually composed of transportation organizations that provide service for the shipping firm. The logistics organization is responsible for selecting the mode or modes and carriers used in moving raw materials, components, and finished goods or for developing private transportation as an alternative. It is important to note that transportation is an important component of the overall supply chain since it is the physical link among the various companies in the supply chain. In fact, it can be regarded as the glue for the supply chain.

Storage A second area, which has a tradeoff relationship with transportation, is storage.

Storage involves two separate but closely related activities: inventory management and warehousing. A direct relationship exists between transportation and the level of inven- tory and number of warehouses required. For example, if organizations use a relatively slow mode of transportation (for example, water), they usually have to hold higher inventory levels and thus have more warehousing space for inventory. An organization might consider using a faster, more expensive mode of transportation (for example, motor) to eliminate some of these warehouses and the inventory stored in them.

A number of important decisions are related to storage activities (inventory and ware- housing), including how many warehouses are needed, how much inventory should be held, where to locate the warehouses, what size the warehouses should be, and so on.

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Because decisions related to transportation affect storage-related decisions, a decision framework to examine the tradeoffs related to the various alternatives is essential to optimize the overall logistics system. An example of a decision framework will be discussed later in this chapter. Storage is also important to the overall supply chain, and there are opportunities to reduce storage (inventory and warehousing) in the overall supply chain, as will be explained in subsequent chapters.

Packaging A third area of interest to logistics is industrial (exterior) packaging. Industrial pack-

aging protects the product during transportation and storage and includes materials such as corrugated cardboard boxes, stretch wrap, banding, bags, and so on. The type of transportation mode selected affects packaging requirements. For example, rail or ocean transportation typically requires additional packaging expenditures because of the greater possibility of damage in transit. For ocean transportation, additional packaging might be needed to prevent moisture from invading the product. In analyzing tradeoffs for proposed changes in transportation modes, logistics managers usually examine how the change will influence packaging costs. In many instances, changing to a premium transportation mode, such as air, will reduce packaging costs because there is less risk of damage. This area has received much more scrutiny in recent years with the increased interest in sustainability. Packaging material often ends up in the landfills. Companies have significantly reduced their packaging waste by using alternate materials and reduc- ing the amount of packaging materials. This is an important sustainability issue.

Materials Handling A fourth area to be considered is materials handling, which may also be of interest to

other functions in a typical manufacturing organization. Materials handling is important in warehouse design and efficient warehouse operations. Logistics managers are concerned with the movement of goods into a warehouse from a transportation vehicle, the place- ment of goods in a warehouse, and the movement of goods from storage to order- picking areas and eventually to dock areas for transportation out of the warehouse.

Materials handling is concerned with mechanical equipment used for short-distance movement and includes equipment such as conveyors, forklift trucks, overhead cranes, and automated storage and retrieval systems (ASRS). Production managers may want a particu- lar pallet or container type that is not compatible with logistics warehousing activities. Therefore, the materials handling designs must be coordinated in order to ensure congruity between the types of equipment used and the storage devices they are moving. This type of coordination is also essential among and between all organizations in a supply chain.

Inventory Control A fifth area to examine is that of inventory control. Inventories can be found in ware-

houses and manufacturing facilities. Inventory control has two dimensions: assuring adequate inventory levels and certifying inventory accuracy. Assuring adequate inventory levels requires monitoring current inventory levels and placing replenishment orders or scheduling production to bring inventory levels up to a predetermined level. For exam- ple, as a distribution center fills customer orders for shipment, current inventory levels are depleted. When these inventory levels reach a certain reorder point, replenishment orders are placed (either manually or electronically) to either another distribution center or to a manufacturing facility to bring current inventory levels to an acceptable level.

Role of Logistics in Supply Chains 43

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Another dimension of inventory control is certifying inventory accuracy. As inventory is physically depleted to fill customer orders, a facility’s information system is electroni- cally tracking the status of current inventory levels. To assure that the actual physical inventory levels match those shown in the information system, cycle counts are taken of selected items every period throughout the year. The use of bar codes and RFID tags has helped to make this process more efficient and effective. Accuracy has taken on increased significance as the concept of the “perfect order” and lean supply chains have become more important for logistics and supply chains.

Order Fulfillment Order fulfillment consists of the activities involved in filling and shipping customer

orders. Order fulfillment is important because it directly impacts the time that elapses from when a customer places an order until the customer receives the order. This is also referred to as order lead time. The four basic processes or activities of order fulfill- ment or lead time are order transmittal, order processing, order preparation, and order delivery.

For example, assume that the present order fulfillment lead time is eight days. Also assume that order processing and transmittal take four days and order preparation takes two days, which allows two days for delivery. The short delivery time might require a premium mode of transportation (at a higher cost). An organization could consider adding technology to the order processing and transmittal to reduce it to a two-day time frame. This would allow the organization to use lower-cost transportation to meet the eight-day commitment or provide a six-day lead time for competitive advantage.

Forecasting Another important activity is demand forecasting. Reliable forecasting is required for

accurate inventory requirements. Materials and components are essential to inventory control, manufacturing efficiency, and customer satisfaction. This is particularly true in organizations that use a JIT or material requirements planning (MRP) approach to controlling inventories. Logistics and supply chain personnel should develop inventory forecasts in conjunction with marketing forecasts of demand to assure that proper inven- tory levels are maintained.

Production Planning Another area of growing interest is production planning and scheduling, which is

closely related to forecasting for effective inventory control. Once a forecast is developed and the current inventory on hand and usage rate are determined, production managers can calculate the number of units to manufacture to ensure adequate market coverage. However, in organizations that have numerous products, manufacturing-process timing and certain product line relationships require close coordination or actual control of production planning and scheduling by logistics.

Procurement Procurement is another activity that can be included in logistics. The basic rationale

for including procurement in logistics is that transportation and inventory costs are related to the geographic location (distance) of raw materials and component parts purchased to meet manufacturing needs. In terms of transportation and inventory costs, the quantities purchased also affect total logistics costs. For example, buying

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component parts from China for a manufacturing facility located in the United States might have a lead time of several weeks. This would have a direct impact on the inven- tory levels that would need to be held at the manufacturing facility to prevent a plant shutdown. Using a premium mode of transportation to reduce this lead time would reduce inventory levels but would increase transportation costs. So, procurement decisions need to be made from a systems perspective.

Customer Service Two dimensions of customer service are important to this discussion: (1) the process

of interacting directly with the customer to influence or take the order and (2) the levels of service an organization offers to its customers. From an order-taking perspective, logistics is concerned with being able to promise the customer, at the time the order is placed, when the order will be delivered. This requires coordination among inventory control, manufacturing, warehousing, and transportation to guarantee that any promises made when the order is taken as to delivery time and product availability will be kept.

The second dimension of customer service relates to the levels of service the organi- zation promises its customers. These service dimensions could include order fill rates and on-time delivery rates. Decisions about inventories, transportation, and warehousing relate to customer service levels. While the logistics area may not completely control cus- tomer service decisions, logistics plays an extremely important role in ensuring that the customer gets the right product at the right time and in the right quantity. Logistics deci- sions impact product availability and lead time, which are critical to customer service.

Facility Location Another area of interest to logistics is plant and warehouse site location. A site loca-

tion change could alter time and place relationships between facilities and markets or between supply points and facilities. Such changes will affect transportation costs and service, customer service, and inventory requirements. Therefore, the logistics manager is concerned and should have input in facility location decisions.

Other Activities Other areas might be considered a part of logistics. Areas such as parts and service

support, return goods handling, and salvage and scrap disposal indicate the reality of logistics activities managed in organizations producing consumer durables or industrial products. In such cases, an integrative approach is necessary. Logistics offers input to product design as well as to maintenance and supply services, since transportation and storage decisions affect these areas. These areas require the development of a reverse logistics system that will allow used, broken, or obsolete products to be returned to the supplier for disposition.

Logistics in the Economy: A Macro Perspective The overall, absolute cost of logistics on a macro basis will increase with growth in the

economy. In other words, if more goods and services are produced, total logistics costs will increase. To determine the efficiency of the logistics system, total logistics costs need to be measured in relationship to gross domestic product (GDP), which is a widely accepted barometer used to gauge the rate of growth in the economy.

Role of Logistics in Supply Chains 45

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As indicated in Figure 2.3, logistics costs as a percent of GDP have declined since 1985 from 12.3 percent to 9.9 percent in 2006. In fact, logistics costs were closer to 20 percent of GDP in the early to mid-1970s. The low point occurred in 2003 with logistics costs being 8.6 percent of GDP. A modest increase in inventory costs starting in 2004 (as will be seen in Figure 2.5), coupled with a larger increase in transportation costs, caused the percentage to increase for 2005 and 2006.

The reduction in logistics cost as a percent of GDP shown in Figure 2.3 has resulted from a significant improvement in the overall logistics systems of the organizations operating in the economy. This reduction in relative cost allows organizations to be more competitive since it directly impacts the cost of producing goods. It can be argued that the turnaround that occurred in the U.S. economy in the early 2000s was due in part to the reduction in relative logistics costs.

Some additional understanding of logistics costs can be gained by examining the three major cost categories included in this cost—warehousing and inventory costs, transpor- tation costs, and other logistics costs. These can be seen in Figure 2.4. Warehousing costs are those associated with the assets used to hold inventory. Inventory costs are all the

On the Line Ce De Candy’s Sweet Transformation

Since 9/11, even candy makers have been enlisted in the fight to keep the nation’s food supply safe from bioterrorists. That’s why Ce De Candy, the maker of the Smarties brand of candy products, installed an automatic data capture and inventory management system in its Union, N.J., and New Market, Ontario, manufacturing plants. Technology is not only transforming the way the company collects data, it is also laying the foundation for using that data to improve its processes in the future.

The technology allows the candy maker to track and trace the source and lot of the ingredients used to make its popular candies as well as the customers who shipped the finished goods. That has enabled Ce De Candy to comply with the new lot and product tracking requirements from the U.S. Food and Drug Administration’s Bioterrorism Act.

When the FDA announced the new requirements, we suddenly had to maintain accurate records in case there was product tampering, contamination, or a recall. An added challenge was that Ce De Candy still ran a paper-based warehouse without a warehouse management system or bar code scanning. Prior to that, we didn’t have to track anything. We had to step up to speed and implement a system that would comply with the new mandates in a hurry.

How fast? Once the requirements were finalized, Ce De Candy had just six months to get the system up and running. The solution it implemented was a highly customizable software package (Portable Technology Solutions) that integrated easily with the manufacturer’s ERP system and utilizes wireless, rugged bar code scanners (Motorola) to accurately track the source of ingredients—the important steps in the manufacturing process and finished products.

Since going live, Ce De Candy is not only compliant with the federal tracking requirements, the company has also discovered additional benefits in its logistics operations. With the additional information available, we now have a record of every pallet picked for a customer. That has improved the way we handle customer disputes regarding shipments.

Source: Bob Trebilcock, Logistics Management, April 2010, p. 26

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expenses associated with holding goods in storage. Carrying costs include interest expense (or the opportunity cost associated with the investment in inventory), risk- related costs (obsolescence, depreciation), and service-related costs (insurance, taxes). Transportation costs are the total national expenditures for the movement of freight in the United States. The third category of logistics costs is the administrative and shipper- related costs associated with managing logistics activities and personnel.

Figure 2.4 probably underestimates the true costs of logistics in the economy because it does not appear to include some of the logistics activities that are discussed in this chapter. Nevertheless, the cost estimate provided in Figure 2.4 captures the major cost categories.

The declining trend for logistics cost relative to GDP shown in Figure 2.3 is important to recognize. The decline started in the early 1980s and was closely related to the dereg- ulation of transportation, which permitted much more flexibility for carriers to adjust their freight rates and service in response to competition. A second factor contributing to the trend has been the improved management of inventory levels. This has been the result of more attention being focused on the investment in inventory and the better technology available to managers to make more effective inventory decisions.

On a macro basis, data are published on the ratio of inventory to GDP in the U.S. economy (see Figure 2.5). In other words, how much inventory do organizations carry to support GDP? Typically, it might be expected that inventory levels will increase with increased sales. Figure 2.5 indicates an interesting trend of inventory levels declining relative to GDP. From 1985 through 2006, nominal GDP increased by 212.3 percent, while the value of all business inventories increased by 119.2 percent for the same period. This is a measure of efficiency and clearly indicates that organizations are improving in managing their inventory.

Figure 2.3 Logistics Costs as a Percentage of GDP

0 1 2 3 4 5 6 7 8 9

10 11 12

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Year

Pe rc

en t

10.1 9.4

8.6 8.5 8.7 9.4 9.7

9.9 9.3

7.8 8.3

Source: Reproduced with permission from Council of Supply Chain Management Professionals.

Role of Logistics in Supply Chains 47

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The two largest cost categories in any organization’s logistics system are transporta- tion and inventory costs. As indicated, transportation is usually the single largest variable cost in any logistics system. Note the magnitude of the motor carrier share of the total freight expenditures shown in Figure 2.4—$635 billion versus $166 billion for all other modes of transportation. This level of expenditure is not based necessarily on the lowest transportation rates but reflects the value to shippers of the service provided by motor carriers. This point is discussed in Chapter 10 on transportation, but it is worth noting here because logistics management requires examining the total cost of logistics, not just one cost such as transportation.

Also worth noting is that one of the most frequent tradeoffs in logistics systems is between transportation and inventory costs. For example, an organization might be will- ing to pay higher rates for air freight service because of the savings it will experience in inventory costs. In making this tradeoff evaluation, organizations are using a systems approach (which is discussed in more detail later in this chapter) to arrive at the lowest total cost solution.

Figure 2.4 Total Logistics Costs—2011

CARRYING COSTS—$2.064 TRILLION—ALL BUSINESS INVENTORY $ BILLION

Interest 4

Taxes, obsolescence, depreciation, insurance 280

Warehousing 112

Subtotal 396

Transportation Costs

Motor Carriers

Truck—Intercity 403

Truck—Local 189

Subtotal 592

Other Carriers

Railroads 60

Water (international 32, domestic 8) 33

Oil pipelines 10

Air (international 15, domestic 23) 33

Forwarders 32

Subtotal 168

Shipper–related costs 9

Logistics administration 47

Total logistics cost 1,211

Source: 22nd Annual State of Logistics Report, http://www.cscmp.org (2011). Reproduced with permission from Council of Supply Chain Management Professionals.

48 Chapter 2

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Logistics in the Firm: The Micro Dimension Another dimension of logistics is the micro perspective, which examines the relation-

ships between logistics and other functional areas in an organization—marketing, manufacturing or operations, finance and accounting, and others. Logistics, by its nature, focuses on processes that cut across traditional functional boundaries, particularly in today’s environment with its emphasis on the supply chain. Consequently, logistics inter- faces in many important ways with other functional areas since the logistics-related flows, as well as supply chain flows, tend to be horizontal in an organization, cutting across other functions.

Logistics Interfaces with Manufacturing or Operations A classic interface between logistics and manufacturing relates to the length of the

production run. Manufacturing efficiency is usually associated with long production runs with infrequent manufacturing line setups or changeovers. These long runs, how- ever, easily result in higher inventory levels of certain finished products and limited sup- plies of others. Thus, the ultimate manufacturing decision requires managers to carefully weigh the advantages and disadvantages of long versus short production runs and their impacts on inventories. Many organizations today tend toward shorter production runs and doing whatever it takes to reduce the time and expense normally associated with changing production lines from one product to another. This is especially true for firms employing JIT or “lean” approaches to inventory and scheduling. The current trend is toward “pull” systems, manufacturing and logistics systems where the product is “pulled” in response to demand as opposed to being “pushed” in advance of demand. This

Figure 2.5 Macro Inventory as a Percentage of GDP

2000 2001 2002 2003 2004 Year 2005 2006 2007 2008 2009

Pe rc

en t

14.9 13.6 13.6 13.5 13.9 14.1 13.9

14.3 13.7 13.2

0

5.0

10.0

15.0

20.0

2010

14.1

Source: Reproduced with permission from Council of Supply Chain Management Professionals.

Role of Logistics in Supply Chains 49

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practice lowers inventory levels, which can lower total logistics costs even though pro- duction costs can increase.

The production manager is interested in minimizing the impact of seasonal products. For example, the candy industry is affected by several holidays or events that occur throughout the year, namely Valentine’s Day, Easter, Halloween, and Christmas. To minimize manufacturing cost, production managers usually like to produce in advance of the holiday or event. This strategy requires accumulating inventory and the associated costs. The manufacturing cost savings should be traded off against the inventory costs and any other related benefits or costs.

Logistics and manufacturing also interface on the inbound side of production. For example, a shortage or stockout could result in the shutdown of a manufacturing facility or an increase in production costs. The logistics manager should ensure that available quantities of raw materials and components are adequate to meet production schedules yet are conservative in terms of inventory carrying costs. Because of the need for this type of coordination, many organizations today have shifted the responsibility for production scheduling from manufacturing to logistics.

Another activity at the interface of logistics and manufacturing is industrial packag- ing, which many organizations treat as a logistics responsibility. In the context of manufacturing or logistics, the principal purpose that industrial packaging serves is to protect the product from damage. This is distinct from whatever value the consumer packaging might have for marketing or promotional reasons.

The interface between logistics and manufacturing is becoming more critical, given the growth in procurement of raw materials and components from offshore sources and sustainability issues. Also, many organizations today are making arrangements with third-party manufacturers, “co-packers,” or contract manufacturers to produce, assemble, or enhance some or all of the organization’s finished products. These arrangements are especially prevalent in the food industry where some manufacturers produce food items to be sold under someone else’s label.

Logistics Interfaces with Marketing Logistics has an important relationship with marketing. The rationale for this strong

relationship is that physical distribution, or the outbound side of an organization’s logis- tics system, plays an important role in the sale of a product. In some instances, physical distribution and order fulfillment may be the key variables in the continuing sales of products; that is, the ability to provide the product at the right time to the right place in the right quantities and the right cost might be the critical element in making a sale.

This section briefly discusses the interfaces between logistics and marketing activities in each principal area of the marketing mix. The material is organized according to the four Ps of marketing—price, product, promotion, and place.4 In addition, recent trends in the interface between logistics and marketing will be discussed.

Price Organizations selling products often provide a discount schedule for larger purchase

quantities. If such discount schedules relate to transportation rate discount schedules in terms of weight, then both the shipper and customer might be able to reduce total trans- portation cost. For example, if an organization sells on a delivered-price basis (price includes transportation charges) and if its price schedule matches the transportation

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shipping requirements on a weight basis, the shipper should be able to get lower rates per pound with larger purchases and thus save money for the shipper and customer. So when an organization calculates the number of units that it wants to sell to a customer for a particular price, it should calculate how the weight of that number of units com- pares with the weight requirements for a transportation rate. In some organizations, entire pricing schedules conform to various quantities that can be shipped by modes of transportation. Under the Robinson–Patman Act and related legislation, transportation cost savings are a valid reason for offering a price discount.

In addition, the logistics manager is interested in the volume requirements of the price schedule because this impacts inventory requirements, replenishment times, and other aspects of customer service. An organization should also consider its ability to pro- vide sufficient volumes within an attractive price schedule. This is especially true when price specials generate extra sales at particular times of the year. The logistics manager should be notified of such price specials so that he or she can adjust inventory levels to meet projected demand.

Product Another decision frequently made in the marketing area concerns products, particu-

larly their physical attributes. Much has been written about the number of new products that come on the market each year in the United States. Their size, shape, weight, pack- aging, and other physical dimensions affect the ability of the logistics system to move and store them. Therefore, the logistics manager should offer input when marketing is deciding on the physical dimensions of new products. In addition to new products, organizations frequently refurbish old products in one way or another to improve or maintain sales. Very often, such changes might take the form of new package design and, perhaps, different package sizes. The physical dimensions of products affect the storage and movement systems. These dimensions also affect the modes of transporta- tion that an organization can use, equipment needed, damage rates, storage ability, use of materials-handling equipment such as conveyors and pallets, industrial packaging, and many other logistical aspects.

Frustration can mount for logistics managers when faced with a change in a product’s dimensions that makes the use of standard-size pallets uneconomical or that uses trailer or container space inefficiently or in a way that can damage products. These issues often seem mundane and somewhat trivial to executives making sales to customers, but they greatly affect an organization’s overall success and profitability in the long run.

Prescribed rules do not exist to guide organizations in how to deal with these situa- tions. However, collaboration can allow the logistics manager to provide input about the repercussions in these situations. The logistics manager may recommend small changes that will make the product more suitable to the movement and storage capabilities and have no impact on product sales.

Another marketing area that affects logistics is consumer packaging. The marketing manager often regards consumer packaging as a “silent salesperson.” At the retail level, the package might be a determining factor in influencing sales. The marketing manager will be concerned about package appearance, information provided, and other related aspects; for a consumer comparing several products on a retailer’s shelf, the consumer package might make the differences. The consumer package is important to the logistics manager for several reasons. First, the consumer package has to fit into the industrial

Role of Logistics in Supply Chains 51

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package, or the external package. The size, shape, and other dimensions of the consumer package will affect the use of the industrial package. Second, the protection offered by the consumer package also concerns the logistics manager. The physical dimensions and the protection aspects of consumer packages affect the logistics system in the areas of transportation, materials handling, and warehousing. Simply stated, consumer packag- ing can negatively impact logistics cost (efficiency) and customer service if there is damage.

Promotion Companies may spend millions of dollars on national advertising campaigns and

other promotional practices to improve sales. An organization making a promotional effort to stimulate sales should collaborate with the logistics manager so that appropriate levels of inventory will be available for distribution to the customer. Problems can still occur, even with collaboration, because of the difficulty of forecasting the demand for a new product, but frequent interchange of information can mitigate problems, and supply chain collaboration can further improve the situation.

Place The place decision refers to the distribution channel selection and thus involves both

transactional and physical distribution channel decisions. Marketers typically become more involved in making decisions about marketing transactions and in deciding such things as whether to sell a product to wholesalers or to deal directly with retailers. From the logistics manager’s perspective, such decisions might significantly affect logis- tics system requirements. For example, organizations dealing only with wholesalers will probably have fewer logistics problems than they will when dealing directly with smaller retailers. Wholesalers, on the average, tend to purchase in larger quantities than do retai- lers and place their orders and manage their inventories more predictably and consis- tently, thereby making the logistics manager’s decision less challenging. Retailers, and in particular small retailers, often order in small quantities and do not always allow suffi- cient lead time for replenishment before stockouts. Consequently, manufacturers might need to purchase premium transportation service or keep higher inventory levels to meet delivery needs. Obviously, the emergence of larger retailers has changed this dynamic, as indicated in Chapter 1.

Recent Trends Perhaps the most significant trend is that marketers have begun to recognize the

strategic value of place in the marketing mix and the increased revenues and customer satisfaction that might result from excellent logistics service. As a result, many organiza- tions have recognized customer service as the interface activity between marketing and logistics and have aggressively and effectively promoted customer service as a key element of the marketing mix. Organizations in such industries as food, chemicals, pharmaceuticals, and technology have reported considerable success with this strategy to improve efficiency and effectiveness.

Logistics Interfaces with Other Areas While manufacturing and marketing are probably the two most important internal

functional interfaces for logistics in a product-oriented organization, there are other important interfaces. The finance area has become increasingly more important during

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the last decade. In fact, it will be argued in a later chapter that finance is the second lan- guage of logistics and supply chain management. The impact that logistics and supply chain management can have upon return on assets (ROA) or return on investment (ROI) is very significant. Logistics can positively impact ROA in several ways. First, inventory is both a current asset on the balance sheet and a variable expense on the income statement. Reducing inventory levels reduces the asset base as well as the corre- sponding variable expenses, thus having a positive impact on ROA. Second, transporta- tion and warehousing costs can also influence ROA. If an organization owns its warehouses and transportation fleet, they are fixed assets on the balance sheet. If these assets are reduced or eliminated, ROA may increase. Similarly, if an organization utilizes third parties for warehousing and transportation, variable expenses will be incurred, which impact the profit margin. Finally, the focus on customer service (discussed further in Chapter 8) can increase revenue. As long as the incremental increase in revenue is larger than the incremental increase in the cost of customer service, ROA will increase.

Increasingly, CFOs in organizations have become knowledgeable about supply chain and logistics because of the impact that they can have on key financial metrics such as ROA or ROI and cash flow. These metrics are important barometers for the external financial community to gauge the financial viability of an organization.

On the other hand, logistics managers have to justify increased investment in logistics-related assets using acceptable financial tools related to payback periods. Conse- quently, supply chain and logistics managers must be knowledgeable about financial metrics and standards of performance.

Accounting is also an important interface for logistics. Accounting systems are critical for providing appropriate cost information for analysis of alternative logistics systems. Far too often in the past, logistics-related costs were not measured specifically and were often accumulated into an overhead account, which made it extremely difficult to sys- tematically monitor logistics costs. The recent interest in customer profitability and the related cost accounting systems such as activity-based costing (ABC) has been beneficial to improving the quality of logistics data and analyses. Accounting systems are also crit- ical for measuring supply chain tradeoffs and performance.

Logistics in the Firm: Factors Affecting the Cost and Importance of Logistics

This section deals with specific factors relating to the cost and importance of logistics. Emphasizing some of the competitive, product, and spatial relationships of logistics can help explain the strategic role of an organization’s logistics activities.

Competitive Relationships Frequently, competition is narrowly interpreted only in terms of price competition.

While price is certainly important, in many markets customer service can be an important form of competition. For example, if an organization can reliably provide customers with its products in a relatively short time period, then its customers can usually reduce their inventory costs. An organization could consider minimizing customer inventory costs to be just as important as keeping product prices low, since minimizing such costs will contribute to more profit and in turn enable the seller to be more competitive.

Role of Logistics in Supply Chains 53

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Order Cycle A well-accepted principle of logistics management is that order cycle length directly

affects inventory levels. Stated another way, the shorter the order cycle, the less inventory required to be held by the customer. Figure 2.6 shows this relationship. Order cycle can be defined as the time that elapses from when a customer places an order until the order is received. The order cycle includes activities such as order transmission, order receipt, order processing, order preparation (picking and packing), and order shipment. Figure 2.6 shows that longer order cycle times usually necessitate higher customer inven- tories. For example, assume that a customer is using 10 units of a product per day and that the supplier’s order cycle time is eight days. The customer’s average inventory during order cycle time is 40 units (80/2). If the supplier can reduce the order cycle time to four days, the customer’s average inventory is reduced to 20 units (40/2). Therefore, if an organization can improve customer service by shortening its order cycle time, its customers should be able to operate with less inventory. It follows, then, that such a cost reduction could be as important as a price reduction.

Substitutability Substitutability often affects the importance of customer service. In other words, if a

product is similar to other products, consumers might be willing to substitute a competitive product if a stockout occurs. Therefore, customer service is more important for highly sub- stitutable products than for products that customers are willing to wait for or back-order. This is one reason why companies spend so much advertising money making consumers aware of their brands. They want consumers to ask for their brands, and, if their brands are temporarily not available, they would like consumers to wait until they are.

Product substitutability varies among industries. Usually, the more substitutable a product, the higher the customer service level required. As far as the logistics manager is concerned, an organization wishing to reduce its lost sales cost, which is a measure of customer service and substitutability, can either spend more on inventory or spend more on transportation to reduce the order cycle.

Figure 2.6 The Relationship Between Required Inventory and Order CycleLength from a Customer Perspective

U ni

ts of

in ve

nt or

y

Order cycle (days)

Source: Center for Supply Chain Research, Penn State University.

54 Chapter 2

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Inventory Effect Figure 2.7 shows that by increasing inventory costs (either by increasing the inventory

level or by increasing reorder points), organizations can usually reduce the cost of lost sales. In other words, an inverse relationship exists between the cost of lost sales and inventory cost. However, organizations are usually willing to increase the inventory cost only until total costs start to increase. Organizations are typically willing to spend increasing amounts on inventory to decrease lost sales cost by larger amounts—that is, up to the point at which the marginal savings from reducing lost sales cost equal the marginal cost of carrying additional inventory.

Transportation Effect A similar relationship exists with transportation, as can be seen in Figure 2.8. Compa-

nies can usually trade off increased transportation costs against decreased lost sales costs. For transportation, this additional expenditure involves buying a better service—for example, switching from water to rail, or rail to motor, or motor to air. The higher trans- portation cost could also result from shipping more frequently in smaller quantities at higher transportation prices. So, as indicated in Figure 2.8, organizations can reduce the cost of lost sales by spending more on transportation service to improve customer service. Once again, most organizations willingly do this only up to the point where the marginal savings in lost sales cost equals the marginal increment associated with the increased transportation cost.

Although discussing and illustrating inventory and transportation cost separately is convenient here, organizations can spend more money for inventory and transportation simultaneously to reduce the cost of lost sales. In fact, improved transportation will

Figure 2.7 The General Relationship of the Cost of Lost Sales to Inventory Cost

TC

COLS

Flow

Lo gi

sti cs

co st

TC INV

COLS

= = =

Total cost Inventory cost Cost of lost sales

INV

Source: Center for Supply Chain Research, Penn State University.

Role of Logistics in Supply Chains 55

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usually result in lower inventory cost. In other words, the situation is much more inter- active and coordinated than is indicated here.

Product Relationships A number of product-related factors affect the cost and importance of logistics.

Among the more significant of these are dollar value, density, susceptibility to damage, and the need for special handling.

Dollar Value The product’s dollar value typically affects warehousing costs, inventory costs, trans-

portation costs, packaging costs, and even materials-handling costs. As Figure 2.9 indicates, as the product’s dollar value increases, the cost in each identified area also increases. The actual slope and level of the cost functions will vary among products.

Transportation prices reflect the risk associated with the movement of goods, and higher-value products are often more susceptible to damage, which will cost the trans- portation provider more for damage reimbursement. Transportation providers may also charge higher prices for higher-value products since these customers may be willing to pay higher rates for transportation service.

Warehousing and inventory costs also increase as the dollar value of the product increases. Higher value means more working capital invested in inventory, resulting in higher total capital costs. In addition, the risk factor for storing higher-value products

Figure 2.8 The General Relationship of the Cost of Lost Salesto Transportation Cost

TC

COLS

Improved transportation service

Lo gi

sti cs

co st

TC Tr

COLS

= = =

Total cost Transportation cost Cost of lost sales

Tr

Flow

Source: Center for Supply Chain Research, Penn State University.

56 Chapter 2

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increases the costs of obsolescence and depreciation. Also, since the physical facilities required to store higher-value products are more sophisticated, warehousing costs increase with higher dollar value products.

Packaging costs also usually increase because the organization uses protective packag- ing to minimize potential damage to the product. An organization spends more effort in packaging a product to protect it from damage or loss if it has higher value. Finally, materials-handling equipment used to meet the needs of higher-value products is very often more sophisticated. Organizations are usually willing to use more capital-intensive and expensive equipment to speed higher-value goods through the warehouse and to minimize the chance of damage.

Density Another factor that affects logistics cost is product density, which refers to the weight/

space ratio of the product. An item that is lightweight compared to the space it occupies—for example, household furniture—has low density. Density affects transporta- tion and warehousing costs, as shown in Figure 2.10. As density increases for a product, its transportation and warehousing costs tend to decrease.

When establishing their prices, transportation providers consider how much weight they can fit into their vehicles, since they quote their prices in dollars and cents per hundred pounds. Therefore, on high-density items, these providers can afford to charge a lower price per hundred pounds because they can fit more weight into their vehicle. For example, assume a motor carrier needs $5,000 in revenue from the freight that fills a

Figure 2.9 The General Relationship of Product Dollar Value toVarious Logistics Costs

Inv

Dollar value of product

Lo gi

sti cs

co st

Inv Tr

Pkg

= = =

Inventory cost (including storage) Transportation cost Packaging cost

Tr

Pkg

Flow

Source: Center for Supply Chain Research, Penn State University.

Role of Logistics in Supply Chains 57

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53-foot trailer. A low-density product might be able to fit 20,000 pounds into this trailer to fill it completely. The motor carrier would need to charge $25 per hundred pounds for this product. On the other hand, a high-density product might be able to fill the trailer at 40,000 pounds. The resulting price per hundred pounds would be $12.50.

Density also affects warehousing costs. The higher the density, the more weight can fit into an area of warehouse space—hence, the more efficient use of warehousing space. So, both warehousing cost and transportation cost tend to be influenced in the same way by a product’s density.

Susceptibility to Damage The third product factor affecting logistics cost is susceptibility to damage (see Figure 2.11).

The greater the risk of damage to a product, the higher the transportation and warehous- ing cost. Because of a higher degree of risk and liability associated with more fragile goods, higher prices are charged by both transportation and warehousing providers. These providers might also charge higher prices because of measures they must take to prevent product damage.

Special Handling Requirements A fourth factor, related to damage susceptibility but somewhat distinct, is special

handling requirements for products. Some products might require specifically designed equipment, refrigeration, heating, or strapping. These special requirements will usually increase warehousing, transportation, and packaging costs.

Figure 2.10 The General Relationship of Product Weight Density to Logistics Costs

Inv

Weight density of product

Lo gi

sti cs

co st

Tr Inv

Whse

= = =

Transportation cost Inventory cost (including storage) Warehousing cost

Tr

Whse

Flow

Source: Center for Supply Chain Research, Penn State University.

58 Chapter 2

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Spatial Relationships A final topic that is extremely significant to logistics is spatial relationships, the loca-

tion of fixed points in the logistics system with respect to demand and supply points. Spatial relationships are very important to transportation costs, since these costs tend to increase with distance. Consider the following example, which Figure 2.12 illustrates.

Example The firm located at point B has a $1.50 production cost advantage over Firm A, since

Firm B produces at $7.00 per unit as opposed to $8.50 per unit for Firm A. However,

Figure 2.11 The General Relationship of Product Susceptibility to Lossand Damage to Logistics Costs

Pkg

Susceptibility to loss and damage

Lo gi

sti cs

co st

Pkg Tr

Whse

= = =

Packaging cost Transportation cost Warehousing cost

Tr

Whse

Flow

Source: Center for Supply Chain Research, Penn State University.

Figure 2.12 Logistics and Spatial Relations

MPC = $8.50 A B PC = $7.00

$0.40

$0 .50

$1.15 $3.50 $ 0.7

5

$0.60

Source: Center for Supply Chain Research, Penn State University.

Role of Logistics in Supply Chains 59

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Firm B pays $1.35 for inbound raw materials ($0.60 + $0.75) and $3.50 for outbound movement to the market (M), for a total of $4.85 in per-unit transportation charges. Firm A pays $0.90 for inbound raw materials and $1.15 for outbound movement, for a total of $2.05 in per-unit transportation charges. Firm A’s $2.80 transportation cost advan- tage offsets the $1.50 production cost disadvantage. Firm B might want to investigate alter- native strategies for its logistics system in order to compete more effectively at M. For example, Firm B might base its $3.50 per unit transportation cost for shipping to M on less-than-truckload prices (low-volume movements). Firm B might consider using a ware- house at M and shipping in full truckload quantities at lower transportation charges.

The distance factor or spatial relationships might affect logistics costs in ways other than transportation costs. For example, a firm located far from one or more of its markets might need to use a market-oriented warehouse to make customer deliveries in a satisfactory time period. Therefore, distance can add to warehousing and inventory carrying costs.

Distance or spatial relationships are of such importance to logistics that logistics responsibilities might include site location. For many organizations, warehouse location decisions are made based on distance to market, distance from suppliers, and access to transportation. Location, or site analysis, is considered in some detail later in this text.

Techniques of Logistics System Analysis In this section, total cost analysis techniques for logistics are discussed. Only the more

basic models are examined; more sophisticated techniques of total cost analysis are discussed later in this text. The basic approaches examined here reinforce some of the basic concepts discussed thus far and provide a background for much of the material in the remainder of this text.

Short-Run/Static Analysis One general approach to total cost analysis for logistics is known as short-run

analysis. In a short-run analysis, a specific point in time or level of production is chosen and costs are developed for the various logistics cost centers described previously. Multiple short-run analyses would be considered, and the system with the lowest overall cost would be selected, as long as it was consistent with constraints the organization imposes on the logistics area. Some authors refer to this short-run analysis as static analysis.5 Essentially, they are saying that this method analyzes costs associated with a logistics system’s various components at one point in time or one output level.

Example Table 2.2 shows an example of static, or short-run, analysis. In this example, an

organization is currently using an all-rail route from its plant and the associated plant warehouse to its customers. At the plant warehouse, chemicals are bagged and pal- letized and shipped by rail to the customer. A proposed second system would use a market-oriented warehouse. The chemicals would be shipped from the plant to the market warehouse and then packaged and sent to the customer. Instead of shipping all goods by rail, the organization would ship them by barge to the market warehouse, taking advantage of low bulk transportation prices. Then, after bagging, the chemicals would move by rail from the warehouse to the customer.

60 Chapter 2

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In this example, the tradeoff is lower transportation costs versus some increases in storage and warehousing. If the analysis is strictly static (at a specific level of output), the proposed system is more expensive than the current one. So, unless further analysis provided additional information more favorable to the proposed system, the organization would continue with its current system.

However, there are two reasons to favor the proposed system. First, there is no infor- mation about customer service requirements. The new market-oriented warehouse might provide better customer service, therefore increasing sales and profits and offsetting some of the higher costs of System 2.

Second, the organization might switch to System 2 even though it is experiencing lower costs with the current system (System 1) because the organization expects System 2 to result in lower costs in the future. This will require the use of dynamic analysis, which is the topic of discussion in the next section.

Long-Run/Dynamic Analysis While short-run analysis concentrates on specific time or level of output, dynamic

analysis examines a logistics system over a long time period or range of output. Using the data from Table 2.2, a dynamic analysis can be undertaken. The results can

Table 2.2 Static Analysis of C&B Chemical Company (50,000 Pounds of Output)

PLANT LOGISTICS COSTS* SYSTEM 1 SYSTEM 2

Packaging $ 500 $ 0

Storage and handling 150 50

Inventory carrying 50 25

Administrative 75 25

Fixed cost 4,200 2,400

Transportation Costs

To market warehouse 0 150

To customer 800 100

Warehouse Costs

Packaging 0 500

Storage and handling 0 150

Inventory carrying 0 75

Administrative 0 75

Fixed cost 0 2,400

Total cost $5,775 $5,950

*All amounts are in thousands of dollars. Source: Center for Supply Chain Research, Penn State University.

Role of Logistics in Supply Chains 61

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be seen in Figure 2.13. For a mathematical solution, the equation for a straight line is used (y = a + bx). In this particular case, a would be the fixed costs of each system, and b would be the variable cost per unit. The x would be the output level. To solve for the output level at which the two systems are equal, an equation for each system is developed and they are set equal to each other in order to solve for x. As shown below, the two systems are equal at 70,588 pounds of output, and this becomes the point of indifference. This can also be seen in the graph in Figure 2.13.

System 1

Total Cost   Fixed Cost   Variable Cost Unit   Number of Units y   $4 200   $0 0315x

System 2

y $4 800   $0 0230x

Tradeoff point

$4 800 $0 0230x   $4 200  $0 0315x 600  0 0085x x   70 588  pounds

Figure 2.13 Dynamic Analysis

0

3,200

3,600

4,000

4,400

4,800

5,200

5,600

6,000

6,400

$6,800

4,000 16,000 28,000 40,000 52,000 64,000 76,000 88,000

Point of indifference

System 2

System 1

Pounds

System 1 $5,775 $4,200 $1,575 $0.0315

Total Cost

Fixed Cost

Total Variable Cost

Variable Cost per Pound

System 2 $5,950 $4,800 $1,150 $0.0230

Source: Center for Supply Chain Research, Penn State University.

62 Chapter 2

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In this case, the organization is better off using System 1 at output levels up to 70,587 pounds. System 2 is less expensive at output levels greater than 70,588. At an output level of 70,588 pounds, both systems produce the same total costs.

A particular organization might consider more than two logistics systems at one time. The same basic methodology can be used for graphing and mathematically solving for the points of indifference regardless of how many systems are analyzed.

Approaches to Analyzing Logistics Systems The analysis of logistics systems may require different views or perspectives of logis-

tics activities. The best perspective to take depends on the type of analysis that is needed. For example, if an organization wants to analyze the long-run design of its logistics system, a view of logistics that focuses on the organization’s network of node and link relationships would probably be most beneficial. On the other hand, if an organization is evaluating a change in a carrier or mode of transportation, it should probably analyze the logistics system in terms of cost centers. In this section, four approaches to analyzing logistics systems are discussed: (1) materials management versus physical distribution, (2) cost centers, (3) nodes versus links, and (4) logistics channels.

Materials Management versus Physical Distribution The classification of logistics into materials management and physical distribution

(inbound and outbound logistics) can be useful to logistics management in an organiza- tion. Frequently, the movement and storage of raw materials in an organization is differ- ent from the movement and storage of finished goods. For example, a drywall manufacturer transports gypsum and other bulk commodities to its plants in rail cars. Storage is very basic and consists of enclosed domes (located outside the plant) with an opening at the top through which the gypsum rock is transferred from the rail cars. Finished goods movement and storage for drywall is different. Transportation is usually provided by specially designed rail cars or flatbed motor carrier vehicles. Storage of the finished drywall product is totally inside the facility where pallets of drywall sheets are stacked and prepared for loading. This internal storage is necessary to prevent the drywall from getting wet.

The different logistics requirements that might exist between materials management and physical distribution might have important implications for the design of an organi- zation’s logistics system. The design for each of these two activities might be quite different. In spite of these differences, close coordination between materials management and physical distribution is still critical.

Heavy Inbound Some organizations have a heavy inbound flow and a simple outbound flow. An air-

craft manufacturer such as Boeing is a good example. Boeing uses thousands of parts and components manufactured by hundreds of suppliers to assemble an aircraft. Multiple modes of transportation (rail, motor, air, and ocean) are used to move these parts to the assembly plant. Once the aircraft is assembled and tested, Boeing simply flies it to the customer (for example, United). The outbound process requires no warehousing, special transportation, or packaging. In contrast, the inbound side requires detailed scheduling, coordination, and planning to make sure that parts arrive when they

Role of Logistics in Supply Chains 63

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are needed. Varying lead times from suppliers present a complex logistics challenge. Automobile manufacturers, using thousands of parts per car, also fit this model. Their outbound systems, while more complex than those of an aircraft assembler, are not nearly as complex as their inbound systems.

Cost Centers A previous discussion mentioned the management activities that many organizations

include in the logistics area, namely, transportation, warehousing, inventory, materials handling, and industrial packaging. By examining these activities as cost centers, tradeoffs between them can be analyzed to determine the overall lowest-cost or highest-service logis- tics system, which represents a second approach to logistics system analysis. For example, changing the mode of transportation from rail to motor might result, because of faster, more reliable transit times, in lower inventory costs that can offset the higher motor carrier price. Table 2.3 shows that the motor carrier price is higher than rail, but resulting reduc- tions in other costs more than offset this higher transportation price. Another example might be increasing the number of warehouses in a logistics system, thereby increasing warehousing and inventory costs but possibly decreasing transportation and lost sales costs. As Table 2.4 shows, however, this might not result in the lowest-cost solution.

Table 2.3 Analysis of Total Logistics Cost with a Change to aHigher-Cost Mode of Transport

COST CENTERS RAIL MOTOR

Transportation $ 3.00 $ 4.30

Inventory 5.00 3.75

Packaging 3.50 3.20

Warehousing 1.50 0.75

Cost of lost sales 2.00 1.00

Total cost* $15.00 $13.00

*Costs per unit. Source: Center for Supply Chain Research, Penn State University.

Table 2.4 Analysis of Total Logistics Cost with a Change to More Warehouses

COST CENTERS SYSTEM 1: THREE WAREHOUSES SYSTEM 2: FIVE WAREHOUSES

Transportation $ 850,000 $ 500,000

Inventory 1,500,000 2,000,000

Warehousing 600,000 1,000,000

Cost of lost sales* 350,000 100,000

Total cost $3,300,000 $3,600,000

*Expected cost based upon probabilities of not having stock or inventory available when customers want it. Source: Center for Supply Chain Research, Penn State University.

64 Chapter 2

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Nodes Versus Links A third approach to analyzing logistics systems in an organization is in terms of

nodes and links (see Figure 2.14). The nodes are fixed spatial points where goods stop for storage or processing. In other words, nodes are manufacturing or assembling facilities and warehouses where the organization stores materials for conversion into finished products or stores finished products for delivery to the customer (balancing supply and demand).

Links represent the transportation network and connect the nodes in the logistics system. The network can be composed of individual modes of transportation (rail, motor, air, ocean, or pipeline) and of combinations and variations that will be discussed in Chapter 10.

From a node–link perspective, the complexity of logistics systems can vary enor- mously. A node system might use a simple link from suppliers to a combined plant and warehouse and then to customers in a relatively small market area. At the other end of the spectrum are large, multiple-product organizations with multiple plant and warehouse locations. The complex transportation networks of the latter might include three or four different modes and perhaps private as well as for-hire transportation.

The node–link perspective, in allowing analysis of a logistics system’s two basic elements, represents a convenient basis for seeking possible system improvements. As has been noted, the complexity of a logistics system often relates directly to the various time and distance relationships between the nodes and the links and to the regularity, predict- ability, and volume of flow of goods entering, leaving, and moving within the system.

Logistics Channels A final approach to logistics system analysis is the logistics channel, or supply chain

of network organizations engaged in transfer, storage, handling, communication, and other functions that contribute to the efficient flow of goods. The logistics channel can

Figure 2.14 Nodes and Links in a Logistics System

P W

W

W P

W

P

W

PW

W

M

M

M M

M

M

W = Warehouse P = Plant M = Market

Source: Center for Supply Chain Research, Penn State University.

Role of Logistics in Supply Chains 65

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be viewed as part of the total distribution channel, which includes both the logistics flow and the transaction flow, which would be of specific interest to the marketing manager.6

The logistics channel can be simple or complex. Figure 2.15 shows a simple channel in which an individual producer deals directly with a final customer. The control in this channel is relatively simple. The individual manufacturer controls the logistics flow since it deals directly with the customer.

Figure 2.16 presents a more complex, multi-echelon channel, with a market ware- house and retailers. The market warehouse could be a public warehouse. In this instance, the control is more difficult because of the additional storage and transportation provided by third-party organizations.

Figure 2.15 A Simple Logistics Channel

Raw materials supply point

Raw materials supply point

Customers Market

Market

Manufacturing plant

Market

Flow

Customers

Customers

Source: Center for Supply Chain Research, Penn State University.

Figure 2.16 A Multi-Echelon Logistics Channel

Retailer

Retailer

RetailerRaw materials supply point

Raw materials supply point

Raw materials supply point

Manufacturing plant

Flow

Warehouse

Warehouse

Retailer

Retailer

Retailer

Source: Center for Supply Chain Research, Penn State University.

66 Chapter 2

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Figure 2.17 illustrates a complex, comprehensive channel. In this instance, the task of achieving an effective logistics flow in the channel is far more challenging. This figure realistically portrays the situation confronting many large organizations operating in the United States and overseas.

Some instances involving production of a basic good like steel, aluminum, or chemicals might further complicate the situation because organizations might be part of more than one supply chain or channel. For example, the steel might be sold to auto manufacturers, container manufacturers, or file cabinet producers. Duplication of storage facilities,

Figure 2.17 A Complex Logistics Channel

Retailer

Raw materials supply source

Raw materials supply source

Raw materials supply source

Raw materials supply source

Raw materials supply source

Manufacturing plant

Manufacturing plant

Manufacturing plant

Manufacturing plant

Warehouse

Warehouse

Warehouse

Warehouse

Warehouse

Wholesaler

Wholesaler

Wholesaler

Wholesaler

Wholesaler

Retailer

Retailer

Retailer

Retailer

Retailer

Retailer

Retailer

Retailer

Retailer

Retailer

Retailer

Retailer

Retailer

Retailer

Retailer

Retailer

Retailer

Retailer

Retailer

Retailer

Retailer

Retailer

Retailer

Retailer

Flow

Source: Center for Supply Chain Research, Penn State University.

Role of Logistics in Supply Chains 67

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small-shipment transportation, conflict over mode choices, and other problems might con- tribute to inefficiencies in the channel. Communications problems might also exist.

Logistics and Systems Analysis An earlier section pointed out that developments in analyses and methodologies

have facilitated the development of logistics. One such development was systems analysis, or the systems concept. Essentially, a system is a set of interacting elements, variables, parts, or objects that are functionally related to one another and that form a coherent group. The systems concept is something to which most individuals have been exposed at an early educational stage; for example, in science, students learn

Supply Chain Technology

Mission Foods’ Wireless Evolution

No matter which wireless technology you’re putting to use in your warehouse/DC operations, going wireless and freeing yourself from paper—while achieving real-time visibility on your trucks and inventory—are the clear beneficial attributes that are making wireless technology the hot topic it is today.

Tortilla manufacturer Mission Foods is a terrific example of what can be done through a compre- hensive wireless system. The company employed a combination of wireless technologies—from handheld computers, to wireless networks, to RFID—to automate transactions, track assets and manage labor and inventory in its distribution operation. Let’s take a closer look at how this innovative manufacturer made it happen.

MISSION’S MISSION With 16 plants and 50 distribution centers (DCs), Irving, Texas-based Mission Foods is one of the largest manufacturers of tortillas, chips, salsa and taco shells in the U.S. Mission’s mission is simple: To deliver fresh, shelf-stable tortilla products to every customer, every time, on time.

Mission’s supply chain operation accomplishes this by following a direct-store-delivery (DSD) model using independent operators to quickly move products to market. It has a network of about 2,000 independent distributors who transport Mission’s products over 2,300 routes. They pick up these products from Mission’s facilities and deliver them directly to supermarkets and retail stores.

Since the late 1980s, Mission Foods had been using batch computers for its DSD routes, while relying heavily on paper and corrugated for picking and packing items. But by 2005, following years of dramatic developments in wireless networks, data capture, and mobile computers, Eduardo Valdes, vice president of management information systems, knew it was high time to leverage these technologies and transform Mission’s distribution process.

Under his watch, Mission Foods began making the move towards wireless technology in three critical areas; its DSD operation; in the tracking of returnable plastic containers; and within the four walls of the warehouse.

Using these wireless handheld scanners in the warehouse has allowed real-time tracking of inven- tory, labor productivity, and delivery status, while seamlessly interfacing with Mission’s SAP sys- tems. In late 2009, they went live with the first location, adding two more locations in 2010.

Source: Maida Napolitano, Logistics Management, April 2011, p. 46

68 Chapter 2

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about the solar system and how relationships among the planets, the sun, and the moon result in day and night, weather, and so forth. In biology, students view the parts of the human body, such as the heart and blood, and their relationships as another system. In a power mechanics class, the internal combustion engine is explained as a system. Engine parts, such as pistons, might be made larger in size and more efficient, but their very efficiency might overload other parts of the engine, causing it to break down, so the pistons have to be designed to work in harmony with other parts of the engine. In other words, the overall performance of the engine is more important than the performance of one part. The general tenet of the systems concept is that the focus is not on individual variables but on how they interact as a whole. The objective is to operate the whole system efficiently and effectively, not just the individual parts. From a supply chain perspective, this is a major challenge, but the supply chain is a system.

Role of Logistics in Supply Chains 69

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SUMMARY • Logistics has developed as an important area or function of business since World War II. It has gone through several phases of development in achieving its present status.

• Logistics is a critical part of supply chain management. The coordination and, perhaps, integration of the logistics systems of all the organizations in a supply chain are nec- essary requirements for successful management of the supply chain.

• Logistics has a number of different definitions because of the broad-based interest in its activities and the recognition of its importance. The definition developed by the Council of Supply Chain Management Professionals is the primary definition used in this text.

• Logistics is an area of management that has four subdisciplines: business, military, service, and event.

• On a macro basis, logistics-related costs have been decreasing on a relative basis, which has helped the U.S. economy regain its competitive position on a global basis.

• Logistics adds place, time, and quantity utilities to products and enhances the form and possession utilities added by manufacturing and marketing.

• Logistics has an important relationship to manufacturing, marketing, finance, and other areas of the organization.

• Logistics managers are responsible for a number of important activities, including transportation, inventory, warehousing, materials handling, industrial packaging, customer service, forecasting, and others.

• Logistics systems can be viewed or approached in several different ways for analysis purposes, including materials management versus physical distribution, cost centers, nodes versus links, and channels. All four approaches are viable for different purposes.

• Logistics systems are frequently analyzed from a systems approach, which emphasizes total cost and tradeoffs when changes are proposed. Either a short- or a long-run perspective can be used.

• The cost of logistics systems can be affected by a number of major factors, including competition in the market, the spatial relationship of nodes, and product characteristics.

STUDY QUESTIONS 1. What is logistics, and why is it important in private companies and public organizations?

2. Why is logistics important on a macro level, and what contributions does logistics make in the economy?

3. How does logistics add value in the economy? How does logistics add value for firms?

4. What is the relationship between logistics and supply chain management? In what ways are they different?

5. Compare and contrast the four major subdivisions of logistics discussed in this chapter.

6. Explain the relationship between manufacturing and logistics. What are the tradeoffs between the two areas?

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7. Physical distribution has a special relationship to marketing. Why is this relationship so special? What is the nature of the overall relationship between logistics and marketing? Is the relationship becoming more or less important?

8. Logistics encompasses a relatively large number of managerial activities. Discuss five of these activities and why they are important to logistics systems.

9. Why do companies analyze their logistics systems from perspective of nodes and links?

10. What product characteristics affect logistics costs? Discuss the effects of these characteristics on logistics costs.

NOTES 1. Stephen H. Russell, “Growing World of Logistics,” Air Force Journal of Logistics, Vol. 24, No. 4 (2000): 13–15.

2. Ibid.

3. Ibid.

4. E. Jerome McCarthy and William E. Perrault, Jr., Basic Marketing: A Managerial Approach, 9th ed. (Homewood, IL: Richard D. Irwin, 1987): 46–52.

5. J. L. Heskett, Robert M. Ivie, and Nicholas A. Glaskowsky, Jr., Business Logistics: Management of Physical Supply and Distribution (New York: Ronald Press, 1973): 454–469.

6. Roy Dale Voorhees and Merrill Kim Sharp, “Principles of Logistics Revisited,” Transportation Journal (Fall 1978): 69–84.

Role of Logistics in Supply Chains 71

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CASE 2 .1

Senco Electronics Company: A Sequel Senco Electronics Company (Senco) is a U.S.-based manufacturer of personal compu-

ters and other electronic equipment. Current assembly operations are still located in the United States and primarily serve the U.S. market. Transportation in the United States from Senco sites to its customers is primarily performed by motor carriers. Rising costs in its U.S. operations have caused Senco to evaluate the construction of a new assembly plant in China. Senco decided to also consider Vietnam. Jim Beierlein, the new executive vice president of supply chain management for Senco, is concerned with how Senco will transport its products from Asia to the United States. “We’ve had the luxury of a well- developed ground transportation infrastructure in the United States to move our pro- ducts. Now we will be faced with moving enormous quantities of electronic products across several thousand miles of ocean. We really don’t have that much experience with other modes of transportation.”

Skip Grenoble, director of logistics for Senco, was called on for his advice. “Obviously, we need to decide on whether to use ocean or air transportation to move our products from the new locations. Air transportation will cost more than ocean but will result in lower inventory costs because of the faster transit times. The opposite is true for ocean transportation. Moving products by air will also result in higher ordering costs since we will be ordering more often for replenishment for our U.S. distribution centers. Using either mode will require some fixed investment in loading and unloading facilities at both the new plant and our U.S. distribution centers. Projected annual demand from the new facility is 2.5 million pounds. However, we expect this demand to grow by 5 percent annually over the next five years. Although the air transportation system appears to be the more expensive option right now, we need to take into consideration our growth and how each mode will help us achieve our profit and service goals.” The rele- vant cost information for each alternative is presented in the following table.

OCEAN AIR

Total transportation costs $150,000 $290,000

Inventory costs

Carrying 48,000 23,000

Handling 20,000 22,000

Ordering 7,000 15,000

Fixed cost 600,000 450,000

Total costs $823,000 $800,000

CASE QUESTIONS 1. If you were Skip Grenoble, which alternative would you advise Jim Beierlein to

implement? What criteria would you use to arrive at your decision?

2. At what level of demand (in pounds) per year would these two alternatives be equal?

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3. Graphically represent these two alternatives and their tradeoff point.

4. Which alternative would you recommend be in place to accommodate future demand growth? What additional factors should be considered?

Source: Center for Supply Chain Research, Penn State University.

Role of Logistics in Supply Chains 73

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CASE 2 .2

Pete’s Pete’s Peanuts Snacks is a large processor of peanuts based in Albany, Georgia. Pete’s

major products are roasted (plain and salted) peanuts distributed in 6-ounce bags and 18-ounce cans. Pete’s dominant market position is a result of its emphasis on product freshness and availability at stores. Pete’s product development department recently created a new peanut product that is spicy flavored. It was also able to reduce the amount of cholesterol and salt in its peanuts, thus making the peanuts a more healthful snack. However, the new flavor also shortened the shelf life of the products.

Pete’s marketing department decided to launch the new peanut product a month before the NCAA basketball playoffs. Advertisements were scheduled on television, on billboards, on Facebook, and in newspaper circulars three weeks before the Final Four weekend. A sweepstakes contest was also proposed that would award the contest winner a free trip for two to next year’s Final Four. Each can of the cinnamon peanuts contained an insert with a serial number that could be matched with the winning number on Pete’s Web site.

To meet the estimated initial demand for the new product, manufacturing started making product two months before the introduction. Demand for the week preceding the Final Four games was estimated to be 3 million 18-ounce cans. Demand following the Final Four games was estimated to be 1 million cans per week. Manufacturing capac- ity for the new product is 1 million cans per week.

Pete’s price per can to its retail customers would be $2.50, which would allow for a gross margin of $1.25 per can. Pete’s cost to produce each can is $0.85. Inventory carrying costs per can are $0.10. Pete’s finance department was concerned that the heavy promotion and high build-up of inventories would eliminate almost all of the profit Pete’s would make on each can. Their directive to the product manager was that the product had to maintain its profit, or it would be pulled from the market.

CASE QUESTIONS 1. What interactions and discussion need to take place among the marketing, manufacturing, logistics, and finance departments? Explain the logistics department’s role in the introduction of the new product.

2. Why is it necessary for the logistics department to be cognizant of all the details (quantity, timing) of the new product introduction? Discuss the issues that might arise (e.g., the drop in demand after the Final Four) and what responsibilities the logistics department would have as a result of these changes.

Source: Center for Supply Chain Research, Penn State University.

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Chapter 3

GLOBAL DIMENSIONS OF SUPPLY CHAINS

Learning Objectives After reading this chapter, you should be able to do the following: • Discuss the complexity of a global supply chain network and understand what

questions need to be addressed for the global supply chain to be competitive.

• Describe the three major phases of globalization and understand the underlying economic and political forces driving each of these phases.

• Appreciate the complexity of the operations of successful global companies and why global expansion is important to their growth and financial viability.

• Explain how technology and logistics service specialists can help companies, especially small- to medium-size firms, penetrate the global marketplace and contribute to their competitive success.

• Appreciate the importance and contributions of the trading partner countries of the United States and how they support our global prosperity.

• Discuss the complexity of global markets and how competitive strategy can help mitigate complexity.

• Appreciate the need for global security measures and the flexibility necessary to ensure that such security measures do not impede trade but rather enhance the flow of goods and services.

• Discuss global transportation options and strategic intermediaries and their role in global supply chains.

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Supply Chain Profile Red Fish–Blue Fish, LLP: A Sequel

Fran Fisher, CEO of Red Fish–Blue Fish, was meeting with his nephew, Eric Lynch, the newly appointed vice president of supply chain management, and his son, Jeff Fisher, vice president of operations. Fran started the meeting by expressing appreciation to both Eric and Jeff for their performance during the last year. Red Fish–Blue Fish had quadrupled its annual sales since its first year of operation. This growth occurred during turbulent economic times in the United States and globally. Fran noted that the company’s consulting and construction sales were leveling out but that Internet sales had been growing geometrically, especially during the last two years in the global markets.

COMPANY BACKGROUND Red Fish–Blue Fish, LLP, was established by Fran Fisher in 2007 after he decided to make a career change. Fran had a successful 40-year career in the broadcasting business—radio and TV. He had worked in every phase of the business but was probably best known for being a television color commentator and play-by-play analyst for college football. He had developed a small media consulting company for radio and TV in Greensburg, Pennsylvania, which is located about 30 miles east of Pittsburgh.

Fran’s interest in exotic fish and large display tanks as a hobby led to the establishment of Red Fish–Blue Fish. Several friends, including a local dentist, asked him for advice on fish selection and the effective use of fish tanks for office décor. The dentist, Andy Zimmerman, thought that fish tanks would enhance the office ambiance and be calming for children and help mitigate their fear. Fran’s media business was declining as the large networks moved aggressively to establish relationships with major conferences and the larger universities. The new social Internet options such as YouTube and Facebook were changing the media business, especially for small businesses in small market areas.

Fran realized the potential of the Internet for his contemplated new business and felt that his radio and TV experience would help with the development of an Internet Web site for the new business. The consulting business developed as a result of the local dentist’s request for assistance. Andy Zimmerman offered to not only buy his exotic fish through Fran but also to buy consulting services to have Fran set up his dental office suite with appropriate equipment and fish. With the help of the son of a mutual friend who was a contractor, the office suite was remodeled to everyone’s satisfaction.

CURRENT SITUATION Now in their fifth year of operation, Fran Fisher felt that Red Fish–Blue Fish was at an impor- tant crossroad for the future. The consulting and construction business was leveling off, but there was an opportunity to extend into the Philadelphia, Baltimore, and Washington, DC, areas. Fran’s construction contractor, Jim Beierlein, had experience working in that general area for a large East Coast construction company before going into business for himself. Fran had approached Jim about the possibility of coming to work for Red Fish–Blue Fish on a full-time basis as a vice president. Jim indicated interest if and when Fran were to make him a formal offer.

U.S. sales had been growing steady through catalog and Internet offerings, but global sales in Canada and Europe had been growing exponentially, and several South American countries had become target markets for Internet sales. There also appeared to be market opportunities in several Asian countries.

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Introduction Globalization was identified in Chapter 1 as being one, if not the leading, external

factor driving change of the economic landscape for not only for-profit companies but also for nonprofit organizations. Global trading has been with us for centuries, but the scope and magnitude of the products, information, and financial flows today are almost mind boggling. For example, the value of trade (total of imports and exports) between the United States and China has grown from $366 billion in 2009 to $457 billion in 2010, which represents a 25 percent increase in one year. This is indicative of the importance of global trade flows in the world economy and, in particular, in the U.S. economy.1

It has been argued that globalization was initially driven by countries (1400–1800) seeking materials and goods not available in their own land, but they also had imperial- istic objectives of enhancing their economic and political power. The second era of globalization (1800–2000) was driven by companies seeking goods and materials, labor, economies of scale, and markets. This era produced multinational companies with global reach and enormous economic market power.2

The development and growth of large multinational companies really moved the world toward globalization. These companies were the ones that initially asked the following global questions first posed in Chapter 1:

• Where in the world should we procure or purchase raw materials, semifinished materials, components, services, and other inputs?

• Where in the world should we locate plants and supporting facilities to produce products or services to meet customer demand?

• Where in the world should we market and sell our products or services?

• Where in the world should we store or distribute our products or services?

The principal source for the fish was in China, and the Liu-Sheng Trading Company had been the principal supplier of fish for the company. Connie Quo was COO for the China company. In a recent meeting with Mr. Fisher, Ms. Quo expressed a strong interest in a closer or even exclusive alliance with Red Fish–Blue Fish. The Chinese company also used UPS almost exclusively for transportation services.

MEETING After bringing Jeff and Eric up to date about the current situation, Fran wanted their input to develop a future direction for the company with associated strategies.

Fran told Eric and Jeff that he was convinced that their success over the past five years had been based upon responsive customer service offered through their supply chain as well as a quality product. However, he was concerned about the future, not because of market opportu- nities but rather because of the need for scale throughout their operations and supply chain. Red Fish–Blue Fish needed to change to maintain its momentum. He asked them for input to set a future course of action and direction for their company.

As you read this chapter, consider what the options are for Red Fish–Blue Fish to expand globally, particularly in terms of outsourcing and collaborative ventures.

Source: John J. Coyle, DBA. Used with permission.

Global Dimensions of Supply Chains 77

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• What global transportation and communication alternatives should we consider and use?

• What global partnerships or alliances should we establish for collaboration to improve our efficiency and effectiveness?

These questions should not be answered separately. They are too interrelated or synergistic and require the evaluation of alternative scenarios to answer all the questions for the optimal or best alternatives. Red Fish–Blue Fish needs to address some of these questions as they look forward to the future as a larger company.

The scope of these questions provides an insight into the nature of being truly global. The established, successful multinational companies also created opportunities for smaller organizations to participate in the global marketplace as they fine-tuned their business models to improve efficiency and effectiveness. For example, the multinationals could purchase component parts needed for the finished products from a variety of sources in different countries. This became a common practice for auto, consumer products, and computer manufacturers. Companies such as Nike outsourced all of their manufacturing. The complexity of global trade sometimes required specialists not only in transportation but also in more specialized areas such as customs and tariffs. Such arrangements led to growing collaboration in many supply chains.

In the second phase of globalization, companies headquartered in developed countries like the United States, Western Europe, and Japan had an advantage in terms of infrastructure, educational systems, and capital markets. It has been suggested that the world was, figuratively speaking, tilted in favor of the developed countries. The economic advantage was such that the citizenry of the less-developed countries tended to migrate to the more developed countries, especially the United States. The well-educated and skillful immigrants added to the advantages enjoyed by the developed countries.3

The third era of globalization is said to have begun around the year 2000. The signifi- cant characteristic of this era is that it is being powered by individuals and smaller organizations in contrast to the countries of the first era and the large companies of the second era.4 The critical ingredients for this new era have been the technological advances, especially in information technology and communications, that have connected the “four corners of the globe.” Thus, with the enabling of more broad-based participation in the global economy without some of the massive infrastructure previ- ously required, the world has indeed become flat. Again, the large, multinational compa- nies have created niche opportunities for individuals and small organizations to collaborate in their supply chains. Red Fish–Blue Fish is a good example of a very small company capitalizing on technology and a global third-party logistics service provider to fill a niche and compete successfully through collaboration and outsourcing.

One of the outcomes of this new global era is an attack on traditional, hierarchical organizational structures.5 Businesses are being transformed into flatter, more horizontal, and more collaborative organizations that participate in more supply chains to add value and efficiency for consumers worldwide.

Chapter 1 argued that the rate of change has accelerated and is being fueled by a number of major external forces or change drivers. The synergy between globalization and technology especially has permanently changed the dynamics of the world’s market- place. The outcry in some quarters about outsourcing is 40 years too late and may be misguided. This new era has and will continue to spotlight supply chains as a critical

78 Chapter 3

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part of the ability of organizations to compete economically, and it deserves special discussion. Red Fish–Blue Fish could not compete now or in the future without some collaboration and without outsourcing.

Supply Chains in a Global Economy In Chapter 1, a supply chain was depicted as being boundary spanning; that is, as

encompassing a group of interrelated firms that is focused on delivering the best price or value products and services to the ultimate customer at the end of the supply chain. It was also noted that a supply chain also should manage four important flows, namely, materials and products, information, financials, and demand.

An important characteristic of today’s world economy is the increasing regional eco- nomic integration. The globalized economy, the establishment of the General Agreement on Tariffs and Trade (GATT) and its 1995 successor, the World Trade Organization (WTO), have together led to multilateral trade promotion and lowered barriers to interna- tional business transactions. Nevertheless, a growing number of countries have grouped together to form regional trade agreements (RTAs). The biggest and best known example of an RTA is the European Union (EU), with its number of memberships growing from six members in the 1950s to 27 members in 2010. The number of RTAs grew significantly during the 1990s. As of July 2005, 330 RTAs had been ratified by the GATT or to the WTO, 206 of which were ratified after the establishment of WTO in 1995. Today, 180 are still in force. Members of an RTA are usually subject to membership requirements and rules while receiving special trade preferences among members of the RTA that are not available to nonmembers. The specific details of these preferences vary across RTAs.6

Comparative advantages of different regions and member countries change as a result of regional position shifts with new RTAs being proposed, new members joining the existing RTAs, and new activities of integration (such as customs unions, currency unions, and visa-free transit) being enforced or proposed among member states. The best supply chains compete very successfully on a national, regional, and global basis.

Walmart is frequently cited for its supply chain efficiency and effectiveness, and rightly so. Consider, for example, that a computer manufacturer such as Hewlett- Packard can sell over 400,000 computers in one day through over 4,000 Walmart stores to customers worldwide during the Christmas season. Each of the computers has compo- nent parts from a number of global providers, and the computers are usually assembled in several global locations. The synchronization of the three flows mentioned above that allows this to happen almost seamlessly is an amazing accomplishment.

Consider also that Americans spend over $35 million per hour, 24 hours per day, 365 days per year in Walmart stores, and the stores stock over 65,000 different items a year.7

None of the above is meant to imply that the supply chains that Walmart is a part of operate perfectly each and every time. Walmart stores do experience shelf stockouts at times (hence the use of rain checks) or overstocks of some stock-keeping units (SKUs) occasionally.8 However, considering the length and complexity of some of its supply chains, it minimizes such happenings using the tools, technology, and management skills discussed in this text.

The net effect of Walmart’s success with supply chain management has enabled it, as indicated in Chapter 1, to become the largest corporation in the world as measured by sales dollars of about $600 billion per year. Other companies have also been successful

Global Dimensions of Supply Chains 79

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based to some extent on the efficiency and effectiveness of their supply chains, for instance, Apple, Dell, Procter & Gamble (P&G), IBM, Johnson & Johnson, General Electric, and Kimberly-Clark.

These companies and others have transformed themselves by changing their supply chains and their business models, which, in turn, has significantly changed the business landscape in the twenty-first century. Consider, for example, that some U.S. companies

On the Line More Deliveries, Same Cost

Kimberly-Clark, a 140-year-old company headquartered in Irving, Texas, USA, makes an assort- ment of personal care products, including such well-known items as Kleenex facial tissues, Huggies diapers, and Scott’s paper towels. In 2010 it reported worldwide revenue of US $19.7 billion from sales in more than 150 countries.

In Europe, Kimberly-Clark sells its products in 45 countries and operates 15 factories. Finished goods are stored in 32 distribution centers, all of which are operated by third-party logistics (3PL) companies.

Back in 2003, some retailers in the Netherlands were trying to restock store inventory based on point-of-sale data, which would allow them to make replenishment decisions based on actual customer transactions. As part of that initiative, the retailers wanted to increase the frequency of deliveries and resupply stores by replenishing only what had been sold. “They really wanted us to deliver more frequently to align to point-of-sale data, so we would be replenishing more in real time.”

The question facing Kimberly-Clark was this: “How can we shorten the replenishment cycle and stop delivering full truckloads without incurring additional transportation costs?”

The solution would be to team up with another company that was making shipments to those same retail stores. If Kimberly-Clark and its partner split a truckload, with each filling half a trailer, both companies could increase delivery frequency without increasing transportation costs.

Kimberly-Clark approached the cosmetics manufacturer Lever Faberge about the idea. The two companies conducted a successful trial with Makro, which operates a chain of warehouse club stores in the Netherlands. The experiment produced other benefits besides transportation savings: it also demonstrated that by shortening cycle time for deliveries, collaborative distribution could reduce store inventories while increasing on-shelf availability of products. When they did the trial with Makro, there was a 30 percent reduction in the value of the products that they were storing. They also got an out-of-stock reduction of 30 percent.

Kimberly-Clark’s venture with Lever Faberge in the Netherlands encouraged other companies to take the plunge into shared distribution. It was the starting point for what is now known as collaborative supply chains in Europe.

“Collaboration now is a big thing in Europe, especially for CPGs (consumer packaged goods companies).” The concept of shared supply chains has proved so attractive, in fact, that a non- profit organization has been formed in Europe to foster such collaboration among other CPG companies, retailers, and third-party logistics companies.

For Kimberly-Clark, its positive experience with collaborative distribution in the Netherlands prompted the consumer goods giant to extend that program to additional countries and business partners.

Source: James A. Cooke, “Sharing Supply Chains for Mutual Gain,” CSCMP’s Supply Chain Quarterly (Quarter 2, 2011): 39

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derive over 25 percent of their profit from global sales, which helps to mitigate declines or instability in domestic markets.

Adam Smith, who is credited with providing the economic rationale for capitalism in his famous book Wealth of Nations, stated that division of labor or labor specialization is limited by the extent of the market or volume of demand.9 In other words, economies and companies could improve their wealth by allowing specialization of tasks. The auto- mobile assembly line is a good example of specialization wherein each individual performs a small task relative to the total product, but the output per individual is higher than if individuals each assembled a complete car. Smith’s caveat, which is relevant here, indicates that the advantage is true as long as you can sell the increased volume that is produced. We argued in 1976, in the first edition of this text, that an important role of logistics was to help extend the market area of countries or companies through improved efficiency to lower the landed cost in new market areas.

The logic of the rationale stated above is even more apropos for supply chains. It can be argued that supply chains help to establish the limits of what is competitively possible in the market. In other words, the cost and value at the end of the supply chain deter- mine a firm’s ability to compete in a global marketplace. Good supply chains are business power, and good supply chain managers are continually pushing the limits of their supply chains to be viable in both domestic and global markets.

Operating globally has become easier to accomplish for even individuals and small companies, such as Red Fish–Blue Fish, because of the advances in information and communications technology and the continuing improvement of specialists such as UPS, FedEx, and DHL that can provide global supply chain services at a very reasonable cost. A growing number of specialists and continuing improvements in information technology and communications are contributing to the flattening of the world. Obviously, large global companies are also contributing to this phenomenon.

It is safe to conclude that supply chains and supply chain management play an impor- tant role in the global economy and have helped to push the growth and success of companies that do “supply chaining” very well. The globalization “train is out of the station” and rolling down the tracks at increasing speed. Global supply chains impact all of us. We love the lower prices, the increased array of products, and the convenience (read 24/7, one-stop shopping), but we are critical of some of the outcomes when individuals lose their jobs, businesses are closed, and so forth. Many would argue that the advantages outweigh the disadvantages; for instance, lower prices have saved consumers billions of dollars in purchase prices. There are tradeoffs (advantages and disadvantages), but there is no turning back. Successful organizations will continue to need effective and efficient supply chain management as they move ahead aggressively in the twenty-first century. The following chapters will address how such success can be accomplished.

In the next several sections of this chapter, we will discuss the magnitude of global operations and supply chains as well as some of the challenges and types of global supply chain services.

The Scope and Magnitude of Global Business In Chapter 1, the concept of the world compressing in terms of time and distance was

presented. Obviously, the distance between New York City and Shanghai, China, is still the same, and these cities have not changed time zones. However, transportation,

Global Dimensions of Supply Chains 81

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communications, and computer-related technology are making it much more convenient for business executives from different countries to meet face to face or via special infor- mation technology. The ability to connect to individuals and companies across the globe and to connect computer information systems on a 24/7 basis has provided unparalleled opportunity for collaboration horizontally and vertically in supply chains. This connec- tivity has allowed the type of interorganizational cooperation, visibility of flows, and real time adjustments necessary for efficient and effective supply chains.

The global data presented in this section reflect this new era. Table 3.1 presents trade data (total of imports and exports) for the top 10 U.S. trading partners. Some interesting and important relationships depicted in Table 3.1 should be noted. China is now our second largest trading partner, supplanting Mexico, which historically has been number two. The trade value with China was 22.2 percent of the total of the top 10 for 2010, and it increased its trade value by 25 percent from 2009 to 2010. In 2000, China was number four on the top-10 list, following Canada, Mexico, and Japan, and its trade value with the United States has nearly quintupled since that time ($457 billion vs. $94 billion). This increase reflects the comments made previously about the growing importance of China. The total value of trade with these top 10 trading partners increased by 22.63 percent from 2009 to 2010, and since 2000 it has increased by about 288 percent in total value. Both of these percentage increases are reflective of the growing interdependence and the trade relationships with other countries. The data lend additional creditability to statements made previously about the importance of global supply chains.

India was mentioned in Chapter 1 in the context of globalization but does not appear in the top 10 countries listed in Table 3.1. India’s strength has been in the area of

Table 3.1 Top U.S. Trading Partners

VALUE OF TRADE ($ BILLIONS)

COUNTRY 2008 2009 2010

Canada $ 601 $ 431 $ 525

China 408 366 457

Mexico 367 306 393

Japan 204 147 181

Germany 152 115 131

United Kingdom 112 93 98

South Korea 83 68 88

France 73 61 66

Taiwan 61 47 62

Brazil 63 46 59

Total $2,124 $1,679 $2,059

Source: TradeStats Express™, International Trade Administration, U.S. Department of Commerce, 2011.

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information technology services, which tends to understate its importance for global sup- ply chains. In 2005, 59 percent of U.S. corporate spending (offshore) for information technology services was spent in India.10 Interestingly, China, which is known for manufacturing various types of products, is attracting U.S. companies to establish research centers. Microsoft and Intel established research centers in Beijing in 1998, Google in 2005, and Rohm & Haas and Dupont in Shanghai in 2006.11 The combined populations of China and India, which are in excess of two billion people, make them attractive as markets and as sources of imports. Consequently, it seems safe to conclude that global supply chain connections to both China and India will continue to grow. Large U.S. consumer product companies and retailers are already connected with sourcing and selling.

Even smaller companies, such as W. W. Grainger, a distributor of maintenance, repair, and operating (MRO) products, is connecting its supply chain to China as a source of products to buy and as a market for distributing and selling its other products. Challenges and risks are associated with doing business with or in China and India, but the opportunities are enormous. Companies will change their business models because of these opportunities. Consider the partnership between IBM and Lenovo for IBM’s personal computer business or Honda Motor in India, which has used different partner- ing strategies for different product lines.

Once risks are identified, leading companies use a variety of strategies to manage them. These risk mitigation strategies are selectively applied depending on the impact and probability of each risk. Evidence is building that those firms that apply a rigorous risk management methodology are much more likely to see the promised benefits from a global outsourcing strategy as well as realize the payback from their overarching globalization strategy.

Global Markets and Strategy The global business environment has changed significantly and become much more

conducive to business activity between and among different countries. Companies are not just importing and exporting products but are also locating plants and other facilities in other parts of the world. Honda and Toyota used to produce cars in Japan and ship them to the United States. Now their cars are, for the most part, produced in the United States for sale in North America. U.S. companies have also located plants in other countries.

As indicated in Chapter 1, tariffs and other trade barriers have been significantly reduced among many countries, allowing a much more competitive global economy. This represents both a threat and an opportunity. Like deregulation of transportation, some companies have not responded well and have lost market share or gone out of business. Other companies have taken advantage of the opportunity and expanded aggressively into global markets, for instance, General Electric, IBM, Walmart, McDonald’s, P&G, and Kimberly-Clark. Many Fortune 500 companies experience 50 percent or more of their sales in global markets. Such sales have helped these compa- nies stabilize their revenues and buffer them against turbulent times in the U.S. market- place such as occurred in 2007.12 Small- and medium-sized companies have also been able to be players in global markets, even a small company like Red Fish–Blue Fish, LLP, which has the opportunity to source and sell on a global basis by developing appropriate relationships.

Global Dimensions of Supply Chains 83

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On the Line Serving Emerging Markets: A Survival Guide

For several decades, the business relationship between mature economies and developing countries was mostly one-way. Materials, components, and finished goods were produced “over there” and shipped “here.” However, today’s reality is different.

Many “low cost” countries in Asia, South America, and Eastern Europe have come into their own as consumers, so their involvement with mature economies is increasingly bi-directional. Consider the results of a survey conducted by Accenture and the National Association of Manufacturers: Among large companies (revenue exceeding $10 billion), North America’s share of market is projected to drop by more than 5 percent between now and 2013, while Asia’s should rise by the same amount over the same period.

For global shippers, the implications of this shift are dramatic. From an opportunity standpoint, emerging markets are clearly the growth markets. But from an operations standpoint, things are murkier, with potentially new capabilities needed to ensure security; assess and mitigate risk; track and manage assets; surmount infrastructure limitations; analyze the impact of rising labor rates; interact with regulators and customs officials; and leverage broadly varying tax and regulatory policies.

In emerging markets, higher levels of political, economic, financial, and operational risk are a certainty, at least in the short-to-medium term. Take infrastructure: Poor roads outside of central cities; insufficiently developed ports; and less-available, less-secure warehouses are commonplace.

Another risk is legislative. In emerging markets, for example, companies must often deal with more corruption, less-orthodox and less-codified business rules, and more nod-and-wink agreements. At the same time, there are fewer protections. In mature economies, companies are generally confident that laws and regulations will protect them. But in emerging markets, there is less chance that authorities can or will insulate companies from dubious practices. It’s important to keep in mind that things companies count on “here” cannot be counted on “there.”

There may be little similarity between the capabilities needed to move goods and materials across developed markets or from low-cost countries into or around emerging markets.

The most fundamental difference is that, in the latter scenario, the challenge is more than just moving the item. When dealing with less-sophisticated markets, for example, a company’s primary medium for receiving item requests could be as traditional as faxes or even delivery via post.

As a result, it may be necessary for a company to reassess and revise its most basic order management capabilities. In fact, many rudimentary structures and protections that compa- nies are used to in the U.S. and the European Union (safety standards, hours of service, “responsible care” standards, security measures, etc.) are often weak or non-existent in emerging markets.

Throughout the developing world, smaller, privately owned logistics companies are still the rule: fewer assets, fewer routes, less sophistication, and typically higher prices. And although some governments (China, for example) may demand that you use a certain percentage of local services, many of those same rulemakers also encourage their smaller outfits to partner with the heavy hitters. These countries believe such partnerships are good for development and that they encourage investment in trucks and facilities.

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Success in the global marketplace obviously requires developing a cohesive set of strategies including product development, technology, marketing, manufacturing, and supply chains. Global companies tend to be more successful when their strategies help them to simultaneously achieve their business objectives at their various global locations. From a supply chain perspective, this means strategically sourcing materials and compo- nents worldwide, selecting global locations for key supply depots and distribution cen- ters, evaluating transportation alternatives and channel intermediaries, providing customer service, understanding governmental influences on global supply chain flows, examining opportunities for collaboration with third- or fourth-party logistics compa- nies, and other supply chain issues. We will discuss some of these topics in this chapter, and the remainder will be covered in subsequent chapters. A topic that merits special consideration is supply chain security, which will be discussed subsequently in this chapter.

From a customer service perspective, global markets and strategy have four important characteristics. First, companies attempt to standardize to reduce complexity, but they recognize that global markets need some customization. For example, in contrast to the U.S. market where large retail stores buy in volume quantities for delivery to their large warehouses, third-world countries have tiny retail stores that may only be 80 to 100 square feet. This means deliveries of small quantities, more frequent deliveries, different packaging, and other adjustments. P&G recently has made changes in its customer ser- vice strategy and related areas to customize for these markets. P&G recognizes that the population base is such in these countries that the total volume of sales will offset some of the lower economies of scale at the tiny stores, particularly in the long run. Customer service levels have to be adjusted for these markets in terms of delivery schedules, volumes, order fulfillment, and other areas.

Second, global competition reduces the product life cycle, as previously mentioned, since products can be copied or reengineered quickly by competitors. Technology com- panies are faced with this phenomenon even in the U.S. market, but globally other pro- ducts are faced with similar experiences. Technology companies counteract with continual upgrades and new products. Apple, for example, had great success with its iPod, but it quickly followed this with the iPhone, and now the iPad, to maintain finan- cial momentum. Shorter product life cycles present challenges for inventory management with respect to obsolete items. Customer service levels are also impacted because changes have to be made as the product matures in terms of sales volume and then declines, which reduces product profitability. Usually, companies cannot afford to provide the same level of customer service when the product volume declines.

But even if the use of local partners isn’t mandatory, these local entities may still be important to help you navigate legal hurdles, negotiate customs, access local infrastructure, and under- stand and meet customers’ expectations.

The logistical characteristics of emerging markets are often very different from those in more mature economies—more different than most companies might expect. What’s more, even companies that acknowledge these differences may not be aware of how difficult, time consum- ing and expensive it will be to build, acquire, and coordinate the capabilities needed to operate effectively in emerging markets.

Source: Pierre J. Mawet and William M. Kammerer, Logistics Management (June 2011): 56S.

Global Dimensions of Supply Chains 85

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Third, traditional organizational structures and related business models frequently change since companies get more involved in outsourced manufacturing and some logistical activities such as transportation, warehousing, and order fulfillment. All of this affects the supply chain and its related customer service activities. The collaboration indicated requires effective coordination among the various parties to ensure that cus- tomer service levels (on-time delivery, complete orders, reliability, etc.) are maintained. This is one of the challenges faced by Red Fish–Blue Fish as it attempts to coordinate both ends of its supply chain.

There are many challenges for supply chain managers. The soft side of global supply chain management continues to present significant challenges to supply chain managers. The social and cultural elements come into play when dealing with foreign business partners and require daily effort to ensure smooth supply chain execution. This is because soft issues and physical problems are, in many cases, not mutually exclusive. Misunderstanding the culture and miscommunicating can cause havoc on the physical side of global supply chain planning and execution. Cross-cultural communication is

On the Line Asia’s Widening Middle

Asia is no longer simply the seat of cheap production capacity. In 2008, Asian consumers spent $4.3 trillion, representing about one-third of consumption expenditures of the Organization for Economic Cooperation and Development’s 34 member countries. By 2030, consumer spending in Asia is likely to reach $32 trillion—or about 43 percent of worldwide consumption, according to Asian Development Bank (ADB), a Manila-based financial institution.

These statistics signify Asia’s emergence as a consumption powerhouse, prompting global manufacturers and retailers to re-think their supply chains to address both the challenges and opportunities of serving Asian markets.

A closer look at the region’s economic demographics tells the story. Asia’s middle class—defined by ADB as earning $2 to $20 per person per day—is growing dramatically relative to other regions of the world. Some 56 percent of developing Asia’s population was considered middle class in 2008, compared to just 21 percent in 1990. Those consumers accounted for more than 75 percent of the region’s aggregate annual expenditure and income.

The sheer size of Asia as a developing mega-market for both products and services offers new and huge growth potential for retailers and manufacturers alike. Multinational companies, for example, expect more than 50 percent of their revenue growth over the next 10 years to come from developing economies. And in 2009, China surpassed the United States for the first time as the world’s largest market for new vehicles.

Multinational companies must learn to support mature markets such as Europe and the United States, while serving diverse emerging markets in Asia and other parts of the world.

Indeed, rapidly escalating development in Asia is reconfiguring global trade patterns. Supply chain flows used to move almost entirely east to west. Not anymore.

The keys to succeeding in Asia are simple: first, make sure you understand the degree of logistics difficulty before going into a country. Then build a supply chain network based on local talent and partners, and tailored to each country or region.

Source: Lisa H. Harrington, “Asia: Manufacturing Dynamo or Consumer Powerhouse,” Inbound Logistics (March 2011): 54.

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made complicated not only by different languages and time zones but also by other culturally rooted practices such as communication styles, different approaches to completing tasks, different attitudes toward conflict, and different decision-making styles, among other factors.

Fourth, globalization introduces more volatility and complexity, as noted in Chapter 1. It is much more likely that supply chains will experience challenges with weather, terror- ism, strikes, and other disruptions. The need for flexibility and responsiveness is a requi- site for customer service through the supply chain. The expanded networks cover long distances and are complex. Trade policy, regulations, tariffs, and currency exchange rates exacerbate the level of complexity for global supply chains. Furthermore, the number of intermediaries that can be involved adds another layer of complexity.

In addition to the four areas indicated above, some of the customary strategies used in the domestic market are also challenged. Reduced order cycle time, for example, has become an important part of supply chain management since it can lead to lower inven- tory levels for customers, improved cash flow, and lower current assets and accounts receivable. The increased length and complexity of the supply chain make it more difficult to achieve shorter lead times.

Also, demand-driven supply or pull systems that can lower inventory levels signifi- cantly are challenged by the longer distance and complexity of multilayered supply chains. Other strategies such as compression and lean supply chains are also more difficult to achieve in the global environment. None of this discussion is meant to imply that compa- nies should not be involved in globalization. Rather it is meant to provide understanding of the challenges necessary to improve the likelihood of success. Without a doubt, global- izing has helped many U.S. companies, as previously noted. Much higher sales and profits and more revenue stability are some of the advantages that have been pointed out thus far, but globalization is a two-edged sword that requires a company to be nimble and continu- ally proactive in managing and responding to change. The topic of the next section, global supply chain security, ties in directly with this discussion of global supply chain strategy.

Supply Chain Security: A Balancing Act Global commerce between the United States and the rest of the world came to a halt

on September 11, 2001, when terrorists attacked the United States. Air transportation into and out of the United States and even some domestic flights were suspended. Ocean vessels loaded with containers and other freighter ships were prevented from unloading or loading in the major ports. Many had to anchor off the coast for days, waiting to come into the assigned port. Fresh fruits and vegetables rotted, and needed materials did not arrive on time. It was a frightening period but a time when we saw firsthand how global and interdependent with the rest of the world we had become.13

Before the events of September 11, 2001, ships would frequently clear U.S. ports in a matter of hours. That scenario has changed because of security measures that have been introduced. More cargo inspections, much more paperwork, and a longer time to clear U.S. borders are now a reality. Ships may be stopped and inspected and cargo inspected and checked. Some ships and items are given very close scrutiny because of their country of origin.14

Given the importance of global trade to the United States, a delicate balance exists between security and the efficient flow of global commerce. If security is too tight it

Global Dimensions of Supply Chains 87

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could impede the flow of needed goods or materials, causing delays and decreased effi- ciency. Ports and border gateways can become congested because of security measures. Consequently, clearance time has increased from hours to days in some instances. Steps have been taken to improve the flow through border crossing.15 This is necessary for our global economy.

Electronic filing of cargo information has helped to improve the border clearance times. The Trade Act of 2002 requires exporters to electronically submit shipping documents to U.S. Customs 24 hours after delivery to a port or 24 hours before vessel departure. For imports, the manifest must be filed by the ocean carrier or the consolida- tor 24 hours before the U.S.-bound cargo is loaded on the vessel in the foreign port. Because of Canada’s importance as a trading partner, an expedited procedure (FAST) has been developed to speed up clearance through the U.S.–Canadian border.16

Supply Chain Technology

Tracing through the Supply Chain

Over the past several years, safety issues with foods, medications, car parts and toys have caused illnesses and deaths, eroded consumer confidence and cost businesses millions of dollars. Despite an organization’s best efforts, problems with products will never completely disappear, which is why traceability for all products, from car parts to peanuts, is critical.

Traceability is not a new concept, but it has grown in importance and use as supply chains grow longer, government regulations become stricter and the technology used in traceability improves. Being able to trace and track a product as it moves along the supply chain is instrumental in dealing with health/safety issues and recalls, but it also can play a role in inventory and quality control.

In the pharmaceutical and goods industries, traceability is not just good business, it is a govern- ment requirement. Last year, the U.S. Congress passed a new goods safety law that sharpens the U.S. Food and Drug Administration’s focus on traceability, requiring the agency to establish a traceability system for the food industry such that food products can effectively be traced through the supply chain. However, any industry affected by a recall, a product safety issue or a quality concern knows the ability to trace forward or backward through the supply chain is essential.

Because of the size and scope of today’s global supply chains, the challenge to the organization is determining what traceability tools to use on what products.

Broad traceability strategies, ranging from a paper-based system to higher-level GPS or RFID, should be in place so that as technology changes and government requirements change, the organization is able to make value- and risk-based decisions about traceability.

Supply management professionals agree that traceability will improve and expand in organiza- tions as the enabling technology becomes more cost-effective. The USDA study points out that a company’s traceability system “is the key to finding the most efficient ways to produce, assemble, warehouse and distribute products.” Professionals also say that while government requirements around traceability act as motivators, more industries will see their value as consumers become more aware and concerned about supply chain safety.

Source: Mary Siegfried, “Tracing Through the Supply Chain,” Inside Supply Management (June/July 2011): 36.

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The U.S. Coast Guard was authorized by the U.S. Maritime Transportation Security Act of 2002 to assess the vulnerability of U.S. ports and to deny entry to ships from countries that do not meet U.S. security standards. This act requires the development of standards for container seals and locks, cargo tracking, identification, and screening systems for ocean containers.17 Some of these requirements have been slow in developing to meet standards.

In addition, the Customs Trade Partnership Against Terrorism (C-TPAT) was established under the direction of the U.S. Department of Homeland Security in November 2001. This voluntary initiative to secure the global supply chain was started with seven companies; by 2007, some 7,400 corporations were involved in this coopera- tive effort to secure the global supply chain and to facilitate legitimate cargo and convey- ance. C-TPAT functions under the U.S. Customs and Border Protection (CBP) Agency, which previously was known as the U.S. Customs Service.

CBP has responsibility for the traditional role of the U.S. Customs Service, namely, preventing illegal entry of people and drugs, protecting agriculture from harmful pests and diseases, protecting the intellectual property of businesses, collecting import duties, and reg- ulating and facilitating global trade. Partner companies in C-TPAT agree to be responsible for keeping their supply chains secure to agreed standards and to implement needed changes. One of the key features of this program is information sharing of best practices for security among members. The goal is to develop a “green lane” to speed goods across the border but also to protect the United States and the global supply chains of the participants.18

Ports As indicated above, ports are a critical part of global supply chains and also a major

focus for global security. Every day, thousands of containers from countries all around the world arrive at U.S. seaports. Each shipment is usually for a specific supply chain— for example, porch furniture from Thailand bound for a St. Louis retailer or shoes from China destined for a Chicago distributor.

America’s ports are a vital part of its global commerce. Over $2 trillion in trade value per year passes through U.S. ports, and over $18 billion is collected in industry fees and taxes. The 50 states utilize 15 ports to handle their imports and exports; a total of about $5.5 billion worth of goods moves in and out every day. About 99 percent of the international cargo of the United States moves through its ports, or about 2.5 billion tons annually. In 1960, inter- national trade accounted for about 9 percent of U.S. GDP. Today, it is over 25 percent.19

U.S. ports also play a vital role for the cruise industry. In 2010, 69.7 million passenger nights were booked on North American cruises, up 9.4 percent from the year before. The top five departure ports accounted for 59 percent of the North American cruise passenger departures, up from 55 percent in 2009. The top three were Florida ports: Miami, Fort Lauderdale, and Port Canaveral.20 This flow of passenger traffic has a positive economic impact on the U.S. economy because of the expenditures to support the cruise industry.21

The ports also play a vital role in national defense and security. The ports are bases of operation to deploy troops and equipment. In 2003, the Surface Deployment and Distribution Command loaded 1.6 million tons of equipment and cargo to support the war effort in Iraq. Port security is important for military and civilian purposes, and it is a shared responsibility between the public and private sectors. C-TPAT is an excellent example of this shared responsibility.

Global Dimensions of Supply Chains 89

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As indicated previously in this chapter, Canada and Mexico are important trade part- ners for the United States; they ranked numbers one and three, respectively, in 2010. These two countries account for about 29 percent of the total U.S. global trade.22 Given their importance, the next section of this chapter will discuss the North American Free Trade Agreement (NAFTA).

North American Free Trade Agreement The North American Free Trade Agreement was signed by leaders of Canada, the

United States, and Mexico in 1993 and was ratified by Congress in early 1994. NAFTA establishes free trade between these three countries and provides the way the agreement is to be interpreted. NAFTA states that the objectives of these three countries is based on the principles of an unimpeded flow of goods, most-favored-nation (MFN) status, and a commitment to enhance the cross-border movement of goods and services. MFN status provides the lowest duties or customs fees, if any, and simplifies the paperwork required to move goods between the partner countries.

Even though the U.S.–Canada Free Trade Agreement has been in effect for some time, certain trade barriers still remain. For example, many U.S. companies do not recognize certain French–English requirements for packaging and ingredient label- ing. Trade with Mexico also poses some trade constraints that NAFTA did not eliminate. The supply chain barriers include a poor transportation infrastructure, restrictive foreign capital rules, and customs rules. The Mexican highway system is poor when compared to that existing in the United States and Canada. Mexico only has one railroad, which is owned and operated by the government. There are no national less-than-truckload (LTL) trucking companies, and air transportation is limited to the few airports. Foreign trucking companies are restricted from hauling intracountry shipments in all three countries; these are known as cabotage restrictions.

Figure 3.1 shows the procedure usually required to move a truck shipment from the United States into Mexico. The U.S. trucking company moves the shipment to the border, where a Mexican cartage carrier hauls the shipment across the border to Mexican customs and to the Mexican carrier after shipment clearance. The U.S. domestic freight forwarder submits shipment documents to the Mexican customs broker, who submits them to Mexican customs. Mexican customs inspects the documents, collects duties, inspects the goods, and clears the shipment. The Mexican cartage carrier delivers the shipment to a Mexican trucking company, which delivers it to the consignee.

The supply chain constraints will eventually be eliminated as NAFTA experience grows. Computerized customs information systems are currently operating in the United States and Canada, with Mexico a few years behind. The electronic transfer of informa- tion for NAFTA shipments into Mexico will speed the border crossing and improve logistics service.

In the long run, the goal of NAFTA is to create a better trading environment; but, in the short run, it has created some confusion due to the record keeping required to prove the origin of the product to obtain favorable tariff treatment. NAFTA’s goals involve making the needed structural changes to operate a borderless logistics network in North America. Information systems, procedures, language, labels, and documentation are being redesigned. As new markets and supply sources develop, new transportation and storage facilities as well as intermediaries will need to be developed.

90 Chapter 3

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Maquiladora Operations A concept that has become popular among U.S.-based firms is to use Mexican

manufacturing and production facilities for subassembly or component manufacturing or for final assembly of products such as electronic devices or television sets. While this has been occurring for some time, U.S. firms have begun to include such maquiladora operations as formal components of their manufacturing and supply chain systems.

Figure 3.1 A Typical Truck Shipment Crossing into Mexico

U.S. carrier Delivers a

loaded trailer to a U.S. customs

broker

U.S. freight forwarder

Collects customs

documentation from shipper

Hires Mexican cartage agent to

drive trailer across border

Presents documents to U.S. customs for clearance

Presents documents to

Mexican customs broker

for clearance

Mexican customs broker

Presents documentation

to Mexican customs agents

Moves trailer to first stop in

customs to verify trailer, chassis,

and license numbers

Moves trailer to second customs stop to approve

and clear the import

documents

Delivers trailer to inspection

station Proceeds out of customsCartage agent

Mexican carrier Delivers goods to consignee Returns trailer

to border

Proceeds out of customs

Delivers trailer to Mexican

carrier

Inspection? Yes

Inspection? No

Source: Edward J. Bardi, Ph.D. Used with permission.

Global Dimensions of Supply Chains 91

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Essentially, in a maquiladora operation, a U.S. manufacturer either operates or subcontracts for a manufacturing, processing, or assembly activity to be performed in Mexico. Mexican production and labor costs are lower than those in the United States, and the operations involve no local content issues. U.S. firms often send semifinished product to Mexico for final assembly, for example, and then have the finished product shipped to the United States. This concept appeals to many companies: U.S. manufac- turers operate more than 2,000 maquiladora facilities in Mexico.

One feature that adds to the feasibility of such an approach is the limited tariff duties. The importing, storing, manufacturing, and subsequent export of goods have virtually no net payment of customs duties or import charges. The duties are limited to the value-added portion of the goods, primarily labor, returning from Mexico.

Asian Emergence The most significant trend of the past 25 years has been the emergence of Pacific Rim

countries as important players in the global business environment. As market forces con- tinue exert pressure on companies to improve profitability, the quest for lower-cost manufacturing has been a factor in the relocation of manufacturing from Mexico to Asia. While Japan has achieved a dominant position in global financial markets, other newly industrialized Asian economies such as Hong Kong, South Korea, Singapore, and Taiwan account for significant portions of global trade growth. South Korea and Taiwan now join the rank of the top 10 trading partners of the United States (see Table 3.1). During the 1990s, China became an attractive country for manufacturing due to its low wage rates and skilled labor. However, as China’s labor costs have increased, other countries such as Vietnam and Thailand have become attractive for outsourced manufacturing. As indicated in Chapter 1, the global marketplace continues to be dynamic and subject to change.

Figure 3.2 Hourly Compensation in Manufacturing

China Mexico Hong Kong Taiwan

South Korea

Singapore

U.S.

1975 1980 1985 1990 1995 2000 200320022001 2004 2005 2006 2007 2008 2009

U SD

/h ou

r

30

25

20

15

10

5

0

Source: Bureau of Labor Statistics, Foreign Labor Statistics (2011)1.

1Accessible: http://www.bls.gov/web/ichcc.supp.toc.htm (Last Modified: March 2011), China data accessible: http:// www.bls.gov/fls/china.htm (Last Modified: April 4, 2011).

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Many Asian countries have become preferred sources for many raw materials and components. These countries have become trusted suppliers of finished goods such as apparel, furniture, consumer electronics, and automobiles. The advantages many of these countries offer are low labor cost and high quality.

New Directions Aside from establishing product sources in other countries, global companies are

locating plants and key logistics facilities in countries that use or consume their output. For example, Japanese-based firms such as Toyota have located plants in the United States. Similarly, U.S. automobile manufacturers such as Ford and General Motors have located plants in other countries.

Some global manufacturers are using a strategy known as focused production in which a given plant produces one or two items of the company’s total product line. The plants are typically located in different countries, requiring a global logistics system to tie the focused plant to the customer, who may be located within the producing country or a different country.

An important dimension of any supply chain is transportation links. Transportation can be depicted as the glue that holds the supply chain together. Global supply chains are very dependent upon efficient and effective transportation and the related services of channel intermediaries discussed next. A brief discussion of alternative global trans- portation options is provided in the next section.

Global Transportation Options Global transportation is usually much more complex than domestic U.S. transporta-

tion. The distances involved are greater, and the number of parties involved is typically more extensive. Because of the large expanses of water separating most regions of the world, the major modes of global transport are ocean and air. Land modes also carry freight between contiguous countries, particularly in Europe, where land routes are short.

Ocean Transport by ship is by far the most pervasive and important global shipment

method, accounting for two-thirds of all international movements. Ocean transporta- tion’s major advantages are low rates and the ability to transport a wide variety of products and shipment sizes. The primary disadvantages include long transit times (slow speed), low accessibility, and higher potential for shipment damage. The pervasive use of containers has reduced damage and increased accessibility via connections with other modes (rail and truck) for inland origins and destinations.

World container traffic in reached an all-time high of 560 million 20-foot-equivalent units (TEUs) in 2010, representing a record year-on-year increase of 14.5 percent over 2009, according to Alphaliner.23 Corresponding to the accelerated relocation of produc- tion bases to Asia Pacific countries, the trans-Pacific trade lane—the deep sea liner route between Asia and North America with typical services operating between the industrial centers of Asian countries and the North American ports on the West Coast, the East Coast, and the Gulf—has become the world’s busiest container trade lane.24 Overall, trade between China, India, the United States, and Europe accounts for 65 percent of

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the 250 million-plus containers moved around the world each year.25 The trans-Pacific trade lane is not only the world’s busiest but also the most unbalanced trade lane in the world. U.S. imports from Asia (head-haul, eastbound trans-Pacific) are consistently strong and at least twice the volume of exports to Asia (backhaul, westbound trans- Pacific). Types of commodity traded also differ. Westbound trans-Pacific trade is domi- nated by commodity-based exports (such as wastepaper, scrap metal, and grain) whereas the eastbound traffic is consumer goods. This condition not only affects ship operating cost (as driven by slot capacity utilization) but also ocean container freight rates. Ocean carriers set rates differently for commodity-based versus high-value consumer goods, subsidizing trade of backhaul commodity-based cargos with traffic of head-haul con- sumer goods that commands about twice the freight rates.26

Ocean shipping comprises three major categories. One is liner service, which offers scheduled service on regular routes. Another is charter vessels, which firms usually hire on a contract basis and which travel no set routes. Finally, private carriers can be part of a firm’s own supply chain. Table 3.2 contains the top 10 ocean carriers. Note the changes that occurred between 2000 and 2011 in ocean carrier rankings. Some of these changes in rank (Table 3.1) are significant and again show the dynamics of the global marketplace.

Liner carriers offer set schedules over specific routes. They also offer set tariffs and accept certain standards of liability. Liners usually carry break-bulk shipments of less-than-shipload size. Most container and roll-on, roll-off (RO-RO) ships are liners.

Liners are operated by large steamship companies, which usually belong to shipping conferences. These conferences are voluntary associations of ocean carriers that operate over common trade routes and use a common tariff for setting rates on the commodities they handle. Conferences also work together to attract customers and to utilize member ships as effectively as possible.

In general, conferences provide good service with frequent and reliable schedules, published daily in the Journal of Commerce. Additionally, conferences help to standard- ize shipping on many routes by stabilizing prices and offering uniform contract rates.

Firms contract charter ships for specific voyages or for specified time periods. Voyage charters are contracts covering one voyage. The carrier agrees to carry a certain cargo from an origin port to a destination. The price the carrier quotes includes all of the expenses of the sea voyage. Time charters allow the use of a ship for an agreed-upon time period. The carrier usually supplies a crew as part of the contract. The charterer has exclusive use of the vessel to carry any cargo that the contract does not prohibit and assumes all expenses for the ship’s operation during the charter period. Bareboat or demise charter transfers full control of the vessel to the charterer. The charterer is then responsible for the ship and all expenses necessary for the vessel’s operation, including hiring the crew.

Chartering usually takes place through ship brokers, who track the location and status of ships that are open for hire. When a shipper needs to contract for a ship, the shipper contacts a broker, who then negotiates the price with the ship owner. The ship owner pays the broker a commission on the charter’s cost.

In a logistics system, private ocean carriers play the same role as private carriage in general. In other words, companies utilize private ocean vessels to lower their overall costs or to improve their control over transportation service. The major differences between domestic and international private ocean transportation are the scale of investment, the complexity of regulations, and the greater risk international transport entails. In interna- tional operations, chartering often provides a viable substitute for private carriage.

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Air The fast transit times that air transport provides have had an impact on global distri-

bution. The speed of airplanes combined with frequency of scheduled flights has reduced some global transit times from as many as 30 days by water carrier to one or two days by air carrier. These transit times have spurred the development of global freight services. These carriers offer door-to-door, next-day services for packages between most large American cities and a growing number of overseas points. Major logistics service compa- nies such as DHL, Federal Express, and UPS have capitalized on this service difference.

The world’s air carriers have usually focused on passenger service, and air cargo accounts for a relatively small percentage of international freight by weight. However, the nature of the cargo, mostly high-value, low-density items, causes the total value of airfreight cargo to be a greater proportion of the world total. Air cargoes include high- value items such as computers and electronic equipment, perishables such as cut flowers and live seafood, time-sensitive documents and spare parts, and even whole planeloads of cattle for breeding stock. Table 3.2 provides a list of major international cargo air carriers.

Most airfreight travels as belly cargo in the baggage holds of scheduled passenger flights. Only a few major airlines have all-freight aircraft.

In addition to short transit time, air transportation offers an advantage in packaging. This mode requires less stringent packaging than ocean transport since air transport will not expose the shipment to rough handling at a port, to a rough ride on the oceans, or to the weather. A firm using air transportation may also be able to use the same packaging for international shipping as for domestic shipping.

A disadvantage of air carriage is higher rates, which may preclude some shippers from transporting international shipments by air. Generally, high-value, highly perishable, or

Table 3.2 Top 10 Cargo Air Carriers by Scheduled Freight Tonne-Kilometres

AIR CARRIER TOTAL INTERNATIONAL AND DOMESTIC

(MILLIONS TONNE-KILOMETRES)

FedEx 15,743

UPS Airlines 10,194

Cathay Pacific Airways 9,587

Korean Air Lines 9,542

Emirates 7,913

Lufthansa 7,428

Singapore Airlines 7,001

China Airlines 6,410

EVA Air 5,166

Cargolux 4,901

Source: International Air Transport Association, 55th World Air Transport Statistics, June 5, 2011.

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urgently needed commodities are more likely to use air freight where inventory cost, packaging cost, and stockout cost can be traded off against the transportation cost to realize a lower total logistics cost, as illustrated in Chapter 2.

Motor Companies will often use motor transport when shipping goods to an adjacent

country—between the United States and Mexico or Canada, for example. It is very com- mon in Europe, where transport distances are relatively short. Motor also plays a major role in intermodal shipments, that is, moving freight to airports and ports and picking up freight for delivery at the destination airports and ports.

The advantages of international motor transport are basically the same as those for domestic shipments: speed, safety, reliability, and accessibility to the delivery site. However, motor shipment across multiple national boundaries usually involves a number of different import regulations. To minimize paperwork and delay, these shipments are often made in bond—the carrier seals the trailer at its origin and does not open it again until it reaches its destination country.

Rail International railroad use is also highly similar to domestic rail use, but rail’s accessi-

bility is much more limited internationally because border crossing points are scarce. Differing track gauges in various countries also prevent long-distance shipments.

Intermodal container shipments by rail are increasing. Various maritime bridge concepts involve railroads both for transcontinental shipments and to and from inland points. For example, a shipper using a land bridge substitutes land transportation for part of a container’s ocean voyage, taking several days off the transit time and saving in-transit inventory costs. A prime example of a land bridge occurs on the trade route between Japan and Europe. The all-water route takes anywhere from 28 to 31 days. If the shipment travels by water from Japan to Seattle (10 days), then by rail to New York (five days), and by water from New York to Europe (seven days), the total shipping time is approximately 22 days.

Global Intermediaries Intermediaries play a much larger role in global supply chain operations than in the

domestic United States. The scope of services that intermediaries offer is very compre- hensive. Intermediaries can play a role in helping new and established companies venture into the global arena. Some companies require assistance in comprehending complex operations involving sources and destinations in other countries. A brief discussion of the major global intermediaries follows.

Foreign Freight Forwarders For a company with little international shipping expertise, the foreign freight

forwarder may be the answer. The foreign freight forwarder, which employs individuals who are knowledgeable in all aspects of international shipping, supplies its experts to small international shippers that find employing such individuals in their shipping departments uneconomical. Foreign freight forwarders are regulated by the Federal Maritime Commission.

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Foreign freight forwarders, like their domestic counterparts, consolidate small ship- ments into more economical sizes. In the international arena, these larger sizes range from containers up to entire ships. Foreign freight forwarders also perform the routine actions that such shipments may require, for example, the export documentation, which can be overwhelming to a neophyte.

The forwarder derives income from different sources. One source is the fees charged for preparing export documentation. Another source is the commissions the forwarder receives from carriers. These commissions are based on the amount of revenue the for- warder generates for the carrier. The third type of income comes from the price differ- ence between the rate the forwarder charges a shipper and the lower rate per pound it pays for the larger, consolidated shipments.

Airfreight Forwarders Airfreight forwarders perform the same functions as surface freight forwarders but for

air shipments only. They do not require a license from the federal government as foreign freight forwarders do. Airfreight forwarders primarily consolidate small shipments, which they present to the air carrier for movement to the destination.

Like the foreign freight forwarder, the airfreight forwarder generates income from fees charged for services provided and the difference between the rate charged the shipper and that paid to the air carrier. The major competitors of airfreight forwarders are the air carriers, who can go directly to the shipper and eliminate the forwarder. For small shipments, air express carriers, such as Federal Express, Emery, UPS Air, and DHL, com- pete directly with the forwarders.

Non-Vessel-Operating Common Carriers The non-vessel-operating common carrier (NVOCC) consolidates and dispenses

containers that originate at or are bound to inland points. The need for these firms arose from the inability of shippers to find outbound turnaround traffic after unloading inbound containers at inland points. Rail and truck carriers often charge the same rate to move containers whether they are loaded or empty. NVOCCs are regulated by the Federal Maritime Commission.

To reduce these costs, the NVOCC disperses inbound containers and then seeks outbound shipments in the same containers. It will consolidate many containers for multiple-piggyback-car or whole-train movement back to the port for export. It also provides scheduled container service to foreign destinations.

Shippers and receivers of international shipments gain from the shipping expertise that NVOCCs possess and from the expanded and simplified import and export oppor- tunities. The ocean carrier gains from the increased market area made possible by NVOCCs’ solicitation services.

Export Management Companies Often, a firm wishes to sell its products in a foreign market but lacks the resources to

conduct the foreign business itself. An export management company (EMC) can supply the expertise such firms need to operate in foreign environments. This is a possible option for Red Fish–Blue Fish for future expansion.

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EMCs act as agents for domestic firms in the international arena. Their primary function is to obtain orders for their clients’ products by selecting appropriate markets, distribution channels, and promotional campaigns. The EMC collects and analyzes credit data for foreign customers and advises exporters on payment terms. It also usually collects payments from foreign customers. EMCs may also supply documentation, arrange transportation, provide warehouse facilities, maintain a foreign inventory, and handle break-bulk operations.

A firm can contract with an export management company to provide its exclusive representation in a defined territory. The EMC may either purchase the goods or sell them on commission. In order to present a complete product line to importers, an EMC will usually specialize in a particular product type or in complementary products.

Using an export management company has several advantages. First, EMCs usually specialize in specific markets, so they understand in detail what an area requires. They will have up-to-date information on consumer preferences and will help the exporter to target its products most effectively. Second, EMCs will usually strive to maintain good relations with the governments of importing countries. This enables them to receive favorable customs treatment when introducing new products. EMCs also remain current on documentation requirements. This helps the goods they are importing to enter with few holdups. Once a company increases its volume of business to a particular country or region, it may hire its own staff to provide those services.

Export Trading Companies An export trading company (ETC) exports goods and services. The ETC locates

overseas buyers and handles most of the export arrangements, including documentation, inland and overseas transportation, and the meeting of foreign government require- ments. The ETC may or may not take title to the goods.

A trading company may also engage in other aspects of global trade, in which case it becomes a general trading company. One reason Japan has been successful in interna- tional trade is because of its large general trading companies, the sogo shosha. These firms, which consolidate all aspects of overseas trade into one entity, may include banks, steamship lines, warehouse facilities, insurance companies, sales forces, and communications networks.

A trading company allows small- to medium-size firms that do not possess the resources to engage in foreign trade. The trading company may purchase their goods and sell them on the global market, taking care of all the intermediate steps. Having all the functional areas centrally controlled expedites coordination and speeds the response time when markets change.

Customs House Brokers Customs house brokers oversee the movement of goods through customs and ensure that

the documentation accompanying a shipment is complete and accurate for entry into the country. U.S. customs house brokers are licensed by the Department of the Treasury.

Customs house brokers operate under power of attorney from the shipper to pay all import duties due on the shipment. The importer is ultimately liable for any unpaid duties. The brokers keep abreast of the latest import regulations and of the specific requirements of individual products. The next section discusses storage facilities and packaging from a global perspective.

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Storage Facilities and Packaging

Storage Facilities At several points during a global shipment, the goods being shipped may require

storage. Storage may be necessary while the shipment waits for loading on an ocean vessel or while customs clearance is being arranged for the merchandise. When goods are packaged in a container, storage facilities are not usually necessary, which is another favorable factor for containers.

Noncontainerized cargo, on the other hand, requires protection if it is to arrive in good order. Ports supply several types of storage facilities to fill this need. Transit sheds, located next to the piers or at the airport, provide temporary storage while the goods await the next portion of the journey. Usually, the port usage fee includes a fixed number of days of free storage. After this time expires, the user pays a daily charge. In-transit storage areas allow the shipper to perform some required operation on the cargo before embarkation. These actions may include carrier negotiations and waiting for documentation, packing, crating, and labeling to be completed. The carrier usually provides hold-on-dock storage free of charge until the vessel’s next departure date, allowing the shipper to consolidate goods and to save storage costs.

When goods require long-term storage, the shipper uses a warehouse. Public warehouses are available for extended storage periods. The services and charges offered by these facilities are similar to those of public warehouses in the domestic sphere, which are discussed in a later chapter.

Bonded warehouses, operated under customs supervision, are designated by the U.S. secretary of the treasury for the purpose of storing, repacking, sorting, or cleaning imported merchandise entered for warehousing without paying import duties while the goods are in storage. Only bonded carriers may move goods into and out of bonded warehouses. Bonded warehouses are very important in global commerce.

One purpose of bonded warehouses is to hold imported goods for reshipment out of the United States. The owner can store items in a bonded warehouse for up to three years, allowing time to decide on the goods’ ultimate disposition without having to pay import duties or taxes on them. If the owner does not reexport the goods before the three years elapse, they are considered imports and are subject to all appropriate duties and taxes.

Packaging Export shipments moving by ocean transportation usually require more stringent

packaging than domestic shipments. An export shipment undergoes more handling: it is loaded at the origin, unloaded at the dock, loaded onto a ship, unloaded from the ship at port, loaded onto a delivery vehicle, and unloaded at the destination. These multiple handlings may occur under unfavorable conditions—in inclement weather or with antiquated handling equipment, for example. If storage facilities are inadequate, the goods may remain exposed to the elements for a long time.

The shipper may find settling liability claims for damage to export goods very diffi- cult. Usually, the freight handling involves many firms, and these firms are located in different countries. Stringent packaging is the key to claims prevention for export shipments.

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SUMMARY • Global companies usually are faced with more complex and longer supply chains,

which challenge them in terms of efficiency, effectiveness, and execution.

• There have been three phases of globalization: the first was driven by countries, the second by large companies, and the third by individuals and small organizations. The political and economic environment was different during these three major eras of globalization.

• Successful global companies have transformed their supply chains on a continuing basis as economic and political circumstances have changed to enable them to deliver best cost and best value to the ultimate customer.

• The scope and magnitude of trade flows between the United States and other countries have grown considerably in the last several decades. One important development has been the growth in the volume of trade with China and several other Asian countries. China has become the second most important country as a global partner to the United States.

• Success in the global marketplace requires ongoing development of a cohesive set of strategies including customer service, product development, business model, and supply chain management. Supply chains have become increasingly more important during the twenty-first century.

• Supply chain security has taken on increased significance since September 11, 2001. Companies individually, jointly, and in cooperation with the various levels of govern- ment are actively involved. The federal government, in particular, has expanded the scope of its regulations and policies for global security.

• U.S. ports play a critical role in global supply chains since over 90 percent of global trade passes through them. Ports are also an important focus for security. The United States needs to focus more attention upon port infrastructure.

• Canada and Mexico are ranked numbers one and three, respectively, on the list of most important trading partners with the United States. That relationship is enhanced by the North American Free Trade Agreement ratified by Congress in 1994. While the treaty had lofty goals, it still is experiencing problems with full implementation of its objectives. Nevertheless, it has fostered trade in North America.

• Global supply chains have a number of transportation and related service options available to managers. Each of the options has advantages and disadvantages that need to be analyzed.

STUDY QUESTIONS 1. There have been three major phases or eras of globalization. What are the important

differences between today’s third phase and the previous two phases? Do you think that there will be a fourth phase? Why or why not?

2. It has been alleged that the world has become “flat.” What does this description mean from a global economic perspective? What factors have contributed to this phenomenon? What changes have come about in the global economy because of our flat world?

3. A number of authors have observed that traditional, hierarchical organizations have changed in the current global economy. How have organizations changed? Why have they changed? What are the impacts of those changes likely to be?

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4. What private-sector company epitomizes the concept of a global company with a well-managed global supply chain? Provide a rationale for your response.

5. What special role do supply chains play in the globalization of organizations? What contributions do successful supply chains make to companies?

6. What is meant by the current description of the global economy that “time and distance have been compressed”? Do you agree? What has been the impact of this compression?

7. Why are customer service and its related strategy so important for companies oper- ating global supply chains? Do you think that customer service is more important than lower cost to the customers?

8. What is meant by saying that supply chain security, especially on a global basis, is a balancing act? Is the pendulum swinging in one direction or the other?

9. Why are ports so important for global supply chains? What challenges do we have with our ports?

10. Compare and contrast the major alternatives for global transportation and the major global intermediaries.

NOTES 1. “TradeStats Express™,” International Trade Administration, U.S. Department of Commerce, 2011.

2. Thomas L. Friedman, The World Is Flat (New York: Farrar, Strauss and Giroux, 2005): 6–11.

3. Ibid.

4. Ibid.

5. Ibid.

6. Bruce A. Forster, “A Brief Overview of Selected World Economy Trends: Past and Present,” The Journal of Applied Business and Economics 12, no. 2 (May 2011): 18–26.

7. Charles Fishman, The Wal-Mart Effect (New York: Penguin Press, 2006): 1–22.

8. The Wall Street Journal (August 9, 2007): 1.

9. Adam Smith, Wealth of Nations.

10. Edward Iwata, “Infosys Kicks Up Growth Mode,” USA TODAY (August 4, 2006): 1B.

11. Bob Fernandez, “U.S. Research Making Great Leap,” Philadelphia Inquirer (November 5, 2006): E-1.

12. Timothy Aeppel, “Overseas Profits Help U.S. Firms Through the Tumult,” The Wall Street Journal (August 9, 2007): A10.

13. J. J. Coyle, E. J. Bardi, and R. A. Novack, Transportation, 6th ed. (Mason, Ohio: Thomson South-Western, 2006): 232–240.

14. Ibid.

15. Ibid.

16. Ibid.

17. Ibid.

18. “Securing the Global Supply Chain,” U.S. Customs and Border Protection (Washington, DC: Office of Field Operations, November 2004): 1–25.

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19. “America’s Ports Today,” American Association of Port Authorities (Alexandria, VA: 2007): 1–8.

20. “North American Cruise Statistical Snapshot 2010,” Maritime Administration, U.S. Department of Transportation (Office of Policy and Plans, March 2011).

21. “America’s Ports Today,” American Association of Port Authorities (Alexandria, VA: 2007): 1–8.

22. “Measurement of Commercial Motor Vehicle Travel Time and Delay at U.S. International Border Stations,” U.S. Federal Highway Administration, 2002.

23. B. Barnard, “Global Container Traffic Hits All Time High,” Journal of Commerce (April 5, 2011).

24. B. Dibenedetto, “Transition Lanes,” Journal of Commerce (August 6, 2007): 1.

25. “Business: Maxing Out Container Ships,” The Economist 382, no. 8158 (March 3, 2007): 74.

26. B. Mongelluzzo, “Coming up Empty,” Journal of Commerce (January 21, 2008): 1.

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CASE 3 .1

Red Fish–Blue Fish, LLP: Another Sequel

Two years have elapsed since Fran Fisher, CEO of Red Fish–Blue Fish, met with Eric Lynch and Jeff Fisher, vice president of supply chain management and vice president of operations, to discuss increasing their scale of operations (see Chapter Profile). There has been good news and bad news during this two-year period. The good news is that sales have increased domestically as the company expanded into Maryland, Virginia, and Washington, DC. In fact the construction and consulting business has improved dramat- ically. Jim Beierlein accepted the position of vice president of construction sales, and his experience and contacts has been a real benefit to Red Fish–Blue Fish. However, global sales have been somewhat disappointing, according to Fran Fisher. European and Canadian sales have been very good, but the Asian market sales have not been not very good. Red Fish–Blue Fish developed some new Web pages for China, India, and Japan. While they have had many “hits” on the Web pages, the sales are not satisfactory. Fran Fisher has not moved forward on the recommendation of Jeff to use an inter- mediary. Instead the company has relied upon Internet sales.

CASE QUESTIONS 1. What are the options for Red Fish–Blue Fish as far as global intermediaries are

concerned? What do you recommend? Why?

2. What other options does Red Fish–Blue Fish have to expand their Asian sales?

Source: John J. Coyle, DBA. Used with permission.

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Part II

The first three chapters made frequent reference to the strategic impor- tance of supply chain management and its role in the competitive success of private and public organizations in today’s global environ- ment. It is essential to develop supply chain strategies that provide world class customer service. These strategies also must be aligned with overall organizational strategy to achieve maximum performance.

While there are many strategic dimensions of supply chains, we have selected three topics to include in Part II, which is devoted to strategic factors for supply chains, namely supply chain relationships, performance measurement and financial analysis, and managing infor- mation flows.

Chapter 4 addresses the overall topic of collaboration and relationships in supply chains. The types of relationships and their importance are discussed with special emphasis on third- and fourth-party logistics and supply chain providers. Special attention is devoted to the types of services, the role of information technology, and customer satisfaction with these service providers.

Performance measurement and financial analysis are the focus of Chapter 5. The scope and complexity of global supply chains require the development and use of effective measures to evaluate the perfor- mance of the managers involved in the supply chain. It is also critical to evaluate the extent to which supply chain strategies and outcomes contribute to the financial performance of the organization.

Chapter 6 addresses the very important topic of supply chain information technology. Information is “power” in creating supply chain visibility, efficiency, and effectiveness. The key issues and importance of technol- ogy in supply chains are discussed as well as the need for quality and integrity in information systems for managing material flows and driving cash flows for financial success.

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Chapter 4

SUPPLY CHAIN RELATIONSHIPS

Learning Objectives After reading this chapter, you should be able to do the following: • Understand the types of supply chain relationships and their importance.

• Introduce a process model that will facilitate the development and implementa- tion of successful supply chain relationships.

• Recognize the importance of “collaborative” supply chain relationships.

• Define what is meant by third-party logistics (3PL) and know what types of firms provide 3PL services.

• Know what types of 3PL services are used by client/customer firms and what types of 3PL providers are used.

• Discuss the role and relevance of information technology-based services to 3PLs and their clients/customers.

• Know the extent to which customers are satisfied with 3PL services and identify where improvement may be needed.

• Understand some of the likely future directions for outsourced logistics services.

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Introduction As indicated throughout this book, many organizations have directed significant

attention toward working more closely with supply chain partners, including not only customers and suppliers but also various types of logistics suppliers. Considering that one of the fundamental objectives of effective supply chain management is to achieve coordination and integration among participating organizations, the development of more meaningful “relationships” throughout the supply chain has become a high priority.

This chapter focuses on two closely related topics. The first is that of supply chain relationships in general, with an emphasis on the types of relationships, the processes for developing and implementing successful relationships, and the need for firms to col- laborate to achieve supply chain objectives. The second is that of the third-party logistics (3PL) industry in general and how firms in this industry create value for their commer- cial clients. The 3PL industry has grown significantly over recent years and is recognized as a valuable type of supplier of logistics services.

Supply Chain Profile Client Intimacy: A New Mission for Supply Chain Managers?

IBM wants its supply chain staff to provide not just products but solutions to its customers. Should this be a goal for every company?

One of the challenges facing IBM today is developing “client intimacy” in its supply chain. Tim Carroll, IBM’s vice president of global operations for the integrated supply chain, made that com- ment this month in his presentation at the Supply Chain and Logistics 2010 summit in Dallas. According to Carroll, client intimacy is not about sales knowledge. This means that supply chain managers have to understand end customers’ expectations when they buy a product. To acquire that knowledge, IBM’s supply chain staff will, of course, need to have direct contact with customers.

Historically, supply chain professionals have focused on execution, synchronizing the functions of procurement, manufacturing, and logistics. They have concentrated their time and effort on mak- ing the operational parts of the business work in sync to deliver the perfect order. But in a world where products can quickly become commodities, visionary companies like IBM want to go beyond “plan, source, make, and deliver” and instead compete on value.

IBM views client intimacy as being crucial to achieving its goal of transforming itself from a company that provides products on a transactional basis to an enterprise that offers broader solutions to its customers. It is not the first company to pursue this idea. What’s interesting is that the tech giant is involving the supply chain operations folks in carrying out this mission.

A shift away from transactional relationships means that supply chain professionals will play a part not only in delivering products but also in providing solutions that may fall outside their traditional sphere of influence and responsibility. Should this, along with client intimacy, be the new mission of all supply chain professionals?

Source: Adapted from James A. Cooke, Editor, Supply Chain Management, December 20, 2010. Copyright © 2010 by CSCMP’s Supply Chain Quarterly, a publication of Supply Chain Media, LLC. All rights reserved. Reproduced by permission.

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As suggested by the late Robert V. Delaney in his Eleventh Annual State of Logistics Report,1 relationships are what will carry the logistics industry into the future. In com- menting on the current rise of interest in e-commerce and the development of electronic markets and exchanges, he states, “We recognize and appreciate the power of the new technology and the power it will deliver, but, in the frantic search for space, it is still about relationships.” This message not only captures the importance of developing logis- tics relationships but also suggests that the ability to form relationships is a prerequisite to future success. Also, the essence of this priority is captured in a quote from noted management guru Rosabeth Moss Kanter who stated that “being a good partner has become a key corporate asset; in the global economy, a well-developed ability to create and sustain fruitful collaborations gives companies a significant leg up.”2

Logistics Relationships

Types of Relationships Generally, there are two types of logistics relationships. The first is what may be

termed vertical relationships; these refer to the traditional linkages between firms in the supply chain such as retailers, distributors, manufacturers, and parts and materials suppliers. These firms relate to one another in the ways that buyers and sellers do in all industries, and significant attention is directed toward making sure that these relation- ships help to achieve individual firm and supply chain objectives. Logistics service provi- ders are involved on a day-to-day basis as they serve their customers in this traditional, vertical form of relationship.

The second type of logistics relationship is horizontal in nature and includes those business agreements between firms that have “parallel” or cooperating positions in the logistics process. To be precise, a horizontal relationship may be thought of as a service agreement between two or more provider firms based on trust, cooperation, shared risk and investments, and following mutually agreeable goals. Each firm is expected to con- tribute to the specific logistics services in which it specializes, and each exercises control of those tasks while striving to integrate its services with those of the other logistics providers. An example of this may be a transportation firm that finds itself working along with a contract warehousing firm to satisfy the needs of the same customer. Also, cooperation between a third-party logistics provider and a firm in the software or infor- mation technology business would be an example of this type of relationship. Thus, these parties have parallel or equal relationships in the logistics process and likely need to work together in appropriate and useful ways to see that the customer’s logistics objec- tives are met.

Intensity of Involvement As suggested by Figure 4.1, the range of relationship types extends from that of a vendor

to that of a strategic alliance. In the context of the more traditional “vertical” context, a ven- dor is represented simply by a seller or provider of a product or service, such that there is little or no integration or collaboration with the buyer or purchaser. In essence, the rela- tionship with a vendor is “transactional,” and parties to a vendor relationship are said to be at “arm’s length” (i.e., at a significant distance). The analogy of such a relationship to that experienced by one who uses a vending machine is not inappropriate. While this form of relationship suggests a relatively low or nonexistent level of involvement between

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the parties, there are certain types of transactions for which this option is desirable. One- time or even multiple purchases of standard products and/or services, for example, may suggest that an “arm’s length” relationship would be appropriate.

Alternatively, the relationship suggested by a strategic alliance is one in which two or more business organizations cooperate and willingly modify their business objectives and practices to help achieve long-term goals and objectives. The strategic alliance by defini- tion is more strategic in nature and is highly relational in terms of the firms involved. This form of relationship typically benefits the involved parties by reducing uncertainty and improving communication, increasing loyalty and establishing a common vision, and helping to enhance global performance. Alternatively, the challenges with this form of relationship include the fact that it implies heavy resource commitments by the par- ticipating organizations, significant opportunity costs, and high switching costs.

Leaning more toward the strategic alliance end of the scale, a partnership represents a customized business relationship that produces results for all parties that are more acceptable than would be achieved individually. Partnerships are frequently described as being “collaborative,” which is discussed further at a later point in this chapter.

Note that the range of alternatives suggested in Figure 4.1 is limited to those that do not represent the ownership of one firm by another (i.e., vertical integration) or the formation of a joint venture, which is a unique legal entity to reflect the combined operations of two or more parties. As such, each represents an alternative that may imply even greater involve- ment than the partnership or strategic alliance. Considering that they represent alternative legal forms of ownership, however, they are not discussed in detail at this time.

Regardless of form, relationships may differ in numerous ways. A partial list of these differences follows:

• Duration

• Obligations

• Expectations

• Interaction/communication

• Cooperation

• Planning

Figure 4.1 Relationship Perspectives

Vendor Partner Strategic Alliance

Arm’s Length

Collaborative Strategic

R e l a t i o n a l

T r a n s a c t i o n a l

Source: C. John Langley Jr., Ph.D. Used with permission.

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• Goals

• Performance analysis

• Benefits and burdens

In general terms, most companies feel that there is significant room for improvement in terms of the relationships they have developed with their supply chain partners. The content of this chapter should help to provide understanding of some key ways in which firms may improve and enhance the quality of relationships they experience with other members of their supply chains.

Model for Developing and Implementing Successful Supply Chain Relationships

Figure 4.2 outlines the steps in a process model for forming and sustaining supply chain relationships. For purposes of illustration, let us assume that the model is being applied from the perspective of a manufacturing firm, as it considers the possibility of forming a relationship with a supplier of logistics services (e.g., transport firm, warehouseman, etc.).

Step 1: Perform Strategic Assessment This first stage involves the process by which the manufacturer becomes fully aware of

its logistics and supply chain needs and the overall strategies that will guide its operations. Essentially, this is what is involved in the conduct of a logistics audit, which is discussed in detail in Chapter 12. The audit provides a perspective on the firm’s logistics and supply chain activities, as well as developing a wide range of useful information that will be help- ful as the opportunity to form a supply chain relationship is contemplated. The types of information that may become available as a result of the audit include the following:

• Overall business goals and objectives, including those from a corporate, divi- sional, or logistics perspective

• Needs assessment to include requirements of customers, suppliers, and key logistics providers

Figure 4.2 Process Model for Forming Logistics Relationships

Perform Strategic

Assessment

1 Evaluate Alternatives 3 Structure

Operating Model

5 Implementation and Continuous

Improvement

6

Potential Partner

Capabilities

Company Needs and Priorities

Decision to Form

Relationship

2

Select Partner(s)

4

Source: C. John Langley Jr., Ph.D. Used with permission.

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• Identification and analysis of strategic environmental factors and industry trends

• Profile of current logistics network and the firm’s positioning in respective supply chains

• Benchmark, or target, values for logistics costs and key performance measurements

• Identification of “gaps” between current and desired measures of logistics per- formance (qualitative and quantitative)

Given the significance of most logistics and supply chain relationship decisions, and the potential complexity of the overall process, any time taken at the outset to gain an understanding of one’s needs is well spent.

Step 2: Decision to Form Relationship Depending on the type of relationship being considered by the manufacturing firm

under consideration, this step may take on a slightly different decision context. When the decision relates to using an external provider of logistics services (e.g., motor carrier, railroad, airline, ocean shipping, express logistics provider, third-party logistics provider), the first question is whether or not the provider’s services will be needed. A suggested approach to making this decision is to make a careful assessment of the areas in which the manufacturing firm appears to have core competency. As indicated in Figure 4.3, for a firm to have core competency in any given area, it is necessary to have expertise, stra- tegic fit, and ability to invest. The absence of any one or more of these may suggest that the services of an external provider are appropriate.

If the relationship decision involves a channel partner such as a supplier or customer, the focus is not so much on whether or not to have a relationship, but on what type of relationship will work best. In either case, the question as to what type of relationship is most appropriate is one that is very important to answer.

Lambert, Emmelhainz, and Gardner have conducted significant research into the topic of how to determine whether a partnership is warranted and, if so, what kind of partnership should be considered.3 Their partnership model incorporates the identifica- tion of “drivers” and “facilitators” of a relationship; it indicates that for a relationship to have a high likelihood of success, the right drivers and facilitators should be present.

Figure 4.3 What Does It Take to Have an Area of Core Competency?

Strategic Fit

Ability to Invest

Expertise

Source: C. John Langley Jr., Ph.D. Used with permission.

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Drivers are defined as “compelling reasons to partner.” For a relationship to be success- ful, the theory of the model is that all parties “must believe that they will receive significant benefits in one or more areas and that these benefits would not be possible without a partnership.” Drivers are strategic factors that may result in a competitive advantage and may help to determine the appropriate type of business relationship. Although other factors may certainly be considered, the primary drivers include the following:

• Asset/cost efficiency

• Customer service

• Marketing advantage

• Profit stability/growth

Facilitators are defined as “supportive corporate environmental factors that enhance partnership growth and development.” As such, they are the factors that, if present, can help to ensure the success of the relationship. Included among the main types of facilita- tors are the following:

• Corporate compatibility

• Management philosophy and techniques

• Mutuality of commitment to relationship formation

• Symmetry on key factors such as relative size, financial strength, and so on

In addition, a number of additional factors have been identified as keys to successful relationships. Included are factors such as exclusivity, shared competitors, physical prox- imity, prior history of working with a partner or the partner, and a shared high-value end user.

Step 3: Evaluate Alternatives Although the details are not included here, Lambert and his colleagues suggest a

method for measuring and weighting the drivers and facilitators that we have discussed.4

Then they discuss a methodology by which the apparent levels of drivers and facilitators may suggest the most appropriate type of relationship to consider. If neither the drivers nor the facilitators seem to be present, then the recommendation would be for the rela- tionship to be more transactional, or “arm’s length” in nature. Alternatively, when all parties to the relationship share common drivers, and when the facilitating factors seem to be present, a more structured, formal relationship may be justified.

In addition to utilization of the partnership formation process, it is important to con- duct a thorough assessment of the manufacturing company’s needs and priorities in comparison with the capabilities of each potential partner. This task should be supported with not only the availability of critical measurements and so on, but also the results of personal interviews and discussions with the most likely potential partners.

Although logistics executives and managers usually have significant involvement in the decision to form logistics and supply chain relationships, it is frequently advanta- geous to involve other corporate managers in the overall selection process. Represen- tatives of marketing, finance, manufacturing, human resources, and information systems, for example, frequently have valuable perspectives to contribute to the dis- cussion and analysis. Thus, it is important to ensure a broad representation and involvement of people throughout the company in the partnership formation and partner selection decisions.

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Step 4: Select Partner(s) While this stage is of critical concern to the customer, the selection of a logistics or

supply chain partner should be made only following very close consideration of the cre- dentials of the most likely candidates. Also, it is highly advisable to interact with and get to know the final candidates on a professionally intimate basis.

As was indicated in the discussion of Step 3, a number of executives will likely play key roles in the relationship formation process. It is important to achieve consensus on the final selection decision to create a significant degree of “buy-in” and agreement among those involved. Due to the strategic significance of the decision to form a logistics or supply chain relationship, it is essential to ensure that everyone has a consistent understanding of the decision that has been made and a consistent expectation of what to expect from the firm that has been selected.

Step 5: Structure Operating Model The structure of the relationship refers to the activities, processes, and priorities that

will be used to build and sustain the relationship. As suggested by Lambert and his col- leagues, components “make the relationship operational and help managers create the benefits of partnering.”5 Components of the operating model may include the following:6

• Planning

• Joint operating controls

• Communication

• Risk/reward sharing

• Trust and commitment

• Contract style

• Scope of the relationship

• Financial investment

Step 6: Implementation and Continuous Improvement Once the decision to form a relationship has been made and the structural elements

of the relationship identified, it is important to recognize that the most challenging step in the relationship process has just begun. Depending on the complexity of the new rela- tionship, the overall implementation process may be relatively short, or it may be extended over a longer period of time. If the situation involves significant change to and restructuring of the manufacturing firm’s logistics or supply chain network, for example, full implementation may take longer to accomplish. In a situation where the degree of change is more modest, the time needed for successful implementation may be abbreviated.

Finally, the future success of the relationship will be a direct function of the ability of the involved organizations to achieve both continuous and breakthrough improvement. As indicated in Figure 4.4, a number of steps should be considered in the continuous improvement process. In addition, efforts should be directed to creating the break- through, or “paradigm-shifting,” type of improvement that is essential to enhance the functioning of the relationship and the market positioning of the organizations involved.

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Need for Collaborative Relationships7 Whether the relationship may or may not be with a provider of logistics services,

today’s supply chain relationships are most effective when collaboration occurs among the participants who are involved. Collaboration may be thought of as a “business prac- tice that encourages individual organizations to share information and resources for the benefit of all.”8 According to Dr. Michael Hammer, collaboration allows companies to “leverage each other on an operational basis so that together they perform better than they did separately.”9 He continues by suggesting that collaboration becomes a reality when the power of the Internet facilitates the ability of supply chain participants to read- ily transact with each other and to access each other’s information.

While this approach creates a synergistic business environment in which the sum of the parts is greater than the whole, it is not one that comes naturally to most organizations, particularly those offering similar or competing products or services. In terms of a logistics example, consider that consumer products manufacturers sometimes go to great lengths to make sure that their products are not transported from plants to customers’ distribution centers with products of competing firms. While this practice does have a certain logic, a willingness of the involved parties to collaborate and share resources can create significant logistical efficiencies. Also, it makes sense, considering that retailers routinely commingle competing products as they are transported from distribution centers to retail stores. When organizations refuse to collaborate, real losses may easily outweigh perceived gains.

Most simply, collaboration occurs when companies work together for mutual benefit. Since it is difficult to imagine very many logistics or supply chain improvements that involve only one firm, the need for effective relationships is obvious. Collaboration goes well beyond vague expressions of partnership and aligned interests. It means that com- panies leverage each other on an operational basis so that together they perform better

Figure 4.4 Implementation and Continuous Improvement

Supply Chain Value

Customer Value

Research

1

Flow Charting2

Benchmarking5

Activity- Based

Costing

4

Statistical Process Control

3

Process Reengineering 6

Source: Ray A. Mundy, C. John Langley Jr., and Brian J. Gibson, Continuous Improvement in Third Party Logistics (2001). Reproduced by permission.

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than they did separately. It creates a synergistic business environment in which the sum of the parts is greater than the whole. It is a business practice that requires the following:

• Parties involved to dynamically share and exchange information

• Benefits experienced by parties to exceed individual benefits

• All parties to modify their business practices

• All parties to conduct business in a new and visibly different way

• All parties to provide a mechanism and process for collaboration to occur

Figure 4.5 provides illustrations of three important types of collaboration: vertical, horizontal, and full. Descriptions of these are as follows:

• Vertical collaboration (see Figure 4.5a) refers to collaboration typically among buyers and sellers in the supply chain. This refers to the traditional linkages between firms in the supply chain such as retailers, distributors, manufacturers, and parts and materials suppliers. Transactions between buyers and sellers can be automated, and efficiencies can be significantly improved. Companies can share plans and provide mutual visibility that causes them to change behavior. A contemporary example of vertical collaboration is collaborative planning, forecasting, and replenishment (CPFR), an approach that helps buyers and

Figure 4.5 Types of Collaboration

(a) Vertical Collaboration

Suppliers

Distributors

Retailers

Manufacturers

(b) Horizontal Collaboration

Supplier #1

Distributor #1

Retailer #1

Manufacturer #1

Supplier #2

Distributor #2

Retailer #2

Manufacturer #2

(c) Full Collaboration

Supplier #1

Distributor #1

Retailer #1

Manufacturer #1

Supplier #2

Distributor #2

Retailer #2

Manufacturer #2

Source: C. John Langley Jr., Ph.D. Used with permission.

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sellers to better align supply and demand by directly sharing critical informa- tion such as sales forecasts.

• Horizontal collaboration (see Figure 4.5b) refers to a relationship that is buyer to buyer and/or seller to seller, and in some cases even between competitors (including providers of logistics services). Essentially, this type of collaboration refers to business arrangements between firms that have parallel or cooperating positions in the logistics or supply chain process. Horizontal collaboration can help find and eliminate hidden costs in the supply chain that everyone pays for by allowing joint product design, sourcing, manufacturing, and logistics.

• Full collaboration (see Figure 4.5c) is the dynamic combination of both vertical and horizontal collaboration. Only with full collaboration do dramatic efficiency gains begin to occur. With full collaboration, it is intended that benefits accrue to all members of the collaboration. The development of agreed-upon methods for sharing gains and losses is essential to the success of the collaboration.

While there are numerous sources of suggestion and insight as to how to most effectively create successful, collaborative relationships, Table 4.1 lists each of the seven immutable laws of collaborative logistics. The collective impact of these principles is that they represent a course of action that, if followed, should enhance the success and benefits to be derived from truly collaborative rela- tionships. Overall, the best results will be achieved by leveraging people, process, and technology to help achieve logistics and supply chain objectives.

Third-Party Logistics—Industry Overview As indicated throughout this book, firms have directed considerable attention toward

working more closely with other supply chain participants, including customers, suppli- ers, and various providers of logistics services. In essence, this has resulted in the devel- opment of more meaningful relationships among the companies involved in overall supply chain activity. As a result, many companies have been in the process of extending their logistics organizations into those of other supply chain participants and facilitators.

On the Line Collaborative Distribution Can Show You the Path to Lower Supply Chain Costs and Carbon Emissions

Collaborative distribution is not an idealist’s dream. There are solid, practical reasons to adopt this approach. First and foremost is the fact that creating this shared infrastructure can reduce supply chain costs by up to 35 percent. Additionally, collaborative distribution offers a “greener” operating method that will strongly appeal to customers.

To understand why collaborative distribution makes such good sense, just take a look at the cur- rent U.S. model for the distribution of consumer packaged goods (CPG). It’s riddled with ineffi- ciency and redundancy. Industry analysts tell us that trucks are running empty 20 to 25 percent

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of the time. That’s a terrible waste, especially when you consider that transportation accounts for 29 percent of U.S. carbon output and a whopping 70 percent of petroleum usage.

The reason for this shocking inefficiency is that each manufacturer treats each delivery to each customer as a separate shipment that exists in its own, unique universe. Because of that, two trucks can end up driving side by side on the highway, half-full of the same class of consumer products that are coming from the same area and going to the same des- tination. Because the greatest inefficiency occurs when small and medium-size CPG manu- facturers plan and make their less-than-truckload (LTL) shipments, perhaps the most dramatic change could come in that sector. But everyone needs to participate. We have a broken system, and it’s up to us—manufacturers, retailers, and third-party logistics service providers (3PLs) together—to mend it.

Imagine a future in which collaboration was a key component of the whole supply chain. A retailer would combine orders from multiple buying groups, and then send those to the CPG manufacturers. Those multiple orders would be relayed electronically to a collaborative DC operated by an “enlightened” 3PL, which would then intelligently pick orders from inventory belonging to multiple manufacturers, including competitors, of similar commodities. The orders would be staged for smart, consolidated delivery, with pallets built to the retailer’s specifications. The retailer would then pick up its own order as a backhaul using a truck that has made a store delivery nearby. The delivery then arrives at the retailer’s dock (tracked all the way through a logistics management system) and is unloaded by workers who know exactly where it is going. Finally, the 3PL calculates the total space and shipping charges for each participant in this efficient, collaborative operation, and bills each manu- facturer based on the percentage of the total volume their products represent.

However, the journey to a more enlightened supply chain starts within the four walls of the company. Inefficiencies, and therefore opportunities to collaborate, often originate internally. Just as each company needs to change its self-image from that of a stand-alone entity to part of a community of companies with shared goals (as well as competing ones, of course), so must the various groups inside a company need to change their “silo” way of thinking and think in terms of the greater good.

Source: Adapted from Chris Kane, “An Enlightened Approach to Distribution,” CSCMP Supply Chain Quarterly, Quarter 3, 2010. Copyright © 2010 by CSCMP’s Supply Chain Quarterly, a publication of Supply Chain Media, LLC. All rights reserved. Reproduced by permission.

Table 4.1 Seven Immutable Laws of Collaborative Logistics

Collaborative logistics networks must support:

• Real and Recognized Benefits to All Members • Dynamic Creation, Measurement, and Evolution of Collaborative Partnerships • Co-Buyer and Co-Seller Relationships • Flexibility and Security • Collaboration Across All Stages of Business Process Integration • Open Integration with Other Services • Collaboration Around Essential Logistics Flows

Source: C. John Langley Jr., Ph.D. Used with permission.

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One way of extending the logistics organization beyond the boundaries of the com- pany is through the use of a supplier of third-party or contract logistics services. The following section provides some background information on how best to define this type of logistics provider and what services might be included.

Definition of Third-Party Logistics Essentially, a third-party logistics firm may be defined as an external supplier that

performs or manages the performance of all or part of a company’s logistics functions. This definition is purposely broad and is intended to encompass suppliers of services such as transportation, warehousing, distribution, financial services, and so on. As is dis- cussed later, there are other desirable characteristics of a “true” 3PL. Among these, mul- tiple logistics activities are included, those that are included are “integrated” or managed together, and they provide “solutions” to logistics/supply chain problems.

Recently, there have been significant increases in the number of firms offering such services, and this trend is expected to continue. While many of these firms are small, niche players, the industry has a number of large firms as well. Examples of the latter include UPS Supply Chain Solutions, FedEx Supply Chain Services, IBM Global Business Services, Ryder, DHL-Exel, Menlo Logistics, Penske Logistics, Schneider Logistics, Cater- pillar Logistics, UTi Worldwide, Inc., Panalpina, and Agility, Inc.

Depending on the firm and its positioning in the industry, the terms contract logistics and outsourcing are sometimes used in place of third-party logistics. While some indus- try executives take care to distinguish among terms such as these, each of these terms refers broadly to the use of external suppliers of logistics services. Except for the sugges- tion that the term contract logistics generally includes some form of contract, or formal agreement, this text does not suggest any unique definitional differences between these terms. Although most customers who use 3PLs choose to have some formal contract to define the terms of the agreement, it is interesting to note that a small number of com- panies choose not to have formal contracts with their suppliers of logistics services.

Types of 3PL Providers Although most 3PL firms promote themselves as providers of a comprehensive range of

logistics services, it is useful to categorize them in one of several ways. Included are transportation-based, warehouse/distribution-based, forwarder-based, financial-based, and information-based firms. Each of these is discussed briefly in the following paragraphs.

Transportation Based Included among the transportation-based suppliers are firms such as UPS Supply

Chain Solutions, FedEx Supply Chain Services, DHL, Ryder, Menlo Logistics, Panalpina, and Schneider Logistics; most of these are subsidiaries or major divisions of large trans- portation firms. Some of the services provided by these firms are leveraged in that they utilize the assets of other companies; some are nonleveraged, where the principal empha- sis is on utilizing the transportation-based assets of the parent organization. In all instances, these firms extend beyond the transportation activity to provide a more com- prehensive set of logistics offerings.

In early 2000, Transplace was formed through the merger of the logistics business units of several of the largest publicly held truckload carriers in the United States. While this company is transportation-based in that major elements of its corporate

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heritage do involve the commercial transportation industry, its approaches to operations, management, and planning significantly utilize and leverage information technologies. For this reason, a more comprehensive description of this company is found later in this section under the topic of information-based providers.

Warehouse/Distribution Based Traditionally, most warehouse/distribution-based logistics suppliers have been in

the public or contract warehousing business and have expanded into a broader range of logistics services. Examples of such firms include OHL, DSC Logistics, Saddle Creek Corporation, and Standard Corporation (now operating as UTi Integrated Logistics). Based on their traditional orientation, these types of organiza- tions already have been involved in logistics activities such as inventory management, warehousing, distribution, and so on. Experience has indicated that these facility- based operators have found the transition to integrated logistics services to be less complex than have the transportation providers.

This category also should include a number of 3PL firms that have emerged from larger corporate logistics organizations. Prominent among these are Caterpillar Logistics Services (Caterpillar, Inc.), Intral Corporation (Gillette), and IBM Global Business Ser- vices (IBM Corporation). These providers have significant experience in managing the logistics operations of the parent firm and, as a result, prove to be very capable providers of such services to external customers. While the idea that a 3PL firm may emerge from a corporate logistics organization is an interesting one, not all of these conversions have been as successful commercially as the ones listed above.

Forwarder Based This category includes companies such as Kuehne & Nagel, Expeditors, C. H. Robinson,

Hub Group, and UTi Worldwide that have extended their middleman roles as forwarders and/or brokers into the broader range of 3PL services. Essentially, these firms are nonasset owners, independent, and deal with a wide range of suppliers of logistics services. They have proven quite capable of putting together packages of logistics services that meet customers’ needs.

Financial Based This category of 3PL provider includes firms such as Cass Information Systems, CTSI,

and Tranzact Technologies. These firms provide services such as freight payment and auditing; cost accounting and control; logistics management tools for monitoring, book- ing, tracking, tracing, and managing inventory, and consulting and advisory services.

Information Based In recent years, growth and development of Internet-based, business-to-business,

electronic markets for transportation and logistics services have been significant. Since these resources effectively represent alternative sources for those in need of purchasing transportation and logistics services, they may be thought of as a newer, innovative type of third-party provider. An interesting example is that of Transplace, Inc., which at the time of its founding represented the merger of the 3PL business units from six of the largest publicly held truckload carriers in the United States. Transplace focuses on applying advanced third-party logistics efficiencies through the use of customized solu- tions and technologies that scale to the business needs of its customers. Services pro- vided by Transplace include third-party logistics, supply chain consulting, freight services, and carrier development.

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Further details concerning information technologies and their applicability to logistics and supply chain management are discussed in Chapter 6: Supply Chain Technology— Managing Information Flows.

3PL Market Size and Scope Table 4.2 contains an excerpt from a summary of specific companies that were iden-

tified by Armstrong & Associates as utilizing multiple 3PLs. General Motors was ranked highest, with 49 third-party providers of logistics services.

Table 4.3 presents estimates of the global 3PL industry revenues for the year 2010. As can be seen, the total revenues for North America of US $143.3 billion represent more than a quarter of the total estimated global spending of US $539.1 billion. Figure 4.6 pro- vides a look at the growth of the 3PL logistics market in the U.S., where turnover growth has risen from US $30.8 billion in 1996 to an estimated US $121.6 billion in 2010 and US $130.1 in 2011. Figure 4.6 also illustrates the impact on 3PL turnover of the eco- nomic recession that occurred during the 2009–2010 time frame.

It is also important to note that since many 3PL providers are “non-asset-based,” another relevant figure is “net” revenue, which is calculated as “gross” revenue minus the expense of purchased transportation and logistics services. Generally speaking, esti- mated net third-party logistics revenues would be approximately 55 to 60 percent of the totals indicated in Table 4.3 and Figure 4.6.

Table 4.2 Top Buyers of 3PL Services

COMPANY NUMBER OF 3PLS USED

General Motors 49

Procter & Gamble 42

Volkswagen; Wal-Mart 37

Daimler 32

Ford Motor Company 31

Pepsico 30

Hewlett-Packard; Nestle 29

Unilever 27

General Electric 26

BMW; Toyota 23

Sears Holdings; Siemens 22

Home Depot; Johnson & Johnson 20

Honda Motor; Royal Philips Electronics 19

Others to Follow <19

Source: Trends in 3PL/Customer Relationships – 2009. © Copyright 2009 Armstrong & Associates, Inc. Reproduced by permission.

Supply Chain Relationships 121

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Figure 4.6 3PL Logistics Market – U.S. Turnover Growth (US $Billions)

$30.8 $39.6

$45.3

$65.3 $71.1

$89.4

$103.7 $113.6

$127.0

$107.1

$121.6 $130.1

$0

$20

$40

$60

$80

$100

$120

$140

2011E1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010E

$34.2

$56.6

$76.9

$119.0

Source: Predictions and Major Trends for Third-Party Logistics – 2011. © Copyright 2011 Armstrong and Associates, Inc. Reproduced by permission.

Table 4.3 Global 3PL Market 2010 Revenue Estimate

REGION YEAR 2010 ESTIMATE US $BILLIONS

United States 121.6

Canada and Mexico 21.7

Total North America 143.3

Europe 164.7

Asia Pacific 147.3

Central America 1.7

South America 27.7

Australia 10.0

UAE (Dubai) 2.9

Remaining Regions/Countries 41.5

Total Global 3PL Market 539.1

Source: Predictions and Major Trends for Third Party Logistics – 2011. © Copyright 2011 Armstrong & Associ- ates, Inc. Reproduced by permission.

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Third-Party Logistics Research Study—Industry Details One significant, ongoing research study, Third-Party Logistics: The State of Logis-

tics Outsourcing, is conducted annually by Dr. C. John Langley Jr. of Penn State University and Capgemini Consulting. The 2010 Fifteenth Annual Third-Party Logis- tics Study, provides a comprehensive look at the third-party logistics industry from the perspectives of users and providers of 3PL services on a global basis.10 The annual studies provide a continuing source of information on the state of the 3PL industry, and they also address timely, special topics that are relevant to both users and providers of 3PL services.

The principal vehicles for gathering perspectives for use in the annual 3PL studies include the following:

• A survey of global users and providers of 3PL services, administered through the Internet. The intended recipients of the surveys are those involved in the management and leadership of logistics/supply chain activities at customer firms, and executive-level contact at 3PL organizations. The customer surveys include a wide variety of prominent industries.

• Focus interviews with experts who are involved in the purchase, use, or provi- sion of 3PL services, and other experts from industry, consulting, and academia who have valuable knowledge and perspective on the topics of interest. These focus interviews are conducted both in-person and by telephone, and they have proved to be a very valuable source of information.

• Workshops with customers of 3PLs at Accelerated Solutions Environment (ASE) facilities operated by Capgemini in locations such as Chicago, New York, Boston, Paris, Berlin, and Utrecht (Netherlands).11 Other workshops were also conducted in conjunction with prominent logistics organizations in Singapore and Shanghai.

Profile of Logistics Outsourcing Activities Figure 4.7 summarizes the use of specific logistics services that were reported as

being outsourced by respondents on a global basis in the 2010 annual 3PL study. Based on this information, the logistics services most frequently outsourced are those that are more operational, transactional, and repetitive in nature. Looking at the results over all of the regions studied, the most frequently outsourced services include domestic transportation (83%), international transportation (75%), warehous- ing (74%), customs brokerage (58%), and forwarding (53%). The responses to this question support the idea that the less frequently outsourced logistics services tend to be customer-related, involve the use of information technology, and are more strategic in nature.

A strategic issue is how customers feel that 3PLs should position themselves in terms of depth and breadth of service offerings. Based on findings reported over recent years of the study, users of 3PL services indicate significant agreement with the statement that “third-party suppliers should provide a broad, comprehensive set of service offerings” and disagreement with the statement that “third-party suppliers should focus on a lim- ited range of service offerings.” This suggests the continued relevance of customer prefer- ences in certain situations for a single-source solution or a “lead logistics manager” role to the provision of integrated logistics services.

Supply Chain Relationships 123

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Strategic Role of Information Technology Considering the importance of information technology (IT) to the planning and exe-

cution of supply chain activities, the annual 3PL study has focused attention for several years on the extent to which customers have availed themselves of IT provided by their 3PLs. Table 4.4 summarizes various IT-based services and the percentage of global cus- tomers reporting the use of these specific services. As indicated, the most frequently used services were transportation management (execution) and warehouse/distribution center management, which directly parallel the specific types of logistics services reported earlier as being used by customers. The next most frequently cited services were global trade management, yard management, transportation sourcing, and transportation manage- ment (planning). The least frequently used IT-based services shown in Table 4.4 tend to be those that are more strategic and customer-related.

Figure 4.8 focuses attention on the “IT gap,” which is the difference measured each year between the percentage of 3PL users indicating that “IT capabilities are a necessary element of 3PL expertise,” and the percentage reporting that they are “satisfied with 3PL IT capabilities.” While this gap has persisted for some time, the most recent three years of data suggest modest decreases in the size of the gap, but it is apparent that most ship- pers do not come close to using the full range of IT capabilities that may be obtained through their relationships with 3PLs. In attempting to analyze the causes of this IT

Figure 4.7 Outsourced Logistics Services

% Respondents by Logistics Services that Use a 3PL (Global Results)

Domestic transportation 83%

75%

74%

58%

53%

38%

36%

35%

31%

28%

20%

18%

14%

International transportation

Warehousing

Customs brokerage

Forwarding

Cross-docking

Product labeling, packaging, assembly, kitting

Reverse logistics

Transportation planning and mgmt

Freight bill auditing and payment

Information technology (IT) services

Supply chain consultancy services provided by 3PLs

Other (e.g., order entry, LLP/4PL, customer services)

Source: 2010 Fifteenth Annual Third-Party Logistics Study, C. John Langley Jr., Ph.D., and Capgemini LLC. Repro- duced by permission.

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Table 4.4 Current–Future IT-Based Services (Global Results)

EXAMPLE IT-BASED SERVICES PROVIDED BY 3PLS PERCENT SHIPPERS CURRENTLY USING

Transportation Management (Execution) 69%

Warehouse – Distribution Center Management 59

Global Trade Management 40

Yard Management 38

Transportation Sourcing 35

Transportation Management (Planning) 34

EDI 22

Web Portals 21

Visibility 19

Bar Coding 18

Supply Chain Network Optimization 13

Supply Chain Event Management 13

RFID 11

Customer Order Management 5

Supply Chain Planning 4

Source: 2009 Fourteenth Annual Third-Party Logistics Study, C. John Langley Jr., Ph.D., and Capgemini LLC. Reproduced by permission.

Supply Chain Technology

Technology a Key Driver of 3PL Competitiveness

As 3PLs and shippers become more proficient at the provision and use of 3PL services, it is becoming increasingly apparent that the availability and use of capable information technologies are essential to the success of 3PL-customer relationships. Thus, many 3PLs have found that the availability of capable IT solutions is a significant factor in helping to differentiate their services from those of competitors. In fact, challenges to both 3PLs and customers have been heightened by the fact that today’s successful supply chains need to be designed for and adapt to a wide range of influences and factors. Some of these are listed below:

• Globalization of supply chains • Economic volatility and uncertainty • Need for end-to-end solutions, and supply chain visibility • Continually changing locations of markets and sources of supply • Need for collaboration among supply chain participants • Relentless quest for increased efficiency and effectiveness of supply chains

As highlighted in the text of this chapter, it has been observed that the percentage of shippers surveyed who indicate they are satisfied with 3PL IT capabilities has doubled from a reported 27% in 2002 to 54% in 2010. Also noted was that the existence of the “IT Gap” suggests there

Supply Chain Relationships 125

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is still significant opportunity for improvement of the success ratings reported by shippers with respect to the use of IT-based services provided by 3PLs. To further expand on this, the following points are some that may help understand why at times this is challenging to accomplish:

• Increased demand by shippers for new and improved IT capabilities from their 3PLs • Growing complexity of supply chain decisions and factors impacting those decisions • Shippers’ needs for standardization of types of IT-based functionality, when many

shippers are currently sometimes using several types of solutions for the same type of application

• New types of tradeoffs to be analyzed and acted upon • Integration needs related to the use of IT-based services • Need for flexibility and increasing comprehensiveness and capability of IT applications

Additionally, 3PLs and technology providers are working on the development of capabilities that may relate to objectives such as: facilitating collaborative relationships between shippers, 3PLs, and other supply chain participants; achieving supply chain visibility through the use of capable solutions, and helpful technologies such as GPS, etc.; utilization of tools to assist with supply chain network design and scenario planning; and assisting 3PLs and customers to make sure their business continue to be in alignment, both strategically and operationally. Also of great interest, is how to integrate the use of contemporary means of communications and social media into supply chain operations.

Last, and aside from the need for and importance of technology, shippers and 3PLs need to keep in mind that the quality of decisions to be made will be related directly to the quality of the peo- ple who are able to effectively utilize technology, gain insight from the use of capable IT-based technologies, and then to make appropriate use of their intellect and judgment.

Source: C. John Langley Jr., Ph.D. Used with permission.

Figure 4.8 Information Technology “IT Gap”

0%

20%

40%

60%

80%

100% 89%

85% 91% 90% 92% 92% 92%

35% 42%40%42%

33% 27%

2002 2003 2004 2005

IT Capabilities Necessary Element of 3PL Expertise Shippers Satisfied with 3PL IT Capabilities

2006 Year

2007 2008 2009 2010

37%

88% 94%

54%

IT “Gap”

42%

Source: 2010 Fifteenth Annual Third-Party Logistics Study, C. John Langley Jr., Ph.D., and Capgemini LLC. Reproduced by permission.

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gap, one factor that has been found to be significant is the complexity of IT-needs of the shipper organizations, and the extent to which their IT capabilities themselves need to be improved.

Management and Relationship Issues The need for competency as it relates to the formation and continuation of successful

relationships has become critical in today’s 3PL industry. Although both providers and users of 3PL services have been improving in their ability to create more productive, effective, and satisfying business relationships, the media is replete with examples of failed relationships. The important question thus becomes “what can we do to improve in this area?”

An interesting finding from one of the earlier year’s studies12 was that the chief exec- utive in the logistics area is the person who clearly is most aware of the need for 3PL services. While available evidence supported the fact that the president or CEO and the finance executive are many times involved with the identification of the need for such services, executives from other areas such as manufacturing, human resources, market- ing, and information systems are also aware of such needs but to a lesser degree. If we look specifically at the task of implementing a 3PL relationship, however, it becomes apparent that information systems executives are becoming increasingly involved. This is not surprising, considering the key role of IT in many of today’s logistics and supply chain processes.

A very insightful topic is that of the “selection” factors that are important to custo- mers as they choose 3PLs with which they want to work. Based on the results of the 2006 Eleventh Annual Third-Party Logistics Study, the two most prevalent 3PL selection factors were price of 3PL services and quality of tactical, operational logistics services.13

Based on all of the 2006 study responses, 87 percent of respondents indicated that price was a factor, and 85 percent indicated that quality of service was a factor. Looking beyond these two selection criteria, others that were of greater importance included geo- graphic presence in required regions (75%), expected capability to improve service levels (67%), range of available value-added logistics services (63%), and capable information technologies (60%).

In addition, successful 3PL relationships establish appropriate roles and responsibili- ties for both 3PLs and client firms. While sometimes the use of a 3PL is interpreted simply as “turning over all logistics activities” to an outsourced provider, respondents to recent years’ studies suggested that a “hybrid” management structure represents a highly effective way to manage 3PL relationships. Essentially, this reflects a desire on the part of the client firm to have sufficient power over operations for a track record of performance or “trust” factor to be built up. Although most client firms (appropriately) retain control over strategy formulation and direction setting for the logistics areas of responsibility, this hybrid approach to the management of operations is an innovative response to the challenge of successfully managing 3PL–client relationships. Table 4.5 provides a useful summary of some of the expectations that 3PLs and their customers have of each other.

A final issue relates to how customers think of their 3PLs. Based on results from the 2005 study and as shown in Figure 4.9, approximately two-thirds of customers think of their 3PLs as providers of tactical or operational services, while approximately one-third think of them as strategic or integrative. While there

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may be a temptation to think that the strategic or integrative relationships are superior to or more advanced than the tactical, the fact is that the best relationships are those that come closest to meeting the logistics and supply chain needs of the customer as well as the provider. While there are some excellent relationships that are strategic or integrative in nature, there also are some excellent examples that are tactical or operational and that conform closely to the stated needs and requirements of the customer.

Figure 4.9 Customers’ Perspectives on 3PL Relationships

0% 10% 20% 30% 40% 50% 60% 70% 80%

2/3 Thought of as “Tactical”

Tactical service provider

Logistics strategist

Supply chain integrator

North America Western Europe Asia-Pacific Latin America

1/3 “Strategic” or “Integrative”

Source: 2005 Tenth Annual Third-Party Logistics Study, C. John Langley Jr., Ph.D., and Capgemini LLC. Repro- duced by permission.

Table 4.5 Expectation Setting Relative to 3PL Relationship Management

CUSTOMERS’ EXPECTATIONS OF 3PL PROVIDERS 3PL PROVIDERS’ EXPECTATIONS OF CUSTOMERS

• Superior service and execution (proven results and performance)

• Mutually beneficial, long-term relationship with company

• Trust, openness, and information sharing • Trust, openness, and information sharing

• Solution innovation and relationship reinvention

• Dedicating the right resources at the right levels, including executives

• Ongoing executive level support • Clearly defined service level agreements

• Service offering aligned with customer strategy and deep industry knowledge

• Fiduciary responsibility and overall fairness relative to pricing

Source: 2005 Tenth Annual Third-Party Logistics Study, C. John Langley Jr., Ph.D., and Capgemini LLC. Repro- duced by permission.

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Customer Value Framework Generally, 3PL users across the global regions studied characterized their outsourcing

efforts as having been successful. In fact, the percentages of users rating their relation- ships with 3PLs as being either “extremely” or “somewhat” successful typically falls in the range of 85 percent to low 90 percent figures.

In addition, participating executives provided continuing evidence of logistics and supply chain metrics that offer tangible documentation of the benefits they have experi- enced from the use of 3PL services. Examples of these metrics are included in Table 4.6. Aside from these impressive metrics, however, respondents in recent years’ studies reported experiencing a number of problems—some of which are listed below:

• Service-level commitments not realized

• Time and effort spent on logistics not reduced

• Cost reductions not realized

• Cost “creep” and price increases once relationship has commenced

• Unsatisfactory transition during implementation stage

• Inability to form meaningful and trusting relationships

• Lack of ongoing improvements and achievements in offerings

• Lack of strategic management and/or consultative/knowledge-based skills

• Lack of global capabilities

This list should be viewed as a starting point for continuous improvement by 3PL providers. Overall, it suggests a need to meet service-level and cost objectives and to avoid unnecessary increases in price to the customer once the relationship has commenced. Also, it appears that some 3PLs need to improve in the areas of strategic management, technology, and knowledge-based skills. These suggest expectations by the customers that currently are not being met. Finally, some users of 3PL services feel that the time and effort spent on logistics have not decreased and that their control over

Table 4.6 Average Customer Results from Use of Third-Party Logistics Providers

RESULTS ALL REGIONS

Logistics Cost Reduction (%) 15%

Logistics Fixed Asset Reduction (%) 25%

Inventory Cost Reduction (%) 11%

Average Order Cycle Length Changed From 17 days

Changed To 12 days

Order Fill Rate Changed From 73%

Changed To 81%

Order Accuracy Changed From 83%

Changed To 89%

Source: 2010 Fifteenth Annual Third-Party Logistics Study, C. John Langley Jr., Ph.D., and Capgemini LLC. Reproduced by permission.

Supply Chain Relationships 129

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the outsourced function may have lessened. In the latter instance, the previously discussed move to “hybrid” management of the 3PL’s responsibilities may be a useful alternative.

A Strategic View of Logistics and the Role of 3PLs One major accomplishment of the past 10 to 15 years has been establishing the validity of

the logistics outsourcing model and specifically of the 3PL provider. As we look to the future, we already see increasing acceptance of the 4PL model, likely growth in expenditures by current users of 3PL services, and a growing sophistication in the outsourced business approaches that respond to a dynamic set of customer logistics and supply chain needs.

Fourth-Party Relationships Although the concept has been around for some time, the “fourth-party logistics” (4PL)

provider is becoming more evident in the business world.14 Essentially a supply chain integrator, a 4PL may be thought of as a firm that “assembles and manages the resources, capabilities, and technology of its own organization with those of complementary service providers to deliver a comprehensive supply chain solution.”15 Figure 4.10 presents some of the types of services that may be provided by a 4PL, including managing multiple 3PLs (lead logistics provider), taking on more risk than 3PLs, providing advanced IT services, providing strategic consultancy, and “control tower” services.

Logistics Outsourcing Model for the Future Figure 4.11 suggests a possible future direction for the further development of logistics

outsourcing models. Starting with the proprietary provision of logistics services, or insourcing, at the bottom of the diagram, the model evolves through several successive stages. Included are basic services (e.g., transportation and warehousing), value-added or third-party logistics services, lead logistics or 4PL services, and advanced services. The diagram also identifies key attributes for each of these stages and specifies a typical geo- graphical coverage for each stage.

To conclude the discussion of outsourced logistics services as a key element of supply chain relationships, Table 4.7 identifies a number of trends that seem to characterize the future direction of the 3PL sector. Regardless of how quickly these trends become appar- ent, the topic of logistics outsourcing is likely to be central and critical to the future successes of logistics and supply chain management.

Table 4.7 Future 3PL Industry Trends

• Continued expansion, acquisition and consolidation of 3PL industry

• IT capabilities to become an even greater differentiator

• Expansion of global markets and needed services

• Increased efforts to update, enhance, and improve 3PL provider–user relationships

• Continued broadening of service offer- ings across supply chain, and broad- based business process outsourcing

• Increased adoption of shared service networks and “coopetition” strategies with traditional competitors

• Two-tiered relationship models (strategic and tactical)

• Emphasis on relationship reinvention, mechanisms for continual improvement, and solution innovation

• Growing range of “strategic” services offered by 3PLs and 4PLs

Source: 2005 Tenth Annual 2005 3PL Study, C. John Langley Jr., Ph.D. and Capgemini LLC. Used with permission.

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Figure 4.10 Evolution of 3PL//LLP/4PL Services

Spin-Off Elements of Supply Chain

4PL

From ... Management of Knowledge

Innovation

Information

Relationships

Integration To ...

Management of ...

Assets

Manage Multiple 3PLs (LLP) Take on More Risk than 3PLs Provide Advanced IT Services Provide Strategic Consultancy “Control Tower” Services

3PL

Advanced Services

Lead Logistics and 4PL Services

Single Source 3PL Contract Logistics

Individual or Multiple Logistics Activities

Insourcing

Transportation Management

Value-Added Warehousing and Distribution Management of Other Logistics Services Software

• Domestic vs. International • Asset vs. Non-Asset Based

Source: C. John Langley Jr., Ph.D. Used with permission.

Figure 4.11 Next Generation of Logistics Outsourcing Models?

Location(s) Specific

Insourcing

Basic Services (Logistics Service Providers)

Value-Added (Third-Party Logistics)

Lead Logistics (4PL)

Advanced Services

Global Supply Chain Integrators

Pan-Regional Integrators

Multiple Locations (intra or inter regional)

• Project Management • Single Point of Contact

• Enhanced Capabilities • Broader Service Offerings

• Resident Client Knowledge

• Focused Cost Reduction

Geographic CoverageKey Attributes

Infrastructure

• Speed of Implementation • Knowledge Transfer • Shared Risk & Reward • Comprehensive Solution

Source: 2005 Tenth Annual Third-Party Logistics Study, C. John Langley Jr., Ph.D., and Capgemini LLC. Repro- duced by permission.

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SUMMARY • The two most basic types of supply chain relationships are “vertical” (e.g., buyer-seller)

and “horizontal” (e.g., parallel or cooperating).

• In terms of intensity of involvement, interfirm relationships may span from transac- tional to relational and may take the form of vendor, partner, and strategic alliances.

• There are six steps in the development and implementation of successful relationships. These steps are critical to the formation and success of supply chain relationships.

• Collaborative relationships, both vertical and horizontal, have been identified as highly useful to the achievement of long-term supply chain objectives. The Seven Immutable Laws of Collaborative Logistics provide a framework for the development of effective supply chain relationships.

• Third-party logistics providers may be thought of as an “external supplier that per- forms all or part of a company’s logistics functions.” It is desirable that these suppliers provide multiple services and that these services are integrated in the way they are managed and delivered.

• The several types of 3PLs are transportation-based, warehouse/distribution-based, forwarder-based, financial-based, and information-based suppliers.

• Based on the results of a comprehensive study of users of 3PL services in the United States, over 70 percent of the firms studied are, to some extent, users of 3PL services.

• User experience suggests a broad range of 3PL services utilized; the most prevalent are transportation, warehousing, customs clearance and brokerage, and forwarding.

• While nonusers of 3PL services have their reasons to justify their decision, these same reasons are sometimes cited by users as justification for using a 3PL.

• Customers have significant IT-based requirements of their 3PL providers, and they feel that the 3PLs are attaching a priority to respond to these requirements.

• Approximately two-thirds of customers suggest 3PL involvement in their global supply chain activities.

• Although most customers indicate satisfaction with existing 3PL services, there is no shortage of suggestions for improvement.

• Customers generally have high aspirations for their strategic use of 3PLs and consider their 3PLs as keys to their supply chain success.

• There is a growing need for fourth-party logistics16 relationships that provide a wide range of integrative supply chain services.

STUDY QUESTIONS 1. What are the basic types of supply chain relationships, and how do they differ?

2. How would you distinguish between a vendor, a partner, and a strategic alliance? What conditions would favor the use of each?

3. What does it take to have an area of “core competency”? Provide an example.

4. Describe the steps in the process model for forming and implementing successful supply chain relationships. What step(s) do you feel is (are) most critical?

5. What are some of the more common “drivers” and “facilitators” of successful supply chain relationships?

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6. What is meant by “collaboration” between supply chain organizations? What are the different types of collaboration?

7. What are the basic types of 3PL firms, and which are in most prevalent use?

8. What are some of the more frequently outsourced logistics activities? Less frequently outsourced?

9. Why do some firms choose not to use the services of 3PL firms?

10. In what ways are clients/customers counting on 3PLs for involvement with informa- tion technology-based services?

11. To what extent are clients/customers satisfied with 3PL services? What is the relative importance of cost, performance, and value creation as determining factors for eval- uating and selecting 3PLs?

12. To what extent do clients/customers think of their 3PL providers in a strategic sense? What evidence suggests that this may change in the future, and what kind of change may be expected?

NOTES 1. Robert V. Delaney, 11th Annual State of Logistics Report (St. Louis, MO: Cass Information Systems, June 5, 2000).

2. Rosabeth Moss Kanter, “Collaborative Advantage: The Art of Alliances,” Harvard Business Review (July-August 1994).

3. Douglas M. Lambert, Margaret A. Emmelhainz, and John T. Gardner, “Developing and Implementing Supply Chain Part- nerships,” The International Journal of Logistics Management! No 2(1996): 1–17. The content of this section relating to drivers and facilitators has been quoted from this excellent research article.

4. Ibid, 4-10.

5. Ibid, 10.

6. Ibid, 10-13.

7. For an overview of collaborative logistics, see C. John Langley Jr., “Seven Immutable Laws of Collaborative Logistics,” 2000 (white paper published by Nistevo, Inc., now a part of Sterling Commerce, an IBM Company).

8. Ibid, 4.

9. Ibid, 2.

10. C. John Langley Jr., Ph.D., and Capgemini, 2010 Fifteenth Annual Third-Party Logistics Study.

11. Additional information concerning the Accelerated Solutions Environment (ASE) operated by Capgemini may be found at www.capgemini.com.

12. C. John Langley Jr., Brian F. Newton, and Gary R. Allen, Third-Party Logistics Services: Views from the Customers (Knox- ville, TN: University of Tennessee, 2000) This report includes the results and findings from the fifth annual version of this comprehensive study.

13. C. John Langley Jr. and Capgemini, 2006 Eleventh Annual Third Party Logistics Study. For further information and down- loads of the current and all previous annual 3PL studies, go to www.3plstudy.com.

14. 4PL and fourth-party logistics are registered trademarks of Accenture, Inc.

15. Accenture, Inc., by permission.

16. ™, Accenture, Inc.

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CASE 4 .1

CoLinx, LLC CoLinx LLC is a manufacturer-owned provider of shared e-commerce and logistics

services in North America. Founded in 2001, CoLinx was formed by four competing manufacturers in the power transmission industry, when they agreed to create a jointly owned, not-for-profit corporation to handle their logistics and electronic commerce operations to gain efficiencies of scale. CoLinx has since helped to improve service levels for its manufacturers by handling everything from system-to-system transactions with distributors, Web site hosting, warehousing, light assembly, shipping, freight auditing, and import-export operations through its designation as a foreign trade zone. The com- panies involved have seen remarkable performance improvements, and CoLinx has ambitious plans for further growth.1

CoLinx has the following three constituencies:2

• Manufacturers. The manufacturers who seek the lowest cost Web solutions while maintaining individual control and brand identity.

• Industrial distributors. CoLinx’s foundation is in enabling distributors to do business with multiple manufacturers through one site, allowing them to respond quickly to their own customers. The founding manufacturers go to market through an open distribution network. Each manufacturer can authorize multiple distributors, and each distributor can represent multiple manufacturers.

• Employee groups. CoLinx’s strong, mission-driven team is dedicated to using the Web site to build the businesses of the manufacturers.

Although CoLinx operates warehouses in the Reno, Dallas, Philadelphia, Toronto, and Edmonton metro areas, the cornerstone of its warehousing and logistics operations is its 670,000 square feet of warehouse space in Crossville, Tennessee. In the outbound ship- ping lanes, CoLinx’s main value is in freight consolidation. Working with several manu- facturers selling through the same distributor base allows it to send like-shipments to like-destinations, meaning fewer trucks in the yard for the distributor, fewer receipts, and a consolidated bill of lading with multiple packing lists, making it easier for the dis- tributor on the receiving end. When shipments are made more frequently, customer ser- vice improves, cost per pound declines, and less inventory is needed in the supply chain. When several companies share a distribution center, common areas and support staff are shared, shared frontline specialists better accommodate peaks and valleys, and invest- ments in high fixed cost technologies such as WMS, conveyance, timekeeping, voice- directed activity, and engineered standards become justifiable.

CoLinx provides members with e-commerce capabilities through a Web site hosting service that passes transaction data from customers to manufacturers (PTplace.com) using a standardized format. Also, CoLinx builds direct system-to-system connections between its manufacturers and their distributors, and between manufacturers and freight carriers as well.3 When many companies are supporting basic e-commerce Web services

1Douglas Chandler, “CoLinx and the Power of Partnership,” Modern Distribution Management 34, No 21 (November 10, 2004). 2Surgency, CoLinx: A Shared Service Portal in Manufacturing (Cambridge, MA: Surgency, Inc., 2001). 3Chandler, “CoLinx and the Power of Partnership.”

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to the same group of distributors or carriers, a common gateway reduces technical com- plexity and simplifies life for users.

Services are offered to manufacturers who undergo a formal application process, pay a membership fee, and make a commitment to use CoLinx services to a substantial extent in both e-commerce and logistics. Members have access to any or all services offered by the company and are assessed fees based on proprietary cost-sharing methodology.

To be clear, CoLinx is a different kind of company that is hard to comprehend. CoLinx is not an exchange or marketplace; does not own, plan, release, or insure any inventory; and does not sell directly to distributors or other customers—only the manu- facturers do. Manufacturer-members of CoLinx just indicate how many bin locations or pallet locations they want and provide instructions to CoLinx as to what needs to move and when. The company does not operate as a profit center, but all benefits accrued by the company are directly passed back to the members in the form of reduced costs. The company does not promote itself to try to build a brand image. The company’s only mis- sion is to “be the best choice” for the member manufacturers it serves and the employees of CoLinx.

CASE QUESTIONS 1. Describe the elements of the value proposition for the manufacturer-members of

CoLinx. What would be the elements of the value proposition for the distributors of products that are shipped from CoLinx?

2. What are the major sources of savings for manufacturer-members of CoLinx?

3. What are the keys to long-term sustainability of a relationship such as CoLinx?

Source: Portions of this case have been adapted from materials available at http//www.colinx.com. Reproduced by permission.

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CASE 4 .2

Ocean Spray Cranberries, Inc. August is typically a challenging month for Ocean Spray Cranberries, Inc., when the

Lakeville, Massachusetts-based firm has to pump up volume to meet the surge in demand for the upcoming holiday season. Ocean Spray is an agricultural co-op owned by more than 750 citrus growers in the United States and Canada. The company pro- duces canned and bottled juice, juice drinks, and food products at distribution centers in Bordentown, New Jersey; Kenosha, Wisconsin; Sulphur Springs, Texas; and Hender- son, Nevada.

Ocean Spray was managing its transportation operations internally, but the company decided it wanted to focus on its core competency, which, according to its director of logistics, was “maintaining our leadership in the shelf-stable juice drink category.” The company also wanted to centralize its transportation operations. Looking carefully at the issue of overall performance in the logistics and transportation areas, a significant amount of variability was found in its operations. For purposes of uniformity and con- trol, a major priority was attached to centralization of its logistics operations.

In addition, Ocean Spray wanted to be able to reach markets for which it did not already have access, which would require expansion of its logistics network. According to the director of logistics, an analysis was undertaken to study how long it would take and what it would cost to build up Ocean Spray’s transportation capabilities to be able to support such a network. As a result, a recommendation was made to seriously investigate the use of a third-party logistics (3PL) provider.

CASE QUESTIONS 1. What rationale is offered by Ocean Spray in support of the idea of using a 3PL? Do

you agree with the reasons cited for the interest in a 3PL?

2. Based on your understanding of Ocean Spray and its business needs, what type of 3PL firm do you feel might be of greatest potential value in terms of a relationship?

3. What steps would you suggest be considered by Ocean Spray as it begins to analyze the feasibility of forming a relationship with individual 3PL providers?

4. Once the selection process is complete, what kind of relationship do you feel would be most appropriate: vendor, partner, strategic alliance, or some other option?

Source: Adapted from Adrienne Bremer, “Outsourcing Helps to Take Squeeze Out of Surge,” Food Logistics (April 15, 1999): 62.

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Chapter 5

SUPPLY CHAIN PERFORMANCE MEASUREMENT AND FINANCIAL ANALYSIS

Learning Objectives After reading this chapter, you should be able to do the following: • Understand the scope and importance of supply chain performance

measurement.

• Explain the characteristics of good performance measures.

• Discuss the various methods used to measure supply chain costs, service, profit, and revenue.

• Understand the basics of an income statement and a balance sheet.

• Demonstrate the impacts of supply chain strategies on the income statement, balance sheet, profitability, and return on investment.

• Understand the use of the strategic profit model.

• Analyze the financial impacts of supply chain service failures.

• Utilize spreadsheet computer software to analyze the financial implications of supply chain decisions.

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Supply Chain Profile CLGN Book Distributors.com

CLGN Book Distributors.com (CLGN) is an Internet company that began operation in 2001 for the sale and distribution of college textbooks and instructional materials. During the first few years, CLGN struggled with the normal technical glitches associated with an Internet-based company, but the concept of online purchasing of college textbooks proved immensely popular with college students. After obtaining information on the textbook(s) required for a course, the students would use their computers to place their orders, avoiding the dreaded long lines at the campus bookstore.

CLGN’s original mission was to be a seller of low-priced college textbooks and instructional materials in the United States. The typical textbook price at CLGN averaged 15 percent below that of the local bookstore, and supplies averaged 20 percent lower. When the cost of shipping was included, the landed cost of the textbook was about 10 percent lower and materials 15 percent lower than purchases at the local bookstore. This lower cost and the convenience of online purchasing resulted in double-digit sales increases every year.

Beginning in 2002, CLGN made a profit and has done so every year since then. In 2010, CLGN had sales of $150 million with a net income of $10.5 million. This net profit margin of 7 percent was above average for business-to-consumer (B2C) Internet companies. However, net income as a percent of sales, or net profit margin, was lower than in the previous years. In 2008 net profit margin was 10.3 percent, and in 2009 it was 9.1 percent. This decreasing profit margin trend was causing considerable concern with top management and CLGN’s stockholders.

Following release of the 2010 financial data, Ed Bardi, the CEO of CLGN, held a meeting with the executive committee consisting of the vice presidents of marketing, finance, information systems, and supply chain management. After reviewing the 2010 financial results and discussing the underlying causes for the lower net profit margin, each vice president was given the assignment of examining his/her respective area for process changes that would remove costs while maintaining the same level of service customers expected.

Particular attention was given to the supply chain area because supply chain cost increases exceeded those in other areas of the company. Dr. Bardi also pointed out that during the past year he had been receiving complaints from irate customers regarding late deliveries of orders and receipt of improperly filled orders (wrong items or not all items ordered). Lauren Fishbay, vice president of supply chain management, said she was aware of these problems and was working on solutions for order fulfillment problems as well as the escalating shipping costs. She said her area was developing plans to transition from measuring orders shipped on time and orders shipped complete to measuring the perfect order (orders received on time, orders received complete, and accurate documentation).

Following the executive committee meeting, Ms. Fishbay gathered her operating managers to review the situation and explore alternatives. She asked Tracie Shannon, supply chain analyst, to prepare financial data measuring the supply chain process. Sharon Cox, warehouse manager, was asked to examine the nature and cause of the order fulfillment problems and to suggest solutions. Finally, Sue Purdum, transportation manager, was charged with examining the rising transportation costs and longer, and less reliable, delivery times.

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Prior to the supply chain operating managers’ meeting, Ms. Fishbay received the following 2010 financial information from Tracie Shannon:

CLGN Book Distributors.com INCOME STATEMENT 2010

Sales $150,000,000

Cost of goods sold 80,000,000

Gross margin $ 70,000,000

Transportation $ 6,000,000

Warehousing 1,500,000

Inventory carrying 3,000,000

Other operating cost 30,000,000

Total operating cost 40,500,000

Earnings before interest and taxes $ 29,500,000

Interest 12,000,000

Taxes 7,000,000

Net income $ 10,500,000

CLGN Book Distributors.com BALANCE SHEET 2010

Assets

Cash $ 15,000,000

Accounts receivable 30,000,000

Inventory 10,000,000

Total current assets $ 55,000,000

Net fixed assets 90,000,000

Total assets $145,000,000

Liabilities

Current liabilities $ 65,000,000

Long-term debt 35,000,000

Total liabilities $100,000,000

Stockholders’ equity 45,000,000

Total liabilities and equity $145,000,000

Supply Chain Performance Measurement and Financial Analysis 139

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Introduction The CLGN Book Distributors.com case highlights the need for all organizations to be

able to measure supply chain performance and link that performance to its impacts on financial performance. Many organizations today have realized that performance metrics are critical to managing the business and achieving desired results. Many organizations want to do the “right things” (effectiveness) and do them “right” (efficiency). However, simply stating those two objectives is not adequate unless there are specific, measurable metrics that enable the organization to gauge whether or not these objectives are achieved.

The purpose of this chapter is to (1) introduce the dimensions of supply chain perfor- mance metrics, (2) discuss how supply chain metrics are developed, (3) offer some methods for classifying supply chain metrics, and (4) develop quantitative tools to show how these metrics can be linked to the financial performance of the organization.

Dimensions of Supply Chain Performance Metrics Before beginning a discussion of the dimensions of supply chain metrics, it is impor-

tant to answer two questions. First, what are the differences among a measure, a metric,

Ms. Shannon determined that the inventory carrying cost rate was 30 percent of the value of the aver- age inventory held per year. The corporate tax rate was 40 percent. Total orders in 2010 amounted to 1.5 million ($150 million in sales at an average sale per order of $100). She estimated the lost sales rate to be 10 percent of the service failures caused by late transportation delivery and 20 percent of the service failures caused by improper order fulfillment. The cost of a lost sale per order is the gross profit per order, or $46.67 ($70 million gross margin divided by 1.5 million orders).

Sharon Cox concluded that the cost of a service failure, whether caused by order fulfillment or deliv- ery problems, resulted in an invoice reduction of $10 per order (to appease the customer) and a rehandling cost of $20 per order (to reship the order). Currently CLGN’s order fill rate is 97 percent. The causes of the improper order fulfillment could be attributed to the lack of warehouse personnel training. In the current economic environment, it is very difficult to obtain experienced warehouse workers. Other problems could be traced to a lack of discipline regarding order-picking procedures and the computer-generated pick slip. At least $100,000 was required annually for ongoing training.

Sue Purdum traced the escalating transportation costs to the 35 percent increase in residential delivery rates charged by CLGN’s ground delivery carrier for standard service (three to five days transit time). The residential delivery rates charged by other ground express carriers were comparable or higher. An alternative to reducing transportation costs was to switch to the U.S. Postal Service, but delivery times would increase and become less reliable. However, CLGN’s current on-time delivery performance is only 95 percent because of the longer order processing times at the warehouse and longer transit times via the ground package carrier to residential delivery locations. By using the carrier’s expedited ground service, CLGN could improve service and on-time delivery to 96 percent and increase transportation costs by 10 percent.

Given this information, Lauren Fishbay was pondering what actions she should explore with the operating managers in preparation for the next executive committee meeting. She knew whatever course of action she proposed had to be financially sound and provide the greatest benefit to CLGN’s stockholders.

Source: Edward J. Bardi, Ph.D. Used with permission.

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and an index? Traditionally, the term measure was used to denote any quantitative output of an activity or process. Today, the term metric is being used more often in place of the term measure. What is the difference? A measure is easily defined with no calculations and with simple dimensions. Logistics examples would include units of inventory and backorder dollars. A metric is more complex to define and usually involves a calculation or a combination of measurements, often in the form of a ratio. Logistics examples would include inventory future days of supply, inventory turns, and sales dollars per stock-keeping unit. An index combines two or more metrics into a single indicator. Usually an index is used to track trends in the output of a process. A logistics example of an index is the perfect order.1

Second, what are the characteristics of a good metric? Figure 5.1 is an excellent frame- work that can be used to determine the characteristic of a good metric. Several questions need to be asked to determine if a metric is appropriate for its intended use. A short discussion of the 10 characteristics in Figure 5.1 is necessary here to lay the foundation for the remainder of this chapter.

The first question to be asked about a metric is, “Is it quantitative?” While not all metrics are quantitative, this is usually a requirement when measuring the outputs of processes or functions. Qualitative performance metrics are better suited for measuring

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Figure 5.1 Characteristics of Good Measures

A GOOD MEASURE DESCRIPTION

• Is quantitative • The measure can be expressed as an objective value.

• Is easy to understand • The measure conveys at a glance what it is measuring and how it is derived.

• Encourages appropriate behavior • The measure is balanced to reward productive behavior and discourage “game playing.”

• Is visible • The effects of the measure are readily apparent to all involved in the process being measured.

• Is defined and mutually understood • The measure has been defined by and/or agreed to by all key process participants (internally and externally).

• Encompasses both outputs and inputs • The measure integrates factors from all aspects of the process measured.

• Measures only what is important • The measure focuses on a key performance indicator that is of real value to managing the process.

• Is multidimensional • The measure is properly balanced between utilization, productivity, and performance and shows the tradeoffs.

• Uses economies of effort • The benefits of the measure outweigh the costs of collection and analysis.

• Facilitates trust • The measure validates the participation among the various parties.

Source: J. S. Keebler, D. A. Durtsche, K. B. Manrodt, and D. M. Ledyard, Keeping Score: Measuring the Business Value of Logistics in the Supply Chain (University of Tennessee, Council of Logistics Management, 1999), p. 8. Reproduced by permission from Council of Supply Chain Management Professionals.

perceptions or assigning products or people to categories (e.g., excellent, good, poor). Qualitative metrics are backed up with quantitative data. For example, a transportation carrier might be rated “excellent” if it has only one late delivery for every 100 attempts.

The second question to be asked about a metric is, “Is it easy to understand?” This question is directly related to the fifth question, “Is it defined and mutually understood?” Experience has shown that individuals will understand a metric if they are involved in its definition and calculation.2 For example, one of the most commonly used metrics in logis- tics is on-time delivery. This is also one of the most commonly misunderstood metrics in logistics. Disagreements can occur between shippers and customers or between marketing and transportation. Research has shown that if all parties affected by the metric are involved in its definition and calculation, it will be easy to understand.3

The third question to be asked about a metric is, “Does it encourage appropriate behavior?”A basic principle of management is that metrics will drive behavior. A well- intentioned metric could very well drive inappropriate behavior. For example, if a ware- house manager is measured by cubic space utilization, he will try to keep the warehouse filled, which could lower inventory turns, drive up inventory costs, and result in product obsolescence.

The fourth question to be asked is, “Is the metric visible?” Good metrics should be readily available to those who use them. A distinction can be made here between a reactive metric and a proactive metric. Some firms state that metrics are available in the system for employees to see and use. However, this means that they must attempt to find them. These are reactive metrics. Leading firms, however, “push” metrics to metrics owners so they can react immediately. These are called proactive metrics. In both cases, metrics are visible. However, proactive metrics will be acted upon more quickly because employees need little or no effort to see them.4

The sixth question to be asked is, “Does the metric encompass both outputs and inputs?” Process metrics, such as on-time delivery, need to incorporate causes and effects into their calculation and evaluation. For example, a decreasing on-time delivery rate might be caused by late pickups, shipments not being ready on time, or even by production shutdowns. So, the outputs must be somehow related to the inputs.

The seventh question to be asked is, “Does it measure only what is important?” The logistics operation generates huge volumes of transactional data on a daily basis. Many times, firms will measure those activities or processes for which large amounts of data are available. Just because data are available to calculate a metric does not mean the metric is important. In some cases, data are hard to generate for important metrics. For example, data for on-time delivery must be generated by either the carrier or receiving location. Matching arrival data in a timely and accurate manner with bills of lading can be a cumbersome process. So, it is important to decide what is important and then gather the data rather than identifying what data are available and then generating metrics.

The eighth question to be asked about a good metric is, “Is it multidimensional?”Although a single metric will not be multidimensional, a firm’s metric program will be. This is where the terms scorecard and key performance indicators (KPIs) will apply. Many organizations will have a few strategic metrics to manage their logistics operations. These metrics will represent productivity, utilization, and performance in a balanced approach to managing their logistics processes.5

The ninth question to be asked is, “Does the process use economies of effort?” Another way to ask this question is, “Do we get more benefits from the metric than we

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incur costs to generate it?” In many cases, much time and effort are devoted to collecting data to generate a specific metric, while the resulting actions from the metric are mini- mal. Some firms find this to be the case when they first develop a metric. However, the longer a firm has a metric in place, the more likely there are to be economies of effort.6

The last question to be asked about a good metric is probably the most important: “Does it facilitate trust?” If it does not, complying with the other nine characteristics makes little or no difference for the effectiveness of the metric. However, if the first nine characteristics are present for a logistics metric, trust should be an expected conclusion.

Evaluating current or potential logistics metrics is critical to a sound metrics program. Also important to note is that metrics need to change over time; not only the perfor- mance standard—for example, 85 percent—but also the individual metric—for example, percentage of orders shipped on time. With regard to the first example, the standard might change to 90 percent as new processes and/or technologies are introduced that enable the organization to consistently exceed the old standard. Advocates of the Six Sigma concept have stressed the focus on continuous improvement, which should result in increasing performance expectations over time.

The second example, indicated previously, regarding changing metrics is also very important. Orders shipped on time and orders shipped complete were frequently used as performance metrics in logistics. These could be considered internal metrics because they focus on the performance of the shipping firm. However, as customer service receives more attention in industry, the metrics have changed to “orders delivered on time” and “orders delivered complete.” These are more external metrics because they measure the experience of the customer. Both internal and external metrics are essential components to a balanced approach to logistics performance measurement. Figure 5.2 shows the results of the 2010 Distribution Center Metrics report conducted by the Ware- house Education and Research Council (WERC) asking shippers what performance

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Figure 5.2 Distribution Center Metrics

Distribution Center Metrics

On-time shipment to customer 85.8%

73.2%

70.4%

60.2%

58.8%

58.7%

57.7%

56.2%

53.0%

50.7%

Order picking accuracy

Warehouse capital utilization

Employee turnover

On-time ready to ship

Peak warehouse capacity used

Fill rate

Dock-to-dock cycle time

Inventory accuracy by location

Order fill rate

Source: 2010 DC Metrics Report, WERC, (May 26, 2010). Copyright © 2010 by WERC. Reproduced by permission.

metrics they use to manage their distribution centers. As can be seen from the results, on-time shipment to customer is the most often used metric to measure distribution center performance.

Figure 5.3 explains how the dimensions and importance of performance measurement have expanded. This figure clearly indicates that expectations have increased since the 1960s and 1970s and that in each of the decades identified there have been important drivers for better performance. Each new decade, however, built upon the improvements in the previous decades.

A question might be raised as to whether or not the focus on performance measure- ment is a recent event in industry. The answer to that question is a definite “no.” Recall from Chapter 2 that the development of the physical distribution and logistics concepts was based upon systems theory with the specific application focused upon least total cost analysis. Total cost is a measure of efficiency and was the rationale supporting physical distribution management. Least total cost was later used to support the logistics manage- ment approach.

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Figure 5.3 Raising the Performance Bar

Logistics Performance

Standards

Logistics Performance

Standards

Logistics Performance

Standards

Logistics Performance

Standards

Logistics Performance

Standards

Competition MRP

Deregulation Customers Technology

Customers Technology

Shareholders DRP

Customers Technology

Shareholders Suppliers

ERP

1970s1960s 1980s 1990s 2000+

Production Costs

Manufacturing and Inventory Costs

Transportation Costs

Distribution and Logistics Costs

Supply Chain and Customer Service Costs

Superior

Excellent

Good

Acceptable

Fair

Key Performance Measures

Drivers of Better Logistics Performance Standards: 1960s–2000+

Source: J. S. Keebler, D. A. Durtsche, K. B. Manrodt, and D. M. Ledyard, Keeping Score: Measuring the Business Value of Logistics in the Supply Chain (University of Tennessee, Council of Logistics Management, 1999). Reproduced by permission from Council of Supply Chain Management Professionals.

The focus upon a least total cost system required measuring the tradeoff costs when a suggested change was made in one of the components or elements of the system. For example, this could include switching from rail to motor transportation or adding a distribution center to the distribution network. Cost has long been recognized as an important metric for determining efficiency. This is still true today. However, we have evolved from measuring functional cost to total logistics cost. This means the relevant point of measurement has changed from totally internal to a firm to the collective costs of many firms involved in the supply chain.

The important point to remember is that successful logistics performance measure- ment relies on appropriate metrics that capture the entire essence of the logistics process. Logistics metrics must also be reviewed to ensure that they are relevant and focus on what is important. A sound, comprehensive set of supply chain performance metrics is critical for an organization to manage its business and identify opportunities to increase profit and market share.

Developing Supply Chain Performance Metrics7 The implementation of new technologies—for example, enterprise resource planning

(ERP) systems—and the changing business environment have prompted many firms to reexamine their supply chain metrics programs. Another driving influence for this reex- amination has been the desire of organizations to change their supply chain focus from a “cost” center to an “investment” center. In other words, how can organizations justify investments in supply chain processes? This will be discussed in a later section in this chapter. In the meantime, here are some suggestions concerning the successful develop- ment of a supply chain metrics program.

First, develop a metrics program that is the result of a team effort. Successful metrics implementations involve development teams comprised of individuals representing functional areas within the firm that will be impacted by the metrics. Because this phase of development requires metric identification and definition, it is critical that all impacted areas agree on the appropriate metrics and their definitions. This agreement will lead to a more successful implementation and use of the metrics to manage the business.

Second, involve customers and suppliers, where appropriate, in the metrics develop- ment process. Because customers feel the impact of metrics and suppliers are actively involved in the execution of the metrics, their involvement is also critical to successful implementation.

Third, develop a tiered structure for the metrics. Many organizations develop a small number (usually less than five) of KPIs or “executive dashboard” metrics that are reviewed at the executive level for strategic decision making. Tied to each strategic KPI are tactical and operational metrics. In this hierarchy, operating unit metrics are tied directly to corporate strategic metrics.

Fourth, identify metric “owners” and tie metric goal achievement to an individual’s or division’s performance evaluation. This provides the motivation to achieve metric goals and use metrics to manage the business.

Fifth, establish a procedure to mitigate conflicts arising from metric development and implementation. A true process metric might require a functional area within an organi- zation to sub-optimize its performance to benefit the organization as a whole. This might

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result in conflict from the sub-optimized function. For example, achieving the desired on-time delivery metric might require transportation to increase its expenditures, result- ing in an unfavorable freight expense. A resolution process must be established to allow the transportation manager to realize the desired on-time delivery goal without being penalized for excess freight expense.

Sixth, establish supply chain metrics that are consistent with corporate strategy. If the overall corporate strategy is based upon effectiveness in serving customers, a supply chain metrics program that emphasizes low cost or efficiency may be in conflict with expected corporate outcomes.

Finally, establish top management support for the development of a supply chain metrics program. Successful metrics programs cost more than expected, take longer to implement than desirable, and impact many areas inside and outside the organization. Top management support is necessary to see the development and implementation of the metrics program to its successful conclusion.

Performance Categories A number of approaches can be used to classify supply chain performance metrics.

Figure 5.4 is one method to use for this type of classification. This figure identifies four

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Figure 5.4 Process Measure Categories

Time

On-time delivery/receipt

Order cycle time

Order cycle time variability

Response time

Forecasting/Planning cycle time

Quality

Overall customer satisfaction

Processing accuracy

Perfect order fulfillment

• On-time delivery

• Complete order

• Accurate product selection

• Damage-free

• Accurate invoice

Forecast accuracy

Planning accuracy

• Budgets and operating plans

Schedule adherence

Cost

Finished goods inventory turns

Days sales outstanding

Cost to serve

Cash-to-cash cycle time

Total delivered cost

• Cost of goods

• Transportation costs

• Inventory carrying costs

• Material handling costs

All other costs

• Information systems

• Administrative

Cost of excess capacity

Cost of capacity shortfall

Other/Supporting

Approval exceptions to standard

• Minimum order quantity

• Change order timing

Availability of information

Source: J. S. Keebler, D. A. Durtsche, K. B. Manrodt, and D. M. Ledyard, Keeping Score: Measuring the Business Value of Logistics in the Supply Chain (University of Tennessee, Council of Logistics Management, 1999). Reproduced by permission from Council of Supply Chain Management.

major categories with examples that provide a useful way for examining logistics and supply chain performance: (1) time, (2) quality, (3) cost, and (4) supporting metrics.

Time has traditionally been given attention as an important indicator of logistics per- formance, especially with regard to measuring effectiveness. Figure 5.4 lists five widely used metrics for time. The metrics capture two elements of time: the elapsed time for the activity and the reliability (variability) for the activity. For example, order cycle time might be 10 days, plus or minus 4 days, or 10 days, plus or minus 2 days. Both cycle times have the same absolute length but have different variability. The difference in variability will have an impact on safety stocks in the supply chain (this will be cov- ered further in Chapter 9, which discusses managing inventory in the supply chain). The important point is that metrics should measure both absolute time and its variability.

The second category indicated in Figure 5.4 is cost, which is the measurement for efficiency. Most organizations focus on cost since it is critical to their ability to compete in the market and make adequate profit and returns on assets and/or investments. A number of cost metrics related to logistics and supply chain management are important to organizations.

Some of the cost metrics shown in Figure 5.4 are obvious and easy to understand. For example, total delivered cost or landed cost will have an impact on the prices that will have to be charged in the market. Total delivered cost is multidimensional and includes the cost of goods, transportation, inventory carrying costs, import/export costs, and warehousing. Inventory turns and days sales outstanding are not as obvious. Inventory turns reflect how long an organization holds inventory and its resulting impact on inven- tory carrying cost (this will be discussed further in Chapter 9). Days sales outstanding impacts service levels to customers and can affect the rate of order fill. The cash- to-cash cycle is receiving increased attention in organizations because it measures cash flow. Organizations are interested in getting their money back as quickly as possible in order to enhance their financial viability.

Quality is the third category of metrics identified in Figure 5.4. Several dimensions in the quality category are important to logistics and supply chain management. The perfect order concept is a good example of the increased emphasis being placed upon customer service because it simultaneously measures multiple metrics that must be achieved to get a positive metric.8 The fourth category indicated in Figure 5.4 offers some supporting metrics such as approval of exceptions to standards.

Another metric classification scheme that has been receiving increased attention is that developed by the Supply Chain Council and contained in the Supply Chain Opera- tions and Reference (SCOR) model. Figure 5.5 is an example of the metrics categories used to measure the performance of Process D1: Deliver Stocked Product. This figure identifies five major categories of metrics that need to be used to measure the perfor- mance of Process D1: (1) reliability—the performance of the supply chain in delivering the correct product, to the correct place, at the correct time, in the correct condition and packaging, in the correct quantity, with the correct documentation, to the correct customer; (2) responsiveness—the speed at which the supply chain provides products to customers; (3) agility—the flexibility of the supply chain in responding to marketplace changes to gain or maintain competitive advantage; (4) costs—the expenditures associ- ated with operating the supply chain; and (5) asset management—the effectiveness of an organization in managing assets to support demand satisfaction and including the management of all assets (fixed and working capital).9 Figure 5.6 identifies metrics in the same categories for the single activity of D1.3, reserve inventory and determine

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Figure 5.5 SCOR Model: Process D1 Metrics

PROCESS CATEGORY: DELIVER STOCKED PRODUCT PROCESS NUMBER: D1

Process Category Definition

The process of delivering product that is sourced or made based on aggregated customer orders/demand and inventory re-ordering parameters. The intention of Deliver Stocked Product is to have the product available when a customer order arrives (to prevent the customer from looking elsewhere). For services industries, these are services that are pre-defined and off-the-shelf (e.g. standard training). Products or services that are “configurable” cannot be delivered through the Deliver Stocked Product process, as configurable products require customer reference or customer order details.

Performance Attibutes Metric

Supply Chain Reliability Perfect Order Fulfillment

Supply Chain Responsiveness Delivery Cycle Time Order Fulfillment Cycle Time

Supply Chain Agility Upside Deliver Adaptability Downside Deliver Adaptability Upside Deliver Flexibility

Supply Chain Costs Cost to Deliver Finished Goods Inventory Days of Supply Order Management Costs

Supply Chain Asset Management Return on Supply Chain Fixed Assets Return on Working Capital Cash-to-Cash Cycle Time

Source: Adapted from Supply Chain Council (2011). Reproduced by permission.

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Figure 5.6 SCOR Model: Process D1.3 Metrics

Process Element: Reserve Inventory and Determine Delivery Date

Process Element Number: D1.3

Process Element Definition

Inventory (both on hand and scheduled) is identified and reserved for specific orders and a delivery date is committed and scheduled.

Performance Attributes Metric

Supply Chain Reliability Delivery Performance to Customer Commit Date Fill Rate % of Orders Delivered in Full

Supply Chain Responsiveness Reserve Inventory and Determine Delivery Date Cycle Time Order Fulfillment Dwell Time

Supply Chain Agility None Identified

Supply Chain Costs Cost to Reserve Resources Determine Delivery Date

Supply Chain Asset Management None Identified

Source: Adapted from Supply Chain Council (2011). Reproduced by permission.

delivery date. Figure 5.7 illustrates another perspective in the form of a logistics quantifi- cation pyramid, which suggests that performance metrics for logistics and supply chain management should include logistics operations costs, logistics service metrics, transac- tion cost and revenue quantification, and channel satisfaction metrics.

Transportation is a good example of logistics operations costs. By calculating the tradeoffs between using less expensive (slower and less reliable) and more expensive (faster and more reliable) transportation service, an organization can quantify the total cost impact on transportation and inventory costs. Using faster and more reliable transportation will result in higher transportation costs but lower inventory costs, which usually generates in an increase in cash flow for the organization.

Logistics service can fall into any one of the five categories shown in Figure 5.8. Prod- uct availability is a logistics metric that is used frequently because it is a good indicator of supply chain performance and its influence on customer inventory requirements, order fill rates, and seller revenue.

Figure 5.7 Logistics Quantification Pyramid

Channel Satisfaction

Transaction Cost and RevenueLogistics

Operations Logistics Service

Source: R. A. Novack, Center for Supply Chain Research, Penn State University (2010).

Figure 5.8 Logistics Outputs That Influence Customer Service

• Product availability

• Order cycle time

• Logistics operations responsiveness

• Logistics system information

• Post-sale logistics support

Source: R. A. Novack, Center for Supply Chain Research, Penn State University (2010).

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Order cycle time (OCT) is another very important logistics service metric. OCT influences product availability, customer inventories, and the seller’s cash flow and profit. Once an expected order cycle time is established for customers, service failures can be measured. One such measure is the number of late deliveries per 100 shipments. From a revenue or cash flow perspective, an organization can calculate the impact of a late delivery on revenue, profit, and cash flow. (This will be discussed further in Chapter 8, which discusses order management and customer service.)

All of the logistics outputs listed in Figure 5.8 can be utilized in some form to develop metrics for service performance. As indicated previously, the service output metrics reflect the quality of service being provided to customers, which is important to sustain and, hopefully, increase revenue and cash flow.

Transaction cost and revenue relates to the value added by logistics. In other words, what is the service and price relationship, and what specifically is the customer’s percep- tion of service quality? To add logistics value from the seller’s perspective, there are three basic alternatives to consider:

• Increased service with a constant price to the customer

• Constant service with a reduced price

• Increased service with a reduced price

All of these alternatives result in the customers receiving more service per dollar for the price they are paying for the service.

Another perspective on transaction cost and revenue focuses on how a seller’s cost influences a customer’s profit and on how a seller’s service impacts a customer’s reve- nue. If the cost of a seller’s logistics service allows a customer to make more profit from the seller’s product, the customer should be willing to buy more products from the seller. For example, a manufacturer is able to deliver its product to the buyer’s retail store for $0.25 less per case than the competitor can deliver its product to the same store. By keeping the price constant at the shelf, the buyer can realize an additional $0.25 per case profit. Similarly, a manufacturer’s logistics service level will have an impact on the retailer’s revenues. For example, the same manufacturer in the previous example has an in-stock rate at the buyer’s store of 98 percent, compared to 90 percent for the competition. This higher in-stock service level allows the buyer to realize higher revenues from the higher product availability. So, transaction cost and revenue highlight the need to emphasize the impacts of logistics cost and service on supply chain profits and revenues.

Let’s look again at the final category shown in Figure 5.7—channel satisfaction, which essentially looks at how logistics cost and service are perceived by channel members. The research in this area is limited. Most of the focus on measurement has been on the perceptions of supply chain members of how well suppliers are performing on logistics cost and service. Leading-edge organizations are beginning to identify the impact of cus- tomer satisfaction on revenues and market share.

Overall, much progress has been made during the last few years toward developing appropriate metrics and using them proactively to measure performance in terms of their impact upon the financial results of the organization and its customers. However, as this discussion has highlighted, there is much more to be accomplished. The next sec- tion will introduce the supply chain–finance connection, a topic that will reappear throughout the remainder of this book.

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The Supply Chain–Finance Connection As noted in the Supply Chain Profile at the beginning of this chapter, CLGN Book

Distributors.com is focusing its attention on the supply chain process as a means to improve its financial performance. CLGN recognizes the impact supply chain performance has on customer satisfaction and future sales. In addition, the effectiveness of the supply chain process impacts the cost of fulfilling customer orders and transporting these orders to the customer, both of which impact the overall landed cost of the product.

More specifically, the supply chain process influences the flow of products from the supplier to the final point of consumption. The resources utilized to accomplish this flow process determine, in part, the cost of making the product available to the con- sumer at the consumer’s location. This landed cost, then, affects the buyer’s decision to purchase a seller’s product.

The cost of providing logistics service not only affects the marketability of the product (via the landed cost, or price), but it also impacts profitability. For a given price, level of sales, and level of service, the higher the logistics cost the lower the organization’s profit. Conversely, the lower the logistics costs, the higher the profits.

The decision to alter the supply chain process is essentially an optimization issue. Management must view the supply chain alternatives as to their ability to optimize the corporate goal of profit maximization. Some alternatives might minimize costs but reduce revenue, and possibly, profits. By implementing supply chain alternatives that optimize profits, the decision maker is taking the systems approach and trading off reve- nue and costs for optimum profit.

Supply chain management involves the control of raw material, in-process, and finished goods inventories. The financing implication of inventory management is the amount of capital required to fund the inventory. In many organizations, capital is in short supply but is required to fund critical projects, such as new plants or new ware- houses. The higher the inventory level, the more capital is constrained and the less capi- tal is available for other investments.

The recent focus on inventory minimization is a direct response to the competing needs for capital and the difficulty some organizations have in raising additional capital. Logistics techniques such as just-in-time and vendor-managed inventories are directed toward reduc- ing an organization’s inventory levels and making more capital available for other projects.

As indicated previously, the level of logistics service provided has a direct impact on customer satisfaction. Providing consistent and short lead times helps manage supply chain inventories and can build customer satisfaction and loyalty. However, the cost of providing this service must also be examined for its impact on a firm’s profit and revenue.

Finally, efficiency of the supply chain impacts the time required to process a custo- mer’s order. Order processing time has a direct bearing on an organization’s order- to-cash cycle—all of the activities that occur from the time an order is received by a seller until the seller receives payment for the shipment. Typically, the invoice is sent to the customer after the order is shipped. If the terms of sale are net 30 days, the seller will receive payment in 30 days plus the time needed to process the order. The longer the order-to-cash cycle, the longer it takes for the seller to get its payment. The longer the order-to-cash cycle, the higher the accounts receivable and the higher the investment in “sold” finished goods. So the length of the order-to-cash cycle directly relates to the amount of capital tied up and not available for other investments.

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On the Line Profit-Focused Supply Chain Planning

Accenture research has shown that enterprise-wide perspectives are critical to the attainment of supply chain mastery, and one of the best examples is a supply chain leader’s ability to under- stand and influence decisions involving corporate revenue, margins, and profitability.

At most companies, however, supply chain decision making remains a unit- and volume-focused exercise. Revenue, margins, and profitability issues are acknowledged, but usually after the fact, once an execution-level decision has been made. Consider a product shortage or allocation issue involving two customers. Standard sales and operations planning (S&OP) approaches treat the problem as an inventory-allocation decision rather than concurrently examining the financial and logistical implications. The larger customer would likely gain the upper hand because it contributes more to the manufacturer’s revenue—regardless of whether that customer contri- butes more from a margin perspective.

Excess or constrained capacity is another common challenge. Standard S&OP processes rarely incorporate profitability implications into manufacturing decisions like making cost/benefit trade- offs for overtime or examining the financial impact of expedited freight. A third scenario may involve product lead times that vary due to multiple sourcing locations or transportation modes. With traditional S&OP, lead times tend to be analyzed only when physical changes are made.

THE BOTTOM LINE There is no one recipe for blending revenue, margin, and profit considerations into a company’s S&OP planning process. To drive the transformation, however, most organizations will need to modify their operating models (restructuring teams, individual roles, and responsibilities), enhance their analytical capabilities, train resources in financial modeling concepts, and estab- lish new metrics for individual and organizational performance.

Deeper and more integrated demand and supply planning efforts will also be critical. On the demand side, that could mean aggregating forecasts by family groupings, incorporating more macroeconomic factors, and reworking pricing and promotional strategies. On the supply side, more attention would likely be given to recognizing supply constraints and opportunities, balanc- ing and reassigning production across the network, and adjusting capacity based on newly formed pricing and promotional strategies.

Another reasonable certainty is the new approach’s potential to benefit industries ranging from consumer goods and high-tech, to media, mining, and oil and gas. After all, most companies and industries share a desire to understand and raise their bottom lines. Taking a more profit- oriented approach to S&OP planning can complement these goals by helping to

• Integrate unit/volume planning with financial/profitability planning; • Shape demand by considering production, inventory, and distribution strategies across

customers with varying demand characteristics and service-level requirements; • Factor capacity and inventory constraints into decisions about promotional strate-

gies and optimal price points;

• Leverage scenario-based modeling to clarify operational and financial perspectives; • Improve product life cycle decisions and asset/product utilization; and • Continuously assess and refine profit/volume tradeoffs across products, channels,

and geographies.

The Revenue–Cost Savings Connection Throughout this text, attention is given to supply chain efficiency and cost reduction.

While process efficiency and cost savings are worthy goals, top management generally refers to corporate improvements in terms of increases in revenue and profit. The apparent conflict between the goals of top management and supply chain management can be readily resolved by converting cost savings into equivalent revenue increases. To improve communications effectiveness with top management, it behooves the supply chain manager to relate efficien- cies and cost savings in a language that top management uses—that is, revenue and profit.

Logistics and supply chain managers find it advantageous to transform cost reductions into equivalent revenue increases to explain to top management the effects of improved supply chain cost performance. To accomplish this, the following equations can be used:

Profit Revenue Costs

where

Cost X% Revenue

then

Profit Revenue X% Revenue Revenue 1 X%

where

1 X% Profit margin

Sales Profit Profit Margin

Assuming that everything else remains unchanged, a logistics cost saving will directly increase pretax profits by the amount of the cost saving. If a logistics cost saving increases profit by the same amount, the revenue equivalent of this cost saving is found by dividing the cost saving by the profit margin, as shown in the preceding equations. For example, if cost is 90 percent of revenue and the profit margin is 10 percent of reve- nue, a $100 cost saving is equivalent to additional revenue of $1,000:

Revenue Cost Saving or Profit Profit Margin

Revenue $100 0 10

Revenue $1,000

Table 5.1 provides examples of equivalent revenue for different logistics cost savings using the data found in the Supply Chain Profile for CLGN at the beginning of this chapter. As shown in the table, CLGN has a profit margin of 7 percent. Given this profit margin, a $200,000 logistics cost saving has the same effect as increasing revenue by

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The most skillful supply chain decisions are usually those that extend from the design room to the storeroom to the boardroom and back—with a consistent emphasis on the bottom line. A profit-oriented approach to S&OP planning can help make that happen.

Source: Adapted from Mark Pearson, “Profit-focused Supply Chain Planning,” Logistics Management (April 2010): 24–25. Reprinted by permission.

$2,857,143, a 1.9 percent increase in revenue. Likewise, a $500,000 and $1 million logis- tics cost savings have equivalent revenue equal to $7,142,857 (4.76 percent revenue increase) and $14,285,714 (9.52 percent revenue increase), respectively.

The lower the profit margin, the higher the revenue equivalent for a given logistics cost because it takes a greater revenue volume to produce a given profit. Table 5.2 shows the equivalent revenue of a given logistics cost saving with varying profit margins. For a $10,000 logistics cost saving, the equivalent revenue equals $1 million for an organization with a 1 percent profit margin but only $50,000 for an organization with a 20 percent profit margin. Logistics cost savings have a much greater revenue impact for organizations with low profit margins.

In the following section, the financial implications of supply chain strategies are dis- cussed. Following that section, statements contained in the Supply Chain Profile for CLGN Book Distributors.com are analyzed.

The Supply Chain Financial Impact A major financial objective for any organization is to produce a satisfactory return for

stockholders. This requires the generation of sufficient profit in relation to the size of the stockholders’ investment to ensure that inventors will maintain confidence in the organi- zation’s ability to manage its investments. Low returns over time will see investors seek alternative uses for their capital. High returns over time, however, will buoy investor confidence to maintain their investments with the organization.

Table 5.1 Sales Equivalent of Supply Chain Cost Savings

CLGN 2010 SALES EQUIVALENT FOR COST SAVINGS OF

(000) Percentage $200,000 $500,000 $1,000,000

Sales $150,000 100.0 $2,857,143* $7,142,857** $14,285,714

Total cost 139,500 93.0 2,657,143 6,642,857 13,285,714

Net profit 10,500 7.0 200,000 500,000 1,000,000

*$200,000 cost saving ÷ 0.07 profit margin

**$500,000 cost saving ÷ 0.07 profit margin

$1,000,000 cost saving ÷ 0.07 profit margin Source: Edward J. Bardi, Ph.D. Used with permission.

Table 5.2 Equivalent Sales with Varying Profit Margins

PROFIT MARGINS

20% 10% 5% 1%

Sales $50,000 $100,000 $200,000 $1,000,000

Total cost 40,000 90,000 190,000 990,000

Cost saving/profit 10,000 10,000 10,000 10,000

Source: Edward J. Bardi, Ph.D. Used with permission.

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The absolute size of the profit must be considered in relation to the stockholders’ net investment, or net worth. For example, if Company A makes a profit of $1 million and Company B makes a profit of $100 million, it would appear that Company B would be a better investment. However, if A has a net worth of $10 million and B $10 billion, the return on net worth for a stockholder in Company A is 10 percent ($1 million/$10 million) and for Company B it is 1 percent ($100 million/$10 billion).

An organization’s financial performance is also judged by the profit it generates in relationship to the assets utilized, or return on assets (ROA). An organization’s return on assets is a financial performance metric that is used as a benchmark to compare management and organization performance to that of other organizations in the same industry or similar industries. As with return on net worth, return on assets is dependent on the level of profits for the organization.

The supply chain plays a critical role in determining the level of profitability in an organization. The more efficient and productive the supply chain, the greater the profit potential of the organization. Conversely, the less efficient and less productive, the higher the supply chain costs and the lower the profitability.

Figure 5.9 shows the financial relationship between supply chain management and return on assets. The effectiveness of supply chain service impacts the level of revenue, and the efficiency affects the organization’s total costs. As noted earlier, revenue minus cost equals profit, a major component in determining ROA.

The level of inventory owned by an organization in its supply chain determines the assets, or capital, devoted to inventory. The order-to-cash cycle affects the time required to receive payment from a sale, thereby impacting the accounts receivable and cash

Figure 5.9 Supply Chain Impact on Return on Assets

Revenue

Costs

Profit

Capital employed

Return on assets

Inventory

Accounts receivable

Cash

Fixed assets

Supply chain effectiveness

Supply chain efficiency

Asset deployment and utilization

Source: Robert A. Novack, Ph.D. Used with permission.

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assets. Finally, the supply chain decisions regarding the type and number of warehouses utilized impacts fixed assets.

Lastly, Figure 5.9 shows that the calculation of ROA is the division of the profit realized by the capital (assets) employed (profit/capital employed). As noted earlier, the higher the profits for a given level of assets (capital) utilized, the higher the ROA.

Another way to examine the impact of supply chain services and costs can be seen in Figure 5.10. As shown in this figure, cash and receivables for an organization are influenced by supply chain time (order cycle time/order-to-cash), supply chain reliability (order completion rate and on-time delivery), and information accuracy (invoice accuracy). All of these supply chain services will determine when the customer begins processing the shipment delivery for payment. Inventory investment for an organization is influenced by required service levels and stock out rates for the organization. Property, plant, and equipment investment is impacted by decisions regarding private warehouses and transportation fleets. Decisions regarding the outsourcing activities such as ware- housing and transportation will influence current liability levels (accounts payable). Finally, decisions regarding financing for inventories and infrastructure will determine debt and equity levels.

Figure 5.11 summarizes the supply chain strategic areas affecting return on assets. The decisions made by the supply chain manager with regard to channel structure, inventory management, order management, and transportation management all have an effect on the level of assets employed or the level of profitability the organization will realize.

Channel structure management includes decisions regarding the use of outsourcing, channel inventories, information systems, and channel structure. By outsourcing supply chain activities, the organization might realize lower supply chain costs (outsourcing firms possess greater functional expertise and efficiencies), a reduction in assets (use of an outsourcing firm’s facilities), and increased revenue (from improved supply chain ser- vice). Decisions that lower supply chain assets and/or improve revenue through supply chain service improvements result in a higher ROA.

Figure 5.10 Supply Chain Impacts on the Balance Sheet

Cash

Receivables

Inventories

Current liabilities

Debt

Equity

Outsourcing policies

Financing options for inventory, warehouses, and equipment

Property, plant, and equipment

Service levels/stockout rates

Distribution facilities Transportation equipment

A S S E T S

Order cycle time/order to cash Order completion rate Invoice accuracy On-time delivery

Source: Robert A. Novack, Ph.D. Used with permission.

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Minimization of channel inventories results in a direct reduction in an organization’s assets. The use of improved information systems enables the organization to better monitor inventory levels, production schedules, and demand forecasts to meet current levels of demand. Streamlining the channel structure through the elimination of unnecessary channel intermediaries—for example, dealing directly with the retailer and bypassing the wholesaler—might eliminate inventory from the channel, as well as reduce the channel cost of transportation and warehousing. The reduction in inventory results in a direct increase in ROA.

Inventory management decisions that reduce inventory (safety stock, obsolete and/or excess stock) and optimize inventory location (in relation to sales or use patterns) reduce the investment in inventory. These decisions require analysis of sales data and inventory levels by channel location, which is readily available with current information systems.

Effective order management not only reduces supply chain costs but also supports increased revenue, the combined effect resulting in a higher ROA. Reducing stockouts implies that sufficient inventories are available to meet demand. Optimizing the order fill rate implies a reduction in the order-to-cash cycle, which reduces the accounts receivable collection time. Reductions in the order processing times, coupled with a reduction in the length of the credit period extended to customers, reduce accounts payable and the cost of capital required to fund accounts payable. All of these reductions in time improve the ROA.

Finally, reducing transportation transit time and the variability of transit time will have a positive impact on revenues as well as on inventory levels. By providing short, consistent transit time, a seller can differentiate its product in the market by lowering the buyer’s inventories and stockout costs. This product differentiation should produce increased revenues and a potential for increased profits. Modal optimization affords the

Figure 5.11 Supply Chain Decisions and ROA

Channel structure management Inventory management

Order management Transportation management

ROA increased

Use of outsourcing

Minimize channel inventories

Improve information

Efficient channel structure

Minimize safety stock

Optimize availability

Improve information

Eliminate obsolete excess items

Reduce stockouts

Optimize order fill rate

Reengineer order-to-cash cycle

Improve information

Improve on-time delivery

Improve information

Optimize mode mix

Reduce transit time variability

Source: R. A. Novack, Center for Supply Chain Research, Penn State University (2010).

Supply Chain Performance Measurement and Financial Analysis 157

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opportunity to lower transportation cost by utilizing a lower-cost method of transporta- tion that does not increase other costs above the transportation cost savings. Transporta- tion management decisions, then, offer the opportunity to increase revenues and lower inventories and costs, resulting in a higher ROA.

Financial Statements Let’s now turn our attention to two very important financial statements: the income

statement and the balance sheet. The data contained in the Supply Chain Profile for CLGN Book Distributors.com will be used in this section. Figure 5.12 presents the CLGN income statement, and Figure 5.13 shows the balance sheet for CLGN. Both financial statements have been prepared using a spreadsheet software program, and the symbol column indicates the symbol and/or equation used for each of the entries.

CLGN’s income statement shows a net income (NI) of $10.5 million on sales (S) of $150 million, a profit margin of 7 percent. Gross margin (GM) is found by subtracting cost of goods sold (CGS) from sales (S). Earnings before interest and taxes (EBIT) are gross margin minus total operating cost (TOC). Net income (NI) is EBIT minus interest cost (INT) and taxes (TX). The supply chain costs include transportation (TC), ware- housing (WC), and inventory carrying cost (IC). Inventory carrying cost is equal to aver- age inventory (IN) times the inventory carrying cost rate (W).

The balance sheet in Figure 5.13 indicates CLGN utilized total assets (TA) of $145 million to generate $150 million in sales. Total assets (TA) consist of $15 million of cash (CA), $30 million of accounts receivable (AR), $10 million of inventory (IN), and $90 million of net fixed assets (FA). These assets were financed by debt (liabilities)

Figure 5.12 CLGN Book Distributors.com Income Statement: 2010

SYMBOL (000) (000)

Sales S $150,000

Cost of goods sold CGS 80,000

Gross margin GM = S − CGS $ 70,000

Transportation TC $6,000

Warehousing WC 1,500

Inventory carrying IC = IN × W 3,000

Other operating cost OOC 30,000

Total operating cost TOC = TC + WC + IC + OOC 40,500

Earnings before interest and taxes

EBIT = GM − TOC $ 29,500

Interest INT 12,000

Taxes TX = (EBIT − INT ) × 0.4 7,000

Net income NI $ 10,500

Source: Edward J. Bardi, Ph.D. Used with permission.

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and stockholders’ equity; that is, the $100 million of total debt (TD), consisting of $65 million of current liabilities (CL) and $35 million of long-term debt (LTD), plus $45 million of stockholders’ equity (SE), paid for these assets.

Figure 5.13 CLGN Book Distributors.com Balance Sheet: December 31, 2010

SYMBOL (000)

Assets

Cash CA $ 15,000

Accounts receivable AR 30,000

Inventory IN 10,000

Total current assets TCA = CA + AR + IN $ 55,000

Net fixed assets FA 90,000

Total assets TA = FA + TCA $145,000

Liabilities

Current liabilities CL $ 65,000

Long-term debt LTD 35,000

Total liabilities TD = CL + LTD $100,000

Stockholders’ equity SE 45,000

Total liabilities and equity TLE = TD + SE $145,000

Source: Edward J. Bardi, Ph.D. Used with permission.

Supply Chain Performance Measurement and Financial Analysis 159

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On the Line Leased Assets to Go Back on Your Books?

The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are collaborating to develop a new model for recognizing assets and liabilities under lease contracts. The proposed new standard is expected to affect the balance sheets of all companies that lease equipment.

Under the existing standard, a company must classify and account for leases as operating or capital leases, depending on whether the lease transfers all or substantially all of the risks and rewards incident to ownership. The capitalization model would require companies to initially account for every lease contract’s rights as assets and obligations as measured by the present value of the expected lease payments.

It would also require that the subsequent accounting for all leases, regardless of their substance, be accounted and presented in the balance sheet, income statement, and cash flow statement. Ralph Petta, vice president of research and industry services for the Equipment Leasing and Finance Association (ELFA), says this could change the benefits of leasing for some businesses. “Instead of taking operating lease treatment, where another party owns the asset and puts the

Financial Impact of Supply Chain Decisions Based on the financial data given in Figures 5.12 and 5.13, an analysis can be under-

taken to determine the impacts of alternative supply chain actions available to Lauren Fishbay to improve CLGN’s profitability. The basic supply chain alternatives are reduc- tions in the areas of transportation, warehousing, and inventory costs. To determine the supply chain area that affords the largest financial impact and then the focus of initial profit improvement efforts, an analysis is undertaken of the effect of a 10 percent reduc- tion in transportation and warehousing costs and a 10 percent reduction in inventory.

Figure 5.14 shows the financial impact of a 10 percent reduction in transportation costs. First, for 2010, CLGN had a net income of $10.5 million on sales of $150 million, or a profit margin of 7.0 percent. CLGN utilized $145 million in assets to produce this profit, thereby generating a return on assets of 7.24 percent. The inventory turn rate for 2010 was 8.0, transportation costs were 4.0 percent of sales, warehousing costs were 1.0 percent of sales, and inventory carrying costs were 2.0 percent of sales.

If CLGN can reduce transportation costs by 10 percent, net income will increase $360,000 to $10,860,000, and the profit margin will increase to 7.24 percent. ROA will increase from 7.24 percent to 7.49 percent. Transportation costs as a percent of sales will decrease from 4.0 percent to 3.6 percent. Warehousing and inventory carrying costs as a percent of sales will not change (assuming the transportation changes do not result in lon- ger or undependable transit times that would cause inventory levels to increase).

Figures 5.15 and 5.16 show the results of a similar analysis of a 10 percent reduction in warehousing costs and a 10 percent reduction in inventory. In each case, the compar- ison is made to the 2010 CLGN performance; that is, transportation cost and inventory are computed at the 2010 level when the 10 percent warehouse cost reduction is ana- lyzed. As would be expected, the reduction in warehousing cost and inventory results in increases in profits, profit margin, and ROA.

The analyses contained in Figures 5.14 to 5.16 provide the input data necessary to answer the question regarding which of the basic supply chain alternatives will provide the greatest potential for increased profitability. Figure 5.17 contains a comparison of the financial results of the alternative supply chain strategies just examined.

From Figure 5.17, it is evident that CLGN’s profit margin will be increased the greatest amount by utilizing a supply chain alternative that reduces transportation costs. This is to be expected, because transportation cost is a larger percentage of sales than the other two supply chain functional areas: 4.00 percent of sales versus 1.0 percent and

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asset on its books, and the lessee just pays a monthly expense, the lessee would have to recog- nize those assets on their balance sheet,” he explains.

ELFA President Kenneth E. Bentsen, Jr. explains his concern: “If the proposed changes do not reflect an appropriate balancing of costs and benefits, they could result in an unwarranted increase in cost of capital to U.S. companies that utilize leasing as a means of capital formation through the acquisition and investment in capital plant and equipment or real estate.”

All leases will likely be affected as soon as the standard is effective, but the boards have not yet discussed the method of transition or effective date.

Source: Logistics Management (August 2009): 64. Reproduced by permission.

2.0 percent for warehousing and inventory, respectively. If the cost to CLGN to realize a 10 percent reduction in these functional areas is the same, it is prudent for Lauren Fishbay to dedicate her resources and efforts to realizing a reduction in transportation costs.

The largest increase in ROA was generated by the transportation alternative. However, the inventory reduction alternative increased ROA by almost the same

Figure 5.14 Financial Impact of a 10 Percent Reduction in Transportation Cost

SYMBOL CLGN, 2010 $(000) TRANSPORTATION COST REDUCED 10 PERCENT

Sales S $150,000 $150,000

Cost of goods sold CGS 80,000 80,000

Gross margin GM = S − CGS $ 70,000 $ 70,000

Transportation TC $ 6,000 $ 5,400

Warehousing WC 1,500 1,500

Inventory carrying IC = IN × W 3,000 3,000

Other operating cost OOC 30,000 30,000

Total operating cost TOC $ 40,500 $ 39,900

Earnings before interest and taxes EBIT $ 29,500 $ 30,100

Interest INT $ 12,000 $ 12,000

Taxes TX 7,000 7,240

Net income NI $ 10,500 $ 10,860

Asset Deployment

Inventory IN $ 10,000 $ 10,000

Accounts receivable AR 30,000 30,000

Cash CA 15,000 15,000

Fixed assets FA 90,000 90,000

Total assets TA $145,000 $145,000

Ratio Analysis

Profit margin NI/S 7.00% 7.24%

Return on assets NI/TA 7.24% 7.49%

Inventory turns/year CGS/IN 8.00 8.00

Transportation as percentage of sales TC/S 4.00% 3.60%

Warehousing as percentage of sales WC/S 1.00% 1.00%

Inventory carrying as percentage of sales IC/S 2.00% 2.00%

Source: Edward J. Bardi, Ph.D. Used with permission.

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amount: 7.49 percent versus 7.42 percent. The financial benefit of an inventory reduction is two-fold: (1) a reduction in the inventory carrying cost and (2) a reduction in assets. Annual inventory turns are increased with the inventory reduction strategy, requiring CLGN to utilize less capital for inventory and making more capital available for other uses in the organization. Thus, an inventory reduction strategy has a double effect on ROA by increasing profits and reducing assets deployed.

Figure 5.15 Financial Impact of a 10 Percent Reduction in Warehousing Costs

SYMBOL CLGN, 2010 $(000) WAREHOUSING COST REDUCED 10 PERCENT

Sales S $150,000 $150,000

Cost of goods sold CGS 80,000 80,000

Gross margin GM = S − CGS $ 70,000 $ 70,000

Transportation TC $ 6,000 $ 6,000

Warehousing WC 1,500 1,350

Inventory carrying IC = IN × W 3,000 3,000

Other operating cost OOC 30,000 30,000

Total operating cost TOC $ 40,500 $ 40,350

Earnings before interest and taxes EBIT $ 29,500 $ 29,650

Interest INT $ 12,000 $ 12,000

Taxes TX 7,000 7,060

Net income NI $ 10,500 $ 10,590

Asset Deployment

Inventory IN $ 10,000 $ 10,000

Accounts receivable AR 30,000 30,000

Cash CA 15,000 15,000

Fixed assets FA 90,000 90,000

Total assets TA $145,000 $145,000

Ratio Analysis

Profit margin NI/S 7.00% 7.06%

Return on assets NI/TA 7.24% 7.30%

Inventory turns/year CGS/IN 8.00 8.00

Transportation as percentage of sales TC/S 4.00% 4.00%

Warehousing as percentage of sales WC/S 1.00% 0.90%

Inventory carrying as percentage of sales IC/S 2.00% 2.00%

Source: Edward J. Bardi, Ph.D. Used with permission.

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Another methodology that can perform the same financial analysis is the strategic profit model (SPM), which makes the same calculations that were made in the spread- sheet analysis. Figure 5.18 contains the SPM for CLGN for 2010 operations and the 10 percent transportation cost reduction.

The SPM shows the same results as those calculated in Figure 5.14. Two ratios were added to the SPM: (1) asset turnover, which is the ratio of sales to total assets and

Figure 5.16 Financial Impact of a 10 Percent Reduction in Inventory

SYMBOL CLGN, 2010 $(000) AVERAGE INVENTORY REDUCED BY 10 PERCENT

Sales S $150,000 $150,000

Cost of goods sold CGS 80,000 80,000

Gross margin GM = S − CGS $ 70,000 $ 70,000

Transportation TC $ 6,000 $ 6,000

Warehousing WC 1,500 1,500

Inventory carrying IC = IN × W 3,000 2,700

Other operating cost OOC 30,000 30,000

Total operating cost TOC $ 40,500 $ 40,200

Earnings before interest and taxes EBIT $ 29,500 $ 29,800

Interest INT $ 12,000 $ 12,000

Taxes TX 7,000 7,120

Net income NI $ 10,500 $ 10,680

Asset Deployment

Inventory IN $ 10,000 $ 9,000

Accounts receivable AR 30,000 30,000

Cash CA 15,000 15,000

Fixed assets FA 90,000 90,000

Total assets TA $145,000 $144,000

Ratio Analysis

Profit margin NI/S 7.00% 7.12%

Return on assets NI/TA 7.24% 7.42%

Inventory turns/year CGS/IN 8.00 8.89

Transportation as percentage of sales TC/S 4.00% 4.00%

Warehousing as percentage of sales WC/S 1.00% 1.00%

Inventory carrying as percentage of sales IC/S 2.00% 1.80%

Source: Edward J. Bardi, Ph.D. Used with permission.

Supply Chain Performance Measurement and Financial Analysis 163

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indicates how the organization is utilizing its assets in relation to sales, and (2) return on equity, which indicates the return the stockholders are realizing on their equity in the organization. Asset turnover was 103 percent for both scenarios, but return on equity increased from 23.33 percent ($10,500/$45,000) for the CLGN 2010 scenario to 24.13 percent ($10,860/$45,000) with the reduced transportation cost scenario.

The preceding analysis and its conclusion examine only the returns from the alterna- tive actions. The risks associated with each must also be considered. The conclusions that cannot be made from the preceding analysis are those regarding the risks associated with the added cost necessary to realize the functional cost reductions, the additional capital required to achieve the reduction, and the service implications accompanying the changes. For example, to accomplish the transportation cost reduction, CLGN might have to revert to a mode of transportation that is slower. This could have a negative impact on customer satisfaction and result in lower sales. Or, the warehouse cost reduction might require the expenditure of $500,000 for automated materials handling equipment that increases the assets deployed and reduces the ROA.

The issues above can be added to the financial analysis presented. For example, the added cost associated with reengineering the warehouse or any additional investment in fixed warehouse assets such as facilities or equipment can be added to the financial analysis along with the resulting warehouse cost savings.

Given the financial analysis and the preceding caveats, CLGN has a better insight into the supply chain areas that will result in the greatest improvement in profitability and the accompanying risks (costs). The next section addresses the financial implications of CLGN’s supply chain service failures.

Supply Chain Service Financial Implications As noted in the Supply Chain Profile, CLGN Book Distributors.com has experienced

service failures in the areas of on-time deliveries and order fill rates. The 95 percent on-time delivery rate means that only 95 percent of CLGN orders are delivered when promised (on-time delivery). Also, only 97 percent of the orders are filled correctly. The alternative view of this service is that 5 percent of the orders are delivered after the promised delivery date and 3 percent of the orders are filled incorrectly.

Figure 5.17 Comparison of Supply Chain Alternatives

RATIO ANALYSIS CLGN, 2010 $(000)

TRANSPORTATION COST REDUCED 10 PERCENT

WAREHOUSING COST REDUCED 10 PERCENT

INVENTORY REDUCED 10 PERCENT

Profit margin 7.00% 7.24% 7.06% 7.12%

Return on assets 7.24% 7.49% 7.30% 7.42%

Inventory turns/year 8.00 8.00 8.00 8.89

Transportation as percentage of sales 4.00% 3.60% 4.00% 4.00%

Warehousing as percentage of sales 1.00% 1.00% 0.90% 1.00%

Inventory carrying as percentage of sales 2.00% 2.00% 2.00% 1.80%

Source: Edward J. Bardi, Ph.D. Used with permission.

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Supply Chain Performance Measurement and Financial Analysis 165

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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

The results of these supply chain service failures are added to the cost to correct the problem and lost sales. Figure 5.19 shows the methodology for determining the cost of service failures. When supply chain service failures occur, a portion of the customers experiencing the service failure will request that the orders be corrected and the others will refuse the orders. The refused orders represent lost sales revenue (refused orders times revenue per order) that must be deducted from total sales. For the rectified orders, the customers might request an invoice deduction to compensate them for any inconvenience or added costs. Finally, the seller incurs a rehandling cost associated with correcting the order such as reshipping the correct items and returning the incorrect and refused items (rectified orders plus refused orders times rehandling cost per order).

Referring to the data provided in the Supply Chain Profile for CLGN’s on-time delivery and order fill rates, you will see that the financial impact of improving these two supply chain service metrics is given in Figures 5.20 and 5.21. Assume that there are 1.5 million orders for the year, the average revenue per order is $100, and the cost of goods per order is $53.33. Also, the lost sales rate for on-time delivery failure is 10 percent; for order fill failures, it is 20 percent. The rehandling charge is $20 per rectified and refused order, and the invoice deduction is $10 per rectified order. The costs and assets are those pro- vided in the Supply Chain Profile and used in the previous section. This pertinent infor- mation is contained within the boxed area of the spreadsheets in Figures 5.20 and 5.21.

Note that the upper portion of the spreadsheet analysis in Figure 5.20 determines the number of service failure orders, lost sales orders, rectified orders, and net orders sold. (The symbols provided in the second column will assist you in creating the spreadsheet analysis.) At the 95 percent on-time delivery rate, 1,425,000 are delivered

Figure 5.19 Supply Chain Service Failure

Annual orders

Correctly filled orders

Service failure orders

Refused orders

Revenue per order

Lost sales revenue

Rectified orders

Invoice deduction per order

Invoice deduction from sales

Total orders rehandled

Rehandling cost per order

Rehandling cost

Source: Edward J. Bardi, Ph.D. Used with permission.

166 Chapter 5

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Supply Chain Performance Measurement and Financial Analysis 167

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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

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168 Chapter 5

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on time (0.95 × 1,500,000 total orders) and 75,000 orders are delivered late (service fail- ures). Of the 75,000 late orders, the customers will decline 7,500 (10%) and CLGN will lose sales on these orders, or $750,000 ($100 revenue per order × 7,500 lost orders). The rehandling cost is $1,500,000 ($20 per order × 75,000 orders [rectified plus refused]), and invoice deduction is $675,000 ($10 per order × 67,500 orders).

In this example, the 1 percent improvement in on-time delivery (from 95% to 96%) results in net income falling by $56,997. The improved on-time delivery reduces invoice deductions by $135,000 and rehandling cost by $300,000, or a total cost saving of $535,000. However, to realize this cost saving of $535,000, a transportation cost increase of 10 percent or $600,000 is necessary. Since the net income is reduced by $56,997 with the proposed strategy to switch to second-day ground delivery service, CLGN will prob- ably not consider this on-time delivery improvement option.

Figure 5.21 shows that the $100,000 cost to provide training to the warehouse person- nel will improve the order fill rate from 97 percent to 98 percent and result in an increase in net income of $276,006. The combined savings of $420,000 (rehandling cost saving of $300,000 and invoice deductions saving of $120,000) are greater than the additional training cost of $100,000.

Given the two options—improve on-time delivery or order fill rate—CLGN would be advised to implement the order fill improvement strategy.

The SPM for these two alternatives is given in Figures 5.22 and 5.23. The profit margin, ROA, and return on stockholders’ equity are greater with the order fill rate improvement strategy than with the on-time delivery improvement strategy. For the order fill rate improvement from 97 percent to 98 percent, the ROE increases to 33.71 percent from 33.10 percent, the profit margin increases to 10.17 percent from 10.01 percent, and the ROA increases to 10.46 percent from 10.27 percent.

The financial goal for supply chain management is to increase return to stockholders. Examining alternative courses of action in light of the bottom-line impact (net income) and resultant ROE accomplishes this goal.

Supply Chain Performance Measurement and Financial Analysis 169

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170 Chapter 5

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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

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Supply Chain Performance Measurement and Financial Analysis 171

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SUMMARY • Performance measurement for logistics systems and, especially, for supply chains is

necessary but challenging because of their complexity and scope.

• Certain objectives should be incorporated into good metrics—be quantitative, be easy to understand, involve employee input, and have economies of effort.

• Important guidelines for metric development for logistics and supply chains include consistency with corporate strategy, focus on customer needs, careful selection and prioritization of metrics, focus on processes, use of a balanced approach, and use of technology to improve measurement effectiveness.

• There are four principal categories for performance metrics: time, quality, cost, and miscellaneous or support. Another classification for logistics and supply chains suggests the following categories for metrics: operations cost, service, revenue or value, and channel satisfaction.

• The equivalent sales increase for supply chain cost saving is found by dividing the cost saving by the organization’s profit margin.

• Supply chain management impacts ROA via decisions regarding channel structure management, inventory management, order management, and transportation management.

• Alternative supply chain decisions should be made in light of the financial implications to net income, ROA, and ROE.

• The SPM shows the relationship of sales, costs, assets, and equity; it can trace the financial impact of a change in any one of these financial elements.

• Supply chain service failures result in lost sales and rehandling costs. The financial impact of modifications to supply chain service can be analyzed using the SPM.

STUDY QUESTIONS 1. “Performance measurement for logistics managers is relatively recent. Their focus

was previously directed toward other managerial activities.” Do you agree or disagree with these statements? Explain your position.

2. What role should employees, in general, play in the development of performance- metrics? Why is this role important?

3. “Metrics must focus upon customer needs and expectations.” Explain the meaning of this statement. Why have customers become more important for performance measurement? What role, if any, should customers play in developing supply chain metrics?

4. It is generally recognized that organizations go through several phases on the path to developing appropriate supply chain metrics. Discuss the stages of supply develop- ment for supply chain metrics. Choose which of the stages of evolution you think would be most challenging for an organization. Explain your choice.

5. Using a spreadsheet computer software program, construct a supply chain finance model and calculate the profit margin; ROA; inventory turns; and transportation, warehousing, and inventory costs as a percentage of revenue for the following:

Sales $200,000,000

Transportation cost $12,000,000

Warehousing cost $3,000,000

172 Chapter 5

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Inventory carrying cost 30%

Cost of goods sold $90,000,000

Other operating costs $50,000,000

Average inventory $10,000,000

Accounts receivable $30,000,000

Cash $15,000,000

Net fixed assets $90,000,000

Interest $10,000,000

Taxes 40% of EBIT Interest

Current liabilities $65,000,000

Long-term liabilities $35,000,000

Stockholders’ equity $45,000,000

6. Using the supply chain finance model developed for Study Question 5, calculate the impact on profit margin; ROA; inventory turns; and transportation, warehousing, and inventory costs as a percentage of revenue for the following scenarios:

Scenario A

Transportation costs increase 20%

Warehousing costs decrease 5%

Average inventory decrease 10%

Scenario B

Warehousing is outsourced with the following:

Net fixed assets reduced 20%

Inventory reduced 15%

Warehousing costs $0

Transportation costs reduced 5%

Outsourcing provider costs $2,500,000

7. Develop a strategic model to depict the scenarios given in Questions 5 and 6.

8. Construct a financial model to determine the redelivery/rehandling cost, lost sales, invoice deduction cost, and net income for the following:

a. On-time delivery increases from 90 percent to 95 percent, with a 5 percent increase in transportation cost.

b. Order fill rate decreases from 96 percent to 92 percent with inventory reduced by 5 percent.

Selling price order $150 order

Gross margin order $35 order

Supply Chain Performance Measurement and Financial Analysis 173

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Lost sales rate is as follows:

On-time delivery failure 15%

Order fill failure 20%

Annual orders 200,000

Rehandling cost $125 order

Invoice deduction service failure $150 order

Transportation cost $1,000,000

Average inventory $1,000,000

Interest cost $1,500,000

Inventory carrying cost rate 25% $ yr

Warehousing cost $750,000

Other operating cost $500,000

Cash $3,000,000

Accounts receivable $4,000,000

Fixed assets $30,000,000

Tax rate 40%

NOTES 1. Thomas S. Davis, Center for Supply Chain Research, Penn State University (2010).

2. Robert A. Novack and Thomas S. Davis, “Developing a Supply Chain Performance Metrics Program” (unpublished manu- script, Center for Supply Chain Research, Penn State University, 2007).

3. Ibid.

4. Ibid.

5. Ibid.

6. Ibid.

7. Ibid.

8. Robert A. Novack and Douglas J. Thomas, “The Challenges of Implementing the Perfect Order Concept,” Transportation Journal, Vol. 43, No. 1 (Winter 2004): 5–16.

9. Supply Chain Council, SCOR Model Version 9.0 (2008): 1.2.6.

174 Chapter 5

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CASE 5 .1

CPDW Harry Groves, CEO of Central PA Distribution and Warehouse (CPDW), had just

called to order the monthly meeting of the board of directors of CPDW. Harry looked tired and grim, thought Joe Zimmerman (a local entrepreneur and board member). Har- ry’s opening statement gave the reason for his body language. CPDW had another dis- mal month that was delineated in the monthly financial statements and Harry’s description of monthly activities.

Company Background

CPDW is located in Milroy, Pennsylvania, adjacent to an interchange on a major east- west roadway in central Pennsylvania. The company was founded five years ago by a group of individuals who owned local businesses or held management positions in local companies. The board members were all limited partners in the venture so they had a very special interest in the financial viability of the organization.

The partners, under the leadership of Harry Groves, had purchased a building(120,000 square feet) and parcel of land (32.6 acres) from the Sanyo Corporation. The building had been used primarily as a manufacturing facility by Sanyo. The partners purchased the build- ing with the express purpose of utilizing it as a distribution facility for providing logistics ser- vices for companies within central Pennsylvania. While the building was not ideal for storage because of the ceiling height, the partners believed that it was versatile enough to be used for various logistics activities including repackaging,order fulfillment, reverse logistics, etc.

The paradox of the situation was that the facility was completely filled with pallet- loads of glass from a local glass manufacturer. In fact, the original estimate on usable storage space, excluding aisles, offices, restrooms, etc., was 99,500 square feet. However, Jon Parton, COO of the company, had pushed and squeezed until they were utilizing 110,000 square feet.

Board Meeting

After reviewing the usage rate, Jay Lenard asked Harry for some additional insight into their situation. He prefaced his question with the comment, “I thought that we wanted to fill the facility and in doing so, we would be profitable. When I look at square foot utiliza- tion, which I thought was our best performance metric, I’m pleased, but you are telling us that this is a problem. I just don’t understand our financial situation based on this metric.”

Harry let out a sigh and said, “Jay, I really wish it was that easy. I have come to realize that our base metric for pricing square feet of space utilized is too narrow. With our current situa- tion, even though we are using more square feet than I thought we had available, thanks to Jon, we are not breaking even. When the building is full and nothing is moving in or out, we are in trouble. We need to change our metrics and align them with a new pricing strategy.”

CASE QUESTIONS 1. Describe the nature of CPDW’s problem.

2. What metrics would you recommend that CPDW use to enhance its pricing strategy? Provide a rationale for your recommendations.

Source: Edward J. Bardi, Ph.D. Used with permission.

Supply Chain Performance Measurement and Financial Analysis 175

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CASE 5 .2

Paper2Go.com Colleen Starky never thought she would be able to sell paper products to consumers

on the Internet. However, after five years in business Paper2Go.com has reached $75 million in revenue. Paper2Go specializes in shipping paper-related products to con- sumers, including diapers, paper towels, and facial tissue from numerous suppliers. Because these items have a low margin, Colleen knows she needs to control costs and at the same time have high service levels.

Paper2Go receives 500,000 orders annually with an average revenue per order of $150 and an average profit per order of $90. Paper2Go’s current order fill rate is 92 percent. Colleen estimates that of the orders not filled correctly or completely, 15 percent of the customers cancel their orders and 85 percent will accept a reshipment of the correct/unfilled items. This rehandling costs Paper2Go $15 per order and is only applicable on the reshipped orders. In an effort to retain customers, Paper2Go reduces the invoice value of rehandled orders by $30.

Paper2Go pays $2,500,000 for transportation, both inbound to and outbound from its warehouses. Its warehousing costs are $1,950,000 annually. Paper2Go has $40 million of debt at an annual interest rate of 12 percent. Other operating costs are $1 million per year and Paper2Go maintains $100,000 in cash at all times.

Paper2Go has an average inventory of $6.7 million. This level of inventory is neces- sary to help fill consumer orders correctly the first time. The inventory carrying cost rate is 30 percent of the average inventory value per year. Its accounts receivable averages $350,000 per year. Paper2Go owns three warehouses that are valued in total at $85.7 million. The net worth of Paper2Go is $45 million.

Colleen has decided that a 92 percent order fill rate is not acceptable in the market and lost customers and rehandled orders are negatively affecting profits. She has decided to invest $1 million in a new stock locater system for the warehouses, increase invento- ries by 10 percent, and increase the on-time delivery of inbound shipments by contract- ing with a new carrier. This carrier upgrade will increase total transportation costs by 10 percent. Colleen hopes these changes will increase the order fill rate to 98 percent. Paper2Go faces a current tax rate of 35%.

CASE QUESTIONS 1. You are the logistics analyst at Paper2Go.com and have been asked to do the

following:

a. Calculate the financial impact of increasing order fill rates to 98 percent from 92 percent.

b. Develop a strategic profit model of both the old system and the modified system that reflects the suggested adjustments.

Source: Robert A. Novack, Ph.D. Used with permission.

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APPENDIX 5A

Financial Terms Account receivable A current asset showing the amount of sales currently owed by a customer.

Balance sheet A snapshot of everything the company owes and owns at the end of the financial year in question.

Cash cycle The time between payment of inventory and collection of cash from receivables.

Cash flow statement A summary showing the cash receipts and payments from all com- pany financial activities; earnings before interest, taxes, depreciation, and amortization (EBITDA).

Cost of goods sold The total cost of the goods sold to customers during the period.

Cost of lost sales The short-run forgone profit associated with a stockout.

Current assets Cash and other assets that will be converted into cash during one operating cycle.

Current liabilities An obligation that must be paid during the normal operating cycle, usually one year.

Current ratio Current assets divided by current liabilities; measures company’s ability to pay short-term debt with assets easily converted to cash.

Debt-to-equity ratio Long-term debt divided by shareholders’ equity.

Earnings before interest and taxes (EBIT) Sales minus cost of goods sold and operating costs.

Earnings per share Net earnings divided by average number of shares outstanding.

Gross margin Sales minus cost of goods sold.

Income statement A summary of revenues and expenses, reporting the net income or loss for a specific accounting period.

Inventory carrying cost The annual cost of holding inventory; the value of the average inventory times the inventory carrying cost rate (W).

Inventory carrying cost rate (W) The cost of holding $1 of inventory for one year, usually expressed as a percentage; includes cost of capital, risk, item servicing, and storage space.

Inventory turns Cost of goods sold divided by average inventory.

Liquidity ratio Cash flow from operations divided by current liabilities; measures short- term cash available to pay current liabilities.

Net income (or loss) Final result of all revenue and expense items for a period; sales minus cost of goods sold, operating costs, interest, and taxes.

Operating expense All expenses other than cost of goods sold, depreciation, interest, and income tax.

Operating ratio Percentage of revenues used for operations; operating expenses divided by operating income.

Order-to-cash cycle The time between receiving customer orders and the collection of receivables.

Supply Chain Performance Measurement and Financial Analysis 177

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Profit margin Net income divided by sales.

Return on assets Net income divided by total assets.

Return on equity Net income divided by average stockholders’ equity.

Shareholders’ equity The difference between the value of all the things owned by the company and the value of all the things owed by the company; the investment made by the stockholders at the time the stock was originally issued plus all past earnings that have not been paid out in dividends; sum total of shareholders’ investment in a company since it was formed, minus its liabilities.

Working capital Current assets minus current liabilities; working capital finances the business by converting goods and services to cash.

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Chapter 6

SUPPLY CHAIN TECHNOLOGY—MANAGING INFORMATION FLOWS

Learning Objectives After reading this chapter, you should be able to do the following: • Appreciate the overall importance of information to supply chain management.

• Understand the role of information technology in the supply chain.

• Explain the key components of an integrated supply chain information system.

• Describe and differentiate between the primary types of supply chain solutions and their capabilities.

• Discuss the critical issues in technology selection and implementation processes.

• Recognize the role of emerging technologies and considerations for improving supply chain information management.

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Supply Chain Profile The Precision Imperative

Supply chain management was a fairly simple proposition when Walmart’s U.S. business was expanding rapidly. There wasn’t much room to worry about anything other than keeping the pipe- line full, with the need for product created by growing consumer demand and the annual open- ings of new distribution centers and hundreds of large stores. Fuel prices were stable and reasonable, sustainability considerations weren’t prevalent, and assortment planning and demand forecasts were less sophisticated.

The situation is dramatically different today. The pace of store expansion has slowed, along with consumer demand, and stores no longer are loaded to the rafters with back stock, thanks to cor- porate directives aimed at limiting inventory growth to half the rate of sales growth. Increased efficiency has eliminated the need to expand distribution capacity. Advance systems, combined with a greater understanding of the myriad financial benefits that stem from reduced inventory, have given rise to a new era of supply chain management where tolerances are tighter and the accuracy of information is imperative.

Not that supply chain considerations haven’t long been at the forefront of decision making at Walmart. The company’s business model is rooted in concepts of efficient distribution, an area where former, current, and future leaders all spent a considerable portion of their careers. Former president and CEO Lee Scott ran logistics for most of his career before quickly ascending the ranks of senior management to president and CEO. When he retired in late 2008, his successor Mike Duke was also someone who spent most of his time at Walmart in the logistics area. Rollin Ford, another longtime logistics executive, became the company’s chief information officer four years ago.

Supply chain sensibilities run deep at Walmart, and given senior leadership’s understanding of the intricacies of inventory control, it is not surprising that the company is embarking on a new supply chain journey where information accuracy, tighter tolerances, and increased efficiency are being enabled by technology and increased business intelligence.

According to Ford, “a lot of companies will get the technology in front of the business processes. The key is getting the process right and then enabling it with the right technology. That creates the environment for innovation.”

Ford offered some insight on the subject of innovation: “Unless the business embraces it and it makes sense for the customer, you can innovate until the cows come home and it is like pushing a noodle. You just can’t do it,” he said.

While good innovation gets copied very quickly, Ford said Walmart tends to work backward from the customer—to develop appropriate business strategies and then leverage technology to exe- cute the business objectives. “A lot of times companies get that reversed,” he said.

Combine a focus on the customer with powerful systems and a senior leadership team with a deep supply chain understanding, and the result is an organization where suppliers can expect to be subject to heightened expectations. This is evident with Walmart’s Supply Chain Reliability initiative, announced in October 2009. Details were disclosed to the supplier community in a let- ter cosigned by Walmart and Sam’s Club chief merchandising officers John Fleming and Linda Hefner. While the program is positioned as an effort to help the company operate at the lowest possible cost and provide the best possible service, the thing that jumped out at suppliers is a new 3 percent fee levied on the value of goods that do not arrive on time.

“Walmart and Sam’s Club incur additional costs for inventory carrying costs, warehousing, store and club labor, and shrink for shipments arriving early, and lost sales on short shipments and shipments arriving late,” Fleming and Hefner explained in the letter.

Introduction Knowledge is essential for supply chain success. Information, along with materials

and money, must readily flow across the supply chain to enable the planning, execution, and evaluation of key functions. For example, timely, accurate information regarding the demand for Apple iPhones is needed by retailers to plan inventory requirements and order additional products. In turn, retailer order information can be used by Apple to acquire needed components from suppliers and by contract manufacturers to assemble additional iPhones. If each organization in the supply chain had to operate without this information, it would be very difficult to maintain a proper flow of the right quantities of the right components and models. A shortage of hot sellers and overage of unwanted models could result from such poor information flows.

Fortunately, supply chain information technologies can provide timely, cost-efficient sharing of information between suppliers, manufacturers, intermediaries, logistics ser- vices providers, and customers. The key, as highlighted by the Supply Chain Profile, is to align technology with supply chain processes and information requirements. As many organizations have learned, there is danger in adopting tools without a specific plan for their implementation.

Recognizing the potential of information technology, organizations have invested vast sums of money to collect, analyze, and make more effective use of supply chain informa- tion. Though sales faltered during a difficult recessionary period (2007–2009), the supply chain industry is seeing a resurgence of buying activity in software.1 Gartner estimates that enterprise software sales will rise by 7.5 percent in 2011. That follows a 6.1 percent growth rate in 2010.2

As supply chains become more global, complex, and demand-driven, information technologies must evolve. Staying ahead of the evolutionary curve requires companies to continually pursue the next level of supply chain performance and adopt relevant information technologies. “Supply chain organizations are under intense pressure to meet demands for greater customer intimacy, lower cost of goods sold, and increased global business processes,” says Beth Enslow, senior vice president of research for Aberdeen Group. “To succeed, these organizations are identifying that they need to change their supply chain technology footprints.”3

This chapter focuses on the role of information and technology in the supply chain. It is intended to introduce key information issues and tools that will be addressed in further detail throughout the book. We have divided the chapter into five sections

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Walmart indicated that it will provide visibility via a new weekly scorecard and a monthly report on Retail Link, but there still will be a need for suppliers to analyze the information to refute or validate any potential charges. Beyond that, suppliers with chronic issues will need to get their arms around the source of their “must arrive by date” noncompliance issues and take remedial action before charges accumulate.

The Supply Chain Reliability initiative would not be possible if it weren’t for sophisticated busi- ness intelligence tools and measurement strategies that are dependent on accurate information.

Source: Mike Troy, “The Precision Imperative,” Connecting Northwest Arkansas (February/March 2010): 8–12. Adapted with permission.

that address the following topics: (1) the role of information in the supply chain, (2) a supply chain information system framework, (3) software solutions, (4) technology selection, and (5) emerging information tools. As you will learn, effective technology for the management of information flows is vital for synchronizing supply chain pro- cesses that span companies and countries, meet customer requirements, and create responsive supply chains.

The Role of Information in the Supply Chain It has been said that information is the lifeline of business, driving effective decisions

and actions. It is especially critical to supply chain managers because their direct line of sight to supply chain processes is very limited. Information provides them with insights and visibility into the supply chain activities taking place at distant supplier and cus- tomer locations. This visibility of demand, customer orders, delivery status, inventory stock levels, and production schedules provides managers with the knowledge needed to make effective situational assessments and develop appropriate responses. In contrast, limited awareness of external activity would leave the supply chain manager blind to the true situation and unable to make knowledge-driven decisions. Actions would be based on educated guesses with no guarantee of effective outcomes.

A wide variety of information is needed for a supply chain to perform as anticipated. As you read through this book, it will become evident just how important information is for both long-range and day-to-day decision making. Supply chain professionals require information from across the channel for strategic planning issues such as network design, tactical planning and collaboration with supply chain partners, and execution of key processes. This information must effectively flow within the organization and between key participants, as outlined in Figure 6.1, to ensure the timely flow and control of materials and money in the supply chain.

Figure 6.1 Supply Chain Information Flows

Carriers & 3PLs

LogisticsProduction

Suppliers Customers

MarketingFinance

Governmental & Financial Institutions

Source: Brian J. Gibson, Ph.D. Used with permission.

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Information Requirements Information quality is a critical characteristic of the knowledge flowing across the supply

chain. If you think about it, the seven Rs definition of logistics applies to information as much as products with some slight alterations—getting the right information to the right partners, in the right quantity, in the right format, at the right place, at the right time, and at the right cost. Change any “right” to “wrong” and the capabilities of the decision maker will decline. Thus, information quality is paramount to effective management of the supply chain.

To ensure that valuable, actionable knowledge readily flows across the supply chain, information must be accessible, relevant, accurate, timely, and transferable.

Accessible Information must be available to supply chain managers who have a legitimate need

for it, regardless of their location or employer. For example, Whirlpool supply chain managers need access to daily sales information at Lowe’s stores to schedule delivery and installation of appliances. Obtaining needed information can be difficult because supply chain data often are dispersed among multiple locations on different information systems that are owned by external organizations. Technical issues must be addressed and trust built between the organizations sharing information.

Relevant Supply chain managers must have pertinent information to make decisions. They

must know what information is needed and be able to quickly acquire only that which is applicable to their current situation. The goal is to avoid being overwhelmed by extra- neous data that are not useful to decision makers and waste their time. When a Honda expeditor logs on to the FedEx Web site to track a critical delivery, he doesn’t need to know about every Honda shipment handled by FedEx that day. He wants to quickly assess the status of the one shipment in question and react accordingly.

Accurate The information must be correct and depict reality; otherwise, it will be difficult to

make appropriate decisions. Information inaccuracies can lead to inventory shortages, transportation delays, governmental penalties, and dissatisfied customers. For example, major retailers rely upon their checkout clerks to accurately scan each item sold because these scans drive the replenishment system. If a clerk scans one bottle of soda four times when a customer actually purchases four different flavors, the store-level inventory loses accuracy and eventually the wrong product will be replenished.

Timely The information must be up to date and available in a reasonable time frame. As sup-

ply chain managers attempt to synchronize activities, become leaner, and address pro- blems before they become crises, they need the knowledge embedded in real-time data. Envision that a computer hardware manufacturer is experiencing quality problems and must postpone shipments of 500-gigabyte hard drives. If informed in a timely fashion, Dell could update its Web site so that customers could not configure computers with that model. The result would be no backlog of orders or unhappy customers.

Transferable The final characteristic of information has multiple meanings. Just as we need translators

to convert words from one language to another, supply chain managers need the ability to transfer supply chain data from one format to another to make it understandable and useful.

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Information also needs to be transferred quickly from one location to another to facilitate accessibility and timeliness. A paper-based supply chain cannot support these requirements or a demand-driven supply chain. Hence, information must reside in electronic formats that can be readily transmitted and converted via supply chain information technology.

Information Technology Capabilities The value and importance of supply chain information technology is not lost on sup-

ply chain leaders. Study after study of executives reveals that organizations are putting more emphasis on information technology to help them become more competitive, inno- vative, and adaptive. Their efforts are not only well intended, but they also have a posi- tive influence on supply chain performance. Research by Premus and Sanders found that information technology has a direct and positive impact on organizational performance, internal collaboration, and external collaboration.4

In their research of trends and issues in supply chain management, Capgemini, Georgia Southern University, University of Tennessee, and JDA Software Group have identified five drivers of sustainable supply chain management practice: (1) optimization, (2) synchronization, (3) adaptability, (4) velocity, and (5) profitability.5 Table 6.1 high- lights the drivers along with the relevant roles of information technology.

Table 6.1 Drivers of Sustainable Supply Chain Practice

DRIVER DEFINITION ROLE OF TECHNOLOGY

Optimization The alignment of global supply chain resources—both tangible and intangible, own or outsourced—to facilitate the success of supply chain members.

A variety of software is available to help maximize supply chain performance. Optimization tools analyze all possible options to find the best solution to a supply chain problem, such as finding the most cost-efficient delivery routes within a set of delivery requirement constraints.

Synchronization The ability to coordinate, organize and manage end-to-end supply chain flows—products, services, information, and financials—in such a way that the supply chain functions as a single entity.

Technology facilitates real-time data availability and sharing between supply chain partners. The information provides common insight and facilitates collaborative decision making by the partners.

Adaptability The degree to which respective supply chain members can change practices, processes and/or structures of systems and networks in response to unexpected events, their effects or impacts.

Supply chain tools generate actionable information by collecting vast amounts of data regarding demand, inventory flows, and orders; filtering the data; and presenting it in a form that can be readily used. That is, technology tools allow users to quickly adjust to changes in the supply chain.

Velocity The speed at which end-to-end flows occur in the supply chain. It encompasses speed- to-market for new product introduction and execution when conditions are rapidly changing.

Properly implemented technologies help organizations rapidly respond to customer requirements for faster, more consistent flows of materials and information. Event management tools have the capability to address problems dynamically, provide recommendations, and automatically resolve the issue.

Profitability The result of creating value through supply chain activities. Asset performance, working capital, returns on investment for infrastructure, technology, and people are some of the critical parts that create value in a global environment.

Technology tools help organizations manage inventory, transportation, and other key supply chain functions more effectively than could be accomplished manually. The outcomes are greater control of costs and enhanced customer service that generate stronger profits.

Source: Brian J. Gibson, Ph.D. Used with permission.

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In previous editions of the study, the group identified six drivers of supply chain excellence: connectivity, visibility, collaboration, optimization, execution, and speed.6

These issues continue to be of critical importance to organizational success, and supply chain technology plays a facilitating role in achieving each one.

Information Technology Challenges As the previous section indicates, information technology holds great promise for

enhancing supply chain performance and organizational competitiveness. However, the implementation of new technologies and software does not guarantee success. Technol- ogy is only an enabler. Many organizations have spent lavishly on supply chain technol- ogies only to achieve limited results. Too often, organizations view information technology as the solution to specific problems rather than as a facilitating tool in the quest for supply chain excellence and sustainability. The problem is that technology can- not make ill-conceived supply chains productive, prompt adversarial organizations to collaborate, or make use of poor quality data (as discussed earlier). In the next few para- graphs, we will discuss some of the major barriers and challenges that must be addressed to make supply chain technology work as intended.

A study by Computer Sciences Corporation (CSC) reveals that people are a major barrier to the effective use of information technology. Half of the study’s interviewees blame a lack of understanding as the primary issue. Most often, the business executives are to blame as their expectations of technology capabilities tend to be too high. That is, they purchase technology based on the hype and promised benefits without real knowledge regarding how it would impact their business. Information technology executives also shoulder some of the blame as they do not always understand the busi- ness processes for which technology is being purchased. Not knowing the key needs and requirements of the business unit can lead to poor technology selection and ineffi- cient implementation.7

The CSC study points to another technology use challenge that has been widely reported. Often, organizations do not change their supply chain processes concurrent with the adoption of new information technology tools. They automate existing activ- ities that may well be outdated rather than improve processes or streamline the supply chain network to take full advantage of the technology’s capabilities. While incremen- tal productivity improvements are made, the failure to address process issues and root-cause problems will limit the impact of the technology and reduce the return on investment.

Another challenge facing supply chain professionals is the wide variety of software solutions that are promoted as being “supply chain” tools. Often, these software solutions support the automation of individual activities to ensure optimal efficiency but are inad- equate for managing supply chain processes across multiple organizations.8 Also, supply chain technology may be implemented in piecemeal fashion, leading to a “patchwork quilt” of technologies. Both issues can result in the creation of dysfunctional information systems that do not seamlessly share information or foster demand-responsive capabilities.

Poor planning and preparation for technology implementation is also problematic. Some organizations do not take the time to create a change management plan with a staged, logical approach to adopting new technologies. This can cause supply chain disrup- tions and problems. Other organizations fail to prepare employees for the new technology. Limited training may lead to suboptimal use of technology as employees do not

Supply Chain Technology—Managing Information Flows 185

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understand the full array of software features and capabilities. Finally, some organizations do not establish adequate budgets for technology installation and implementation.

The good news is that these challenges are not insurmountable if the organization views technology implementation as a business improvement project rather than an information technology project. Supply chain leaders must take an active role in the planning, implementation, and evaluation of the new tools. They would do well to follow these 10 golden rules for success compiled by Favilla and Fearne.

1. Secure the commitment of senior management.

2. Remember that it is not just an information technology project.

3. Align the project with business goals.

4. Understand the software capabilities.

5. Select partners carefully.

6. Follow a proven implementation methodology.

7. Take a step-by-step approach for incremental value gains.

8. Be prepared to change business processes.

9. Keep end users informed and involved.

10. Measure success with key performance indicators (KPIs).9

A Framework for Managing Supply Chain Information10 The term supply chain information system (SCIS) is widely used, although few for-

mal definitions exist. One such attempt describes SCIS as “information systems that automate the flow of information between a firm and its suppliers to optimize the plan- ning, sourcing, manufacturing, and delivery of products and services.”11 While the defi- nition provides a general idea of the needed links between key supply chain functions, additional issues must be addressed. SCIS should also have the capacity to collect and synchronize data, manage exceptions, and help streamline key processes, among other capabilities.

These additional issues are effectively encapsulated in a model created by Capgemini to link the traditional functional areas of the supply chain to promote visibility of actionable information and enhanced decision making. This model for achieving excel- lence in SCM is depicted in Figure 6.2. Although it is not specifically a conceptual model of SCIS, it does identify key capabilities of a well-integrated technology plat- form. Thus, it will serve as our framework for the effective management of supply chain information.

Foundation Elements The ability to capture and manage supply chain information depends upon a strong,

well-integrated foundation of people, processes, and technology. All three elements must be considered in the development of SCIS or problems will occur, as highlighted in our discussion of technology use barriers.

People ultimately determine the success or failure of SCIS. Today, technological capabilities are not usually the problem when it comes to improving supply chain visibil- ity and performance. The sheer computing power and speed of information transfer capabilities available today adequately meet the needs of most supply chains. The

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problem more commonly lies with the competence of the people involved with the tech- nology. Individuals making information technology selection decisions must have rea- sonable expectations regarding the technology being considered and access to team members with operational expertise in its functionality. The people tasked with imple- menting and integrating technology need the requisite skills, as well as adequate staff and financial resources to complete the work. Finally, the day-to-day technology users must be properly trained in the appropriate, accurate use of the tools.

Process management also plays a role in SCIS performance. Organizations should review existing methods in light of the new technology adoption. The risk of not doing this is that inefficient, outdated, or unnecessary processes will be automated, providing little benefit to the organization. Supply chain professionals and their technology coun- terparts must also determine how the SCIS tools can be used to enhance internal proce- dures and streamline information flows to supply chain partners. Standard operating procedures and goals regarding supply chain productivity, accuracy, timeliness, and cost also must be established for technology-enhanced processes. Without them, it would be impossible to ensure that processes are being performed correctly across the supply chain or generating the desired outcomes.

Technologies used in SCIS have the greatest impact when they are based on the open systems concept and take advantage of the Internet. Software applications that are based on well-defined, widely used, nonproprietary open standards require minimal changes to interoperate with other SCIS tools and interact with users in a style that facilitates porta- bility (i.e., is easy to transfer). Interoperability can be achieved through enhanced, stan- dardized Web links and simplified protocols that allow different systems to work together in a unified manner. Data transfer becomes seamless, and there is a reduced need for data manipulation by each organization.

The Internet provides the platform for supply chain activities to be carried out in a synchronized, instantaneous manner to maximum performance. Just as we leverage the

Figure 6.2 Master Model of Supply Chain Excellence

Open Systems

D at

a C ol

le ct

io n

(e .g

. R FI

D )

D at

a S yn

ch ro

ni za

tio n

Sk ill

s

People

Process

Technology

M et

ho ds

W eb

-b as

ed

Standards Resources

Metrics and Dashboard

Agents-Automated Decision Making

Exception Management

Visibility

Planning & Execution Infrastructure

Organization’s Skills & Functional Expertise

Source: Peter Moore, Karl Manrodt, and Mary Holcomb, Collaboration: Enabling Synchronized Supply Chains, Year 2005 Report on Trends and Issues in Logistics and Transportation (New York, NY: Capgemini, 2005): 21.

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speed and efficiency of the Web to place orders, track shipments, and communicate, organizations are dramatically increasing their use of the Internet to manage their supply chain strategies and processes. Information can be shared among collaborating companies quickly and at low cost using Internet tools as an alternative to or as the platform for electronic data interchange (EDI). Supply chain activities such as procure- ment can be conducted via the Web, and process performance can be monitored. Organizations can even access supply chain software over the Internet as a cost- saving alternative to purchasing, installing, and maintaining it on their own networks. These are just a few examples of the ways that Internet-enhanced SCIS promote efficient, responsive supply chains.

Key Requirements By themselves, software and other SCIS components cannot provide actionable

knowledge for supply chain managers. Data must be collected and synchronized so that it can be used by skilled individuals in the planning and execution of supply chain pro- cesses. Scorecards and dashboards are also needed to monitor performance and make necessary adjustments. With these requirements satisfied, managers are able to take full advantage of SCIS data analysis and decision support capabilities. They are also properly positioned to pursue supply chain excellence.

Data collection of relevant information is needed at every point in the supply chain. Whether it is captured via barcodes, radio-frequency identification, or other technology, the information must be relevant, accurate, and accessible to users in real time. A lack of timely information leads to dysfunctional decisions that spread across the supply chain.

Data synchronization focuses on the timely and accurate updating of item informa- tion within and across enterprises to ensure dependable, consistent product information within a company’s systems and between business partners. It is critical for every orga- nization in the supply chain to have standardized, complete, accurate, and consistently aligned data in their SCIS to perform at peak effectiveness. It is impossible for supply chain partners to effectively collaborate, utilize automatic identification, or leverage demand-driven replenishment techniques if the product, price, or invoice data being transferred are inaccurate. Thus, organizations must clean and align data internally before sharing it with partners.

Furthermore, processes have to be in place to maintain high-data quality. This requirement has both technology and organizational structure implications. First, the organization must be willing to make data management processes a priority. Second, there must be strong business ownership of product data and aligned SCIS that enables access to timely, accurate data. Those who succeed will achieve inventory and logistics cost reductions, as well as fewer out-of-stock situations.

Functional expertise in each organization will be enhanced by access to the synchro- nized data. Managers must be able to leverage information from the SCIS to support plan- ning and decision making across all supply chain operations—procurement, production, delivery, and returns. For example, timely point-of-sale (POS) data are needed to initiate the replenishment cycle in a retail supply chain. This sales information is used to build store orders, initiate order preparation at the distribution center, alert the buyer to pur- chase additional units, and signal the manufacturer to make additional units.

Metrics, as discussed in Chapter 5, help organizations articulate their impact on the supply chain. Just as a baseball manager reviews the standings, statistics, and box scores

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to assess the team’s strengths and weaknesses, so do supply chain managers need score- cards and dashboards to help them evaluate performance and make necessary adjust- ments when things aren’t going as planned. These metrics must be defined and understood by all parties, measure service issues that are critical to the customer, and provide actionable information. Given the importance of time, accuracy, and cost in the supply chain, valuable metrics include order cycle time, proportion of perfect orders, and cash-to-cash cycle time.

Differentiating Capabilities To state that all SCIS are not created equal may be the greatest understatement of fact

in this textbook. While leveraging technology for more adaptive capabilities is a widely desired goal, the process of transforming the organization and its SCIS is a complex, multilayered effort. After the foundation has been built and the key requirements attained, supply chain partners must integrate processes and achieve SCIS connectivity to support cross-chain visibility, event management, and automated decision making.

The planning and execution infrastructure consists of the software tools that are uti- lized to provide supply chain speed, optimization, and connectivity. In the past, the infrastructure was largely comprised of narrowly focused functional applications that tar- geted automation and efficiency. The focus has shifted to applications that promote pro- cess effectiveness and the creation of actionable information. Major categories of SCIS software applications are identified and explored in the next section of this chapter.

Visibility tools focus on providing a seamless flow of timely, important information across the supply chain. Accurate knowledge of what is occurring outside the organiza- tion via Web-enabled SCIS allows managers to monitor sourcing, transportation, and inventory data at the order and item level. As the supply chain becomes more transpar- ent, managerial vision and control extend beyond internal activities and facilities. This enhanced intelligence propels supply chain managers from a reactive to a predictive mode, which promotes proactive strategic planning, collaboration, and decision making. Ultimately, the objective is to have the right information available so that action can be taken when needed, not after the fact.

Exception management is the logical step beyond visibility. With this capability, SCIS can detect performance problems and alert the affected organizations. Immediate correc- tive action can be taken to resolve the situation before it impacts the supply chain. Then efforts can be made to eliminate the root cause of the problem. The ability to identify and correct problems with little delay promotes supply chain agility and enhances cus- tomer service.

Automated decision making is the pinnacle of differentiating capabilities but remains a future prospect for many SCIS. Software tools are rapidly being developed to recognize exception alerts, assess the problem, evaluate alternatives, and recommend solutions. In some cases, these supply chain event management tools will dynamically replan activities and take corrective action without human intervention, and then notify stakeholders that the exception has been resolved.

It is important to remember that the foundation, requirements, and capabilities must be developed in a logical, sequential fashion. Wilson provides the following recommen- dations for pursuing SCIS capabilities: “Before pursuing extended supply chain optimiza- tion, a company’s own system needs to be functioning properly. Implementation should be done in segments, company data needs to be accurate, objectives need to be clearly

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defined, recommendations need to be reliable, and personnel using the system must believe in the system and its results.”12

In addition, organizations cannot expect to quickly activate this world-class supply chain management framework or the supporting SCIS. Integrating systems, synchroniz- ing data, institutionalizing collaboration, and adopting the other drivers of supply chain excellence is a long-term proposition. Ongoing SCIS investment, effort, and upgrades are the keys to supporting supply chain excellence.

SCM Software One of the key components of a strong SCIS is the software that is used to manage

the supply chain. The supply chain software market includes technologies that address virtually every function and task that occurs in the supply chain. Whether you need to develop a sales and operations plan, analyze facility relocation options, or maintain visi- bility of inventory, there is software available to assist your efforts. These tools harness the computational power and communication abilities of today’s technology to help organizations plan, execute, and control supply chain activities in real time.

As you might expect, it takes a wide array of tools to accomplish these goals. Figure 6.3 provides an overview of the generally recognized supply chain solutions categories. We use a puzzle analogy to highlight the critical need for linkages and information sharing

Figure 6.3 Supply Chain Software Categories

Business Intelligence

Supply Chain Event Management

Supply Chain Planning

Supply Chain Execution

Source: Brian J. Gibson, Ph.D. Used with permission.

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between each software category. The more integrated the tools are in a SCIS, the better support they will provide for effective management of the supply chain—from planning to execution, event response, and performance evaluation. This discussion will focus on the general purpose and issues in each category while the details regarding specific soft- ware applications will be handled in upcoming chapters.

Planning Supply chain planning applications help organizations evaluate demand for materials,

capacity, and services so that effective fulfillment plans and schedules can be developed. These planning tools are employed across supply chain processes, assisting with deci- sions regarding the number and location of facilities (network design), where to purchase materials (strategic sourcing), when to build goods (production planning and schedul- ing), and how to deliver the goods (routing and scheduling), just to name a few tasks. This category encompasses a comprehensive set of software tools designed to help man- agers gain more accurate, detailed insight into issues that affect their development and planning of supply chain activities. Figure 6.4 reveals that planning tools are among the most widely deployed supply chain applications.

Figure 6.4 SCM Application Adoption Phase

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Supply chain visibility 22% 12% 29% 14% 17%

20% 14% 24% 20% 19%

18% 10% 25% 32% 13%

17% 11% 30% 19% 18%

17% 5% 16% 28% 29%

15% 11% 21% 29% 20%

15% 6% 22% 20% 26%

14% 10% 16% 16% 35%

13% 10% 12% 6% 51%

12% 5% 18% 19% 34%

10% 8% 17% 16% 34%

10% 9% 14% 19% 31%

9% 6% 24% 39% 21%

Supply chain analytics or supply chain performance management

Supply chain planning

Inventory optimization

Transportation management system (TMS)

Sales and operations planning

Network design

Reverse logistics or returns management

Radio frequency identification (RFID)

Labor management

Global trade compliance

Distributed order management

Warehouse management system (WMS)

Actively investigating Piloting Deployed partially Fully deployed Not doing anything currently

Source: Dan Gilmore, “Annual Gartner Supply Chain Study Highlights,” Supply Chain Digest, June 18, 2010. Retrieved from http://www.scdigest.com/ASSETS/FirstThoughts/10-06-18.php?cid=3537

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These tools address a range of longer-term planning horizons (weeks, months, or years) and important issues such as demand forecasting. Moving from manual, indepen- dent processes to software that leverages real-time data and enables collaboration across departments, suppliers, and customers has a positive effect on forecast speed and enhances accuracy. Shorter-range planning tools that support sales and operations, pro- duction, and distribution planning can leverage these accurate forecasts. Supply chain managers will ultimately be able to make better operational and tactical decisions, lead- ing to more efficient process execution, reduced waste and stockouts, and improved profitability.

Can better planning make that much of a difference? Absolutely, as indicated by the performance of SanDisk, a global leader in flash memory cards for mobile phones, digital cameras, and USB flash drives. To maintain its market leadership, SanDisk implemented an advanced planning solution that provides the company with the demand visibility necessary to improve forecasting and integrate planning with manufacturing. Forecast accuracy has improved by more than 25 percent, higher inventory turns have been achieved, and a lower cost structure has been established for SanDisk’s supply chain.13

Execution Supply chain execution tools carry out key tasks from the time an order is placed

until it is fulfilled. This order-driven category of software focuses on the day-to-day activities required to buy, make, and deliver the materials that flow through the supply chain. Traditionally, execution tools have focused on a company’s internal logistics activ- ities—order management, warehouse management, inventory management, labor optimi- zation, and transportation management. As attention shifts to integrated supply chain capabilities, the category is encompassing a broader array of functionality, including pro- curement and supplier relationship management, manufacturing execution and shop floor control, and customer relationship management.

Supply chain execution does not rely upon a single software program. Instead, it con- sists of a group of tightly integrated tools that link well with supply chain partners’ sys- tems to share relevant data and provide visibility. Interest and investment in execution tools is high because of the strong capabilities being developed, the costs being saved, and the return on investment being achieved. Successful implementation can provide users with improved inventory visibility, improved data accuracy, faster throughput and higher inventory turns, better control of transportation costs, and improved customer service.14 The tools also support supply chain planning, event management, and perfor- mance metrics.

Individually, we rely upon these supply chain execution tools to carry out order ful- fillment. When you want to purchase a digital camera from Photo-Op.com, you interact with its order management system via the Internet to prepare and transmit your request. This system checks the availability of inventory through its link to the warehouse man- agement system. If the inventory is available, your order is processed and transmitted to the warehouse management system, which schedules the picking and packing of your camera. When it is ready to be shipped, the transportation management system selects a carrier, optimizing delivery cost within your transit time requirement. You can also use the carrier’s transportation management system to monitor the delivery status of your order until it arrives at your front door. Without these execution capabilities, the order to delivery process could take weeks instead of days and you would have little vis- ibility into the process.

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A good example is provided by Welch’s, a company that produces and markets 400 perishable fruit-based products for distribution to more than 50 countries. The com- pany’s supply chain team must deal with expanding product lines, lot tracking require- ments, and customer demands. To address these challenges, Welch’s uses supply chain execution software and collects data using radio frequency devices to boost real-time information on receiving, shipping, manufacturing, and inventory. These tools trace orders within 24 hours, while providing Welch’s with over 99 percent visibility and over 99 percent inventory accuracy rates.15

Event Management Supply chain event management tools collect data in real time from multiple sources

across the supply chain and convert them into information that gives business managers a clear picture of how their supply chain is performing. These systems monitor the sup- ply chain for events that are out of tolerance, such as a shortage of parts at a manufacturing location or the breakdown of a truck delivering an important order. When exceptions occur, the system notifies a decision maker by e-mail, pager, or fax who can then take an action to correct the problem.

As the geographic scope and number of companies involved in a supply chain grow, the ability to monitor activities exceeds manual capabilities. Hence, supply chain event management tools are becoming more important, and more organizations are turning toward these solutions to help them detect, evaluate, and resolve issues before they snow- ball into major problems. Some systems have built-in work flow rules that suggest solu- tions to the exception or initiate action based on established guidelines. Although they were once considered stand-alone applications, event management and visibility solu- tions are today increasingly integrated into other applications.16

Event management tools have been adopted by Del Monte Foods, a premium quality branded food and pet products company. Although the company had a strong SCIS, there was a need to improve processes for alerting employees to existing or potential order fulfillment problems. The software chosen by Del Monte has the capability to help evaluate orders for a specific product on a specific day and determine which distri- bution center should be responsible for fulfilling the order and whether there is sufficient inventory. In situations where there is a product shortage, the event management soft- ware provides users with information about incoming re-supply or the availability of inventory at other locations.17

Business Intelligence Business intelligence tools build upon the traditional reports and output systems that

provided historical accounts of functional performance for internal planning, operations, and control. The newer capabilities are more dynamic, frequently delivering data from transactional systems across the supply chain to a data warehouse. The data can be ana- lyzed and fresh information sent to frontline employees and executives for more effective planning and decision making.

In addition to the data collection and analysis capabilities, business intelligence soft- ware supports self-service reporting, performance scorecarding versus goals, development of dashboards and other graphical report displays, and activity monitoring in support of event management. These tools can provide better access to data residing on multiple SCIS without the need for technology department involvement, improve knowledge of decision makers, and support collaboration across the supply chain.

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Interest in business intelligence applications is rising, due to the increasing user- friendliness of the tools. Previous generations of business intelligence software were geared toward trained analysts who had to define specific problems for the software to analyze. However, emerging capabilities make it easier to interpret data via simple dash- board items such as charts, graphs, and maps that are easier to understand than pages of data. Because these graphics are linked to the data warehouse, it is possible to manipulate them, review the effect of different variables on results, and test alternative scenarios, in addition to monitoring performance.18

One of Florida’s largest healthcare providers had already realized the benefits of busi- ness intelligence software for monitoring clinical data and generating physician scorecards. Confronted with mounting supply chain costs and reduced insurance reimbursements, the tool was used to analyze inefficiencies in their supply chain. A chief problem identified was too many suppliers of medical devices and significant pricing variation. Using this infor- mation, management engaged two high-volume vendors in discussions, offering them exclusive supplier status in exchange for additional discounts.19

Related Tools While the four categories of supply chain software cover much of the solutions spec-

trum, additional tools exist. Some fall in between the categories, while other software applications are not supply chain specific. Although difficult to categorize, they help improve the flow and usefulness of supply chain information, support the development and implementation of key strategies, and enhance analysis. These valuable tools include, but are not limited to, the following:

• Supply chain collaboration tools. The software related to these tools helps users integrate their information technology systems with those of trading partners to streamline and automate supply chain processes. These middleware tools provide interoperability between different SCIS to support collaboration initiatives. Leveraging Internet standards, these applications support collabora- tive planning, forecasting, and replenishment as well as vendor managed inventory and other strategic supply chain initiatives.

• Data synchronization applications. These tools provide a platform for manufac- turers, distributors, and retailers to aggregate and organize item-related data (item number, price, description, weight, etc.). Cleaning up the data so that they are con- sistent across multiple organizations is required for using RFID technology, streamlining and automating processes, and improving supply chain visibility.

• Spreadsheets and database software. You may be surprised to think of these commonly used applications as relevant to this discussion, but Excel has been coined “the most widely used supply chain software” only half jokingly by sup- ply chain professionals. Spreadsheet software provides managers with handy, portable tools for gathering, consolidating, and analyzing supply chain data. However, it is critical that the planning and analytical work done via these tools be linked to the SCIS so that information does not become fragmented and visibility lost.

Throughout this discussion of the supply chain software categories, we have discussed the supply chain applications individually. It is critical to note that they must work together to provide a holistic view of all relevant processes. The applications must also link effectively to supply chain partners and support the overall goals of visibility, responsiveness, and cross-enterprise agility.

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Enterprise Resource Planning Just as the boundaries between supply chain planning and execution tools are blur-

ring, it is becoming more difficult to completely segment SCIS from enterprise resource planning (ERP) systems. Many of the supply chain software applications discussed above are growing increasingly reliant upon the type of information that is stored inside ERP systems. Thus, it is important to briefly discuss ERP systems and their relationship to supply chain software tools.

ERP systems are multimodal application software platforms that help organizations manage the important parts of their businesses. Initially concentrated on manufacturing issues, ERP systems now focus on integrating information and activities across the orga- nization (i.e., the enterprise) via a common software platform and centralized database system. Key business processes linked via ERP include accounting and finance, planning, engineering, human resources, purchasing, production, inventory/ materials manage- ment, order processing, and more. The centralized and shared database system ties the entire organization together, allowing information to be entered once and made available to all users. Business processes can also be automated for rapid, accurate execution.

As the ERP systems branch out to include supplier relationship management, cus- tomer relationship management, and other supply chain components, the connections between SCIS and ERP grow stronger. Supply chain members can access the organiza- tion through the ERP system to assess inventory availability, production schedules, and delivery information. In short, the ERP system provides a mechanism for supply chain members to efficiently share information so that visibility is improved, transactions are completed with more speed and accuracy, and decision making is enhanced.20

C. R. Bard, a medical device manufacturer, uses a combination of ERP and supply chain execution systems to manage the production and distribution of its catheters and heart stents. A product requisition begins as a work order in the ERP system, which cre- ates a master record that is complete and readily accessible. The ERP system routes the product through various processes (assembly, packaging, and sterilization) at multiple facilities and signals the global distribution center that a delivery is on the way. The warehouse management system receives the signal and prepares for arrival. This system also receives customer orders through the ERP system, fills orders, prepares them for delivery, and updates the ERP system when the order is shipped. These linked tools pro- vide the company with real-time visibility of customer orders, improved fulfillment accu- racy and speed, and lot traceability.21

Supply Chain Technology Implementation As the preceding section indicates, a wide array of software tools support supply chain

planning, execution, and control. Companies spend billions of dollars on these technolo- gies with the goal of making their supply chains more productive and effective. However, spending does not guarantee success. Implementation headaches, systems integration complexities, and training requirements translate into significant spending (often twice the cost of the software) and time (frequently in excess of six months) to achieve soft- ware functionality. Thus, gaining a positive return on technology investments can be very challenging.

The key to overcoming these issues and harnessing the capabilities of supply chain technology within a reasonable time frame is informed decision making. Supply chain

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managers must not make rush decisions regarding technology selection. They must take the time to investigate a variety of technology-related issues and base decisions on the specific requirements of their supply chain. It is possible to achieve a 12 to 18 month return on investment only if an organization effectively assesses its specific needs, under- stands software application and delivery options, addresses the technical issues, and asks the right questions before making a purchase decision.

Needs Assessment The most important step in software selection and implementation is to understand

the supply chains that the technology is intended to support. Too often, supply chain managers undertake the software selection process in isolation and without knowledge of the processes to be automated. They may also attempt to use the technology to improve inadequate or outdated processes. Any of these situations will lead to the deployment of technologies that are poorly matched to the true needs of the supply chain; unable to link departments, suppliers, and customers; and/or too narrowly focused to support supply chain visibility and event management.

Organizations must start with a diagnosis of their situation. They should assess their supply chain process capabilities and benchmark them against the needs of their supply chain partners. If the current capabilities are deemed inadequate, improvements and innovations must be developed for relevant processes. Only then should technology be considered, based upon its ability to facilitate the planning and execution of these enhanced processes. Technology can also be used to improve adequate processes but only after deficiencies have been addressed.

This needs assessment sequence highlights the link between effective business pro- cesses, appropriate technology, and supply chain performance. Companies like Walmart, Dell, and Zara have generated a competitive advantage in their respective industries because they support innovative supply chain practices with technology. They properly view supply chain software as an enabler of process improvement rather than a “quick fix” solution. This ultimately leads to realistic expectations of the technology, more effec- tive implementation, and greater returns on supply chain software investments.

Software Selection Supply chain managers face a multifaceted decision when selecting supply chain soft-

ware. First, the manager must determine which type of software—planning, execution, event management, or business intelligence—is appropriate for the given process or situ- ation. Additionally, supply chain managers must compare the advantages of commercial software to in-house solutions, choose between single vendor suites and applications from multiple vendors, and consider licensing versus on-demand purchases, among other issues.

Development Alternatives The first issue involved in software selection focuses on who will develop the solution.

The choices are to develop the tools in-house for your organization only or to purchase software from an external vendor. Walmart and Amazon.com are two organizations that have largely depended upon their own information technology departments to build sup- ply chain applications. Some third-party logistics firms develop in-house solutions as well. While this requires significant resources and development time, all of the tools are

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tailored to their specific industries and supply chain processes. They are able to achieve a level of customization and flexibility that is not possible with off-the-shelf tools.

Most organizations, especially small to mid-size companies, are not able to build their own supply chain software. In reality, many supply chain managers struggle just to get supply chain technology on the priority list of the information technology department. Thus, they rely heavily on external software vendors to develop and implement the tools needed to plan and execute supply chain processes. These tools effectively support supply chains that are not overly unique or complex. Because they can be implemented faster than what could be accomplished in-house, are built with interoperability as a key focus, and have some ability to be tailored, the vendor-developed tools are the proper choice for most organizations.

Solutions Packages If an organization chooses to purchase software rather than develop it in-house, it

has to determine what types of applications are needed and how they should be pur- chased. At one extreme, organizations can purchase individual applications from lead- ing providers in each software category, commonly called “best-of-breed” solutions. At the other extreme, organizations can work with a single vendor’s software suite. Of course, they can also opt for the middle ground, purchasing the main applications from a single supply chain software suite vendor and adding tools from the best- of-breed specialists.

Historically, the best-of-breed option was used by most organizations. Supply chain software tools were purchased independently from different vendors and the organization’s information technology staff was assigned the challenge of integrating the various tools. Best-of-breed tools tend to offer powerful applications for specific functions. They provide great flexibility and can be tailored to an individual company’s supply chain issues. How- ever, they are more complex and typically take longer to integrate into the SCIS.

Today, more organizations are opting for supply chain suites. Due to mergers and acquisitions in the software industry and ERP vendors moving into the supply chain applications market space, it is possible to purchase supply chain software suites that combine planning, execution, event management, and related capabilities. Figure 6.5 pro- vides a diagram of one vendor’s software suite that links applications from the four main categories.

Each strategy has its merits. Single vendor supply chain suites should take less time to implement than a variety of tools from different vendors since there are fewer compati- bility and connectivity issues to overcome. Also, there is only one vendor to work with rather than multiple companies, which reduces administrative and coordination effort. Single vendor suites also require less training time and have lower implementation costs as there is only one set of integration requirements to master. However, some suites do not contain the advanced functionality or industry-specific capabilities found in spe- cific best-of-breed applications, though the vendors are working to close the gaps.

The challenge for the supply chain executives choosing between these options is to understand the implementation issues; their organization’s need for tailored, advanced capabilities; and the constantly changing vendor landscape.

Purchase Options Historically, supply chain software buyers had one option—purchase solutions from

software vendors for their own information systems. The licensed software is installed on the buyer’s powerful client-server systems, which is a valuable method, given the

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intense computational activity required by most supply chain processes. The downside of this purchase option is the high capital investment and complex deployment associated with conventional licensed applications. Buyers have to pay for the software up front; manage the implementation issues; and deal with ongoing issues of software upgrades, fixes, and maintenance costs.

The Internet brought other options collectively known as on-demand software that is not installed on a company computer. The application resides on an external system, and the Internet is used to deliver the software. Initially, application service providers (ASP) owned, operated, and maintained the software application, as well as the servers running the application. Users access the software via the Internet and are billed for the applica- tion on a per-use basis or on a monthly/annual fee basis. The benefit of the ASP pur- chase model is low-cost access to solutions because there are no major up-front license or installation costs. The downside of ASPs is the inefficiency of hosting one copy of the software application and dedicating a computer or part of a server for each user.22

Hence, the ASP model has not prospered in supply chain management. Some of the on-demand issues that hampered ASP efforts are being addressed by

multitenant capabilities and software-as-a-service offerings. This option allows multiple parties to access the software simultaneously via the Internet and potentially leverage shared server capacity (the concept behind cloud computing, which is discussed at the end of this chapter). Because the application is shared, carriers, suppliers, shippers, and customers can all work together using a standard business process and have a common view of supply chain activity, as highlighted in the On the Line feature that follows.

This on-demand purchase option is gaining in popularity as more supply chain tools are offered via this method. Faster implementation and return on investment, lower capital requirements, and an ability to stay current with technology upgrades are cited as key reasons for interest in this method. Of course, certain issues must be addressed: The functionality of on-demand solutions may not be as robust as traditional software, data control is an issue, opportunities to tailor the software are limited, and the total cost of ownership must be analyzed as software transaction fees may exceed purchase costs over the long run.23

Figure 6.5 Supply Chain Software Suite

X-SUITE SOLUTIONS

PLATFORM APPLICATIONS Total Cost to Serve

Supply Chain Intelligence Supply Chain Visibility

Supply Chain Event Management

SUPPLY CHAIN SOLUTIONS

SUPPLY CHAIN PROCESS PLATFORM

Planning and

Forecasting Inventory

Optimization Order

Lifecycle Management

Transportation Lifecycle

Management Distribution Management

Source: Manhattan Associates

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Technical Issues Supply chain managers tend to focus on functionality when considering software, but they

also must consider the technical issues related to its operation. Potentially useful software will become “shelfware” if it is difficult to install, unable to link to other tools in support of

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On the Line SaaS Capabilities Boost Transportation Software Sales

While the effects of the global recession took its toll on enterprise software markets to a large degree in the form of a double-digit revenue reduction, it does not appear that damage to the Transportation Management System (TMS) market was nearly as severe, according to research from ARC Advisory Group.

As defined by ARC, TMS are software services that facilitate the procurement of transportation services, including the short-term planning and optimization of transportation activities, assets, and resources; and the execution of transportation plans on a regional or global basis for all modes of freight transportation and parcel management.

Dr. Steve Banker, service director of supply chain management at ARC, said in a statement that even though TMS sold on a traditional software model declined at a double digit rate between 2007 and 2009, those losses were quelled by TMS services sold as part of a SaaS (software- as-a-service) model, which is comprised of services packaged as part of a leasing model and are hosted online.

“When people think of SaaS, they think of lower costs and not spending [hundreds of thousands of dollars] to implement, along with paying a lower monthly rental fee to get payback more quickly,” said Banker in an interview. “TMS falls into that model.”

Another reason for TMS in a SaaS model hanging tough during the recession, according to Banker, is that it is well-suited to be sold in a network model. The reason being that with SaaS, it is viewed as a single-instance, multi-echelon, multi-tenant solution based on a single piece of code running from the software vendor to multiple shippers.

These shippers are all working off of the same piece of code, which provides myriad advantages in the transportation sector, said Banker.

“Shippers typically have preferred carriers,” said Banker. “But if a carrier is for some reason unable to move a load it needs to be tendered to other carriers. It is not unusual for shippers to have 40 or 50 carriers that they work with on an ad-hoc basis for a particular lane. But the problem there is that it is generally based on EDI (electronic data interchange) messaging, which many carriers and 3PLs use as their own dialect.”

In a traditional TMS, picking up EDI messages and effectively making use of them is not easy or straightforward, Banker noted. And data cleansing is not something which is preferred by any shipper, whereas they want to buy an application and have it work.

Going forward, ARC expects TMS sales to rise between 2010 and 2014, but company officials would not provide specific figures regarding projected sales growth and percentages.

Source: Jeff Berman, “Logistics Technology: ARC Says SaaS Sales Helped Overall TMS Market Growth,” Logistics Management (May 25, 2010). Retrieved March 17, 2011 from http://www.logisticsmgmt.com/article/ logistics_technology_arc_says_saas_sales_helped_overall_tms_market_growth/. Reprinted with permission.

visibility and event management, or too cumbersome to use on a daily basis. Hence, up-front effort must be expended to assess implementation challenges before selecting a supply chain software suite or best-of-breed application. We have already identified some of the key con- siderations such as interoperability and data synchronization. Here, we briefly discuss two additional technical issues in SCIS implementation.

Data Standardization Given the variety of software vendors, proprietary tools, and legacy systems, coordi-

nating and sharing information across the supply chain can be a significant challenge. Just as different languages, dialects, and alphabets hamper human communication, the variety of systems and programming languages used in SCIS make it difficult to bring data together in an efficient, useful manner.

One option is to translate data as they move between software applications, but this can be as cumbersome as two people trying to communicate through a translator. Rather than manually or electronically translating data, a better solution is to use a standardized format to enhance communication between partners. Just as English is the standard language of global business, EDI and extensible markup language (XML) are key elements of data stan- dardization. These tools improve the data flows between applications and organizations.

EDI provides interorganizational, computer-to-computer exchange of structured information in a standard, machine-processable format. It has been the primary method of transaction data sharing between vendors and customers for over two decades, sup- porting the exchange of trade-related documents, such as purchase orders, invoices, and corporate electronic funds transfer (EFT) in a standard format.

EDI allows the rapid exchange of large amounts of information, reduces errors, and low- ers the cost per transaction, allowing supply chain partners to work more efficiently and effectively. Nevertheless, EDI does have its drawbacks. Implementation can be complex, and value-added network services that provide the company-to-company linkages charge transaction fees, making this standardization method infeasible for smaller organizations.

XML is a robust, logically verifiable text format based on international standards. It provides a flexible way to create structured, common information formats and share both the format and the data via the Internet, intranets, and other networks. XML can be used to define complex documents and data structures such as invoices, inventory descriptions, shipment records, and other supply chain information.

The benefits of XML are numerous—it is a simultaneously human-readable and machine-readable format, it supports multiple languages, its plain text file displays are unencumbered by licenses or restrictions, and it is platform-independent and thus rela- tively immune to changes in technology. XML is gaining traction in the supply chain because it supports the integration of various information systems, is less complex than EDI, and eliminates the need for value-added networks, which reduces cost while speed- ing data transmission.

When selecting individual applications, buyers must seek out these data standardization capabilities. Such capabilities will ensure that information is quickly transferred in a format that is usable by the SCIS and key decision makers. This will help buyers avoid costly, time- consuming software integration projects and improve SCIS interoperability. Enhanced vis- ibility and faster communication across the supply chain will also be achieved.

Application Integration Not only is it important to put data into a standardized and common format, but it is

also imperative that different tools seamlessly share the data. This can be readily accom- plished within a self-contained supply chain software suite, but supply chain partners

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often rely on different vendors, applications, or software versions. The greater the variety of applications, the more challenging the connectivity and information-sharing issues become. The problem lies in the fact that these applications tend to present data differ- ently, making communication between them difficult.24

Extensive efforts have been made to improve application integration and foster supply chain information synchronization. The initial work focused on the development of application programming interfaces (API) to allow companies to link their SCIS with supplier and customer applications. ERP vendors focused their API efforts on making it easier for third-party vendors to build ERP-compatible supply chain software. Other organizations developed tools to fit between and connect existing applications, such as linking a warehouse management system to an ERP-based order management system. Today, APIs provide a set of programming instructions and standards for accessing Web-based software applications and tools.25

The focus has shifted toward a technology model called service-oriented architecture (SOA)—the underlying structure supporting communications between services with “plug and play” functionality. A service is defined as a unit of work to be performed on behalf of some computing entity, such as a human user or another program. SOA defines how two computing entities interact in such a way as to enable one entity to per- form a unit of work on behalf of another entity.

Supply chain technology buyers need to understand the challenges of application inte- gration while pursuing improved SCIS connectivity. They must assess and compare inte- gration methods, and then choose those that best fit current needs while providing the flexibility to meet future functionality requirements.

Asking the Right Questions26 Senior management plays a key role in facilitating the implementation of supply chain

technology. Executives must provide the vision, the required resources, and commitment to SCIS initiatives if the organization is to achieve its goals. This vision must clearly explain how technology upgrades will facilitate the organization’s overall supply chain strategy and improved performance.27 An intelligent executive will take the time to ask important questions and gather appropriate information in order to establish and refine the vision. Only then should the organization move forward with technology investment and implementation. Several key questions must be asked:

• Who will lead our implementation effort? Senior management must assign people with expertise in supply chain processes and software functionality to direct SCIS implementation. Team members must be given the authority to make boundary-spanning technology decisions. They must also be given the ability to manage the implementation process without interference.

• How will technology support our business needs and processes? Senior man- agement must ensure that their implementation team takes the time to docu- ment current processes and identify desired capabilities before embarking upon software reviews. Having a business plan prior to dealing with vendors will ensure that solutions support this plan rather than the business having to adapt to proposed solutions.

• What is the status of our existing data? It is critical to assess data quality, rel- evance, and completeness to ensure that the needed information is available. If the data are lacking in any of these key requirements, the software cannot function as needed and the organization will encounter a garbage in–garbage

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out scenario. Accurate data are also important for testing potential software solutions to determine how well they model reality.

• How well does our existing system integrate with suppliers and customers? SCIS will fall woefully short on vital capabilities if they are unable to commu- nicate with supply chain partners in an efficient manner. Systems structures and capabilities should be mapped to identify where compatibility challenges exist. Senior management must use this knowledge to support improved linkages of SCIS with key partners.

• What external issues must our systems address? Given the financial and product flow data contained within most SCIS, such systems have a major impact on an organization’s ability to comply with government mandates such as Sarbanes-Oxley regulations. The SCIS must also provide visibility of orders from suppliers through customer delivery so that the organization can monitor and control its operations, its inventories and other assets, and its financial results. Visibility is also imperative for participation in international security initiatives such as the Customs-Trade Partnership Against Terrorism (C-TPAT).

Supply Chain Technology Innovations Technology has enabled the evolution of supply chain management. Innovations in

supply chain software, automatic identification tools, communications systems, and Inter- net functionality have forever changed the way supply chains perform. When effectively deployed, these technical advances improve information speed and access, support process improvement and optimization, and provide product visibility from global supplier to local consumer. Ultimately, these innovative technologies enable fast execution of supply chain strategies, helping organizations to leverage time as a source of competitive advantage.

We have discussed a number of innovations throughout the chapter. Certainly, the Internet provides a critical platform for the development and execution of technologies that can be used in a supply chain context. On-demand applications and software- as-a-service, XML, data synchronization, and event management capabilities all leverage the Internet. Meanwhile, increases in raw computing power and data storage facilitate supply chain data mining, business intelligence, and optimization.

Innovative technologies that can make supply chains more robust will continue to emerge. Software and hardware providers will do their part to promote supply chain optimization, synchronization, adaptability, velocity, and profitability. It is up to supply chain managers to identify and implement appropriate tools with the potential to posi- tively impact supply chain performance and gain widespread adoption. At the same time, tools that are long on promise and light on effectiveness must be avoided.

With this challenge in mind, we conclude the chapter with a discussion of three technolo- gies that hold significant promise for the future enhancement of supply chain management.

Radio-Frequency Identification (RFID) Over the last ten years, radio-frequency identification (RFID) has had an up-

and-down roller coaster ride like no other technology. It is simultaneously hailed as a great SCIS tool and panned as an overpriced feature that does little more than what is accomplished by a much cheaper barcode. The reality is likely somewhere between these two extreme perspectives.

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Like barcoding, RFID is an automatic identification method. RFID tags consist of a microchip and a printed antenna that can be packaged into many forms, such as a label or imbedded in between the cardboard layers in a carton or product packaging. Unique product identification information, in the form of a universal electronic product code (EPC), which identifies the manufacturer, product category, and individual item, is stored on these 96-bit tags. The tags are affixed to the pallet, case, or individual product and are read when they pass within proximity of an RFID reader. These tags contain unique identifiers not found on barcodes, and direct line of sight is not required to read RFID tags. The collected information is relayed back to the SCIS, updating the loca- tion status of the associated product.

RFID technology has been available for decades and is widely used for aircraft identi- fication, toll collection, and library book tracking. However, supply chain applications did not receive much attention until major organizations like Walmart took an active interest in RFID. In 2005, the company issued mandates for major suppliers to tag select pallets and cases. The rollout was expected to gain momentum, but as of 2010 only 600 suppliers and a limited number of Walmart and Sam’s Club distribution centers and stores were using RFID tags to capture key data.28

Initial results of RFID tests were positive. Users noted that out-of-stocks decreased, theft was reduced, and inventory level information could be quickly captured. Still, numerous issues—the high cost of RFID tags, read reliability problems related to liquid and metal products in particular, tag durability, and the economic downturn—limited deployment of the technology. Also, the technology has not always provided noteworthy benefits over less costly alternatives such as barcodes.29

Despite these challenges, industry experts are convinced that RFID will gain wide- spread acceptance. As the economy improves, cost and performance problems are miti- gated, and future enhancements are made, RFID spending is expected to increase dramatically. The prospects of faster return on investment for RFID implementations, greater product visibility and traceability, and process automation will further propel RFID to the forefront of technology initiatives.30

Cloud Computing Cloud computing is the latest buzzword in the technology world and it is gaining

great attention from the supply chain management community. However, defining cloud computing is like defining art—everyone seems to have their own definition and it is evolving. The National Institute of Standards and Technology (NIST) recently issued the fifteenth version of its definition:

Cloud computing is a model for enabling convenient, on-demand network access to a shared pool of configurable computing resources (e.g., networks, servers, storage, applications, and services) that can be rapidly provisioned and released with minimal management effort or service provider interaction.31

The excitement surrounding cloud computing is based on its economic, architectural, and strategic value, according to MWD Advisors. The economic value comes from the ability to pay as you go and to avoid huge up-front infrastructure investment costs. The simple, consistent environment in which application development and deployment take place is the architectural value. Finally, cloud platforms help companies focus strategi- cally on their core competencies while leaving the technical responsibilities to a third party expert at a competitive price.

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The case for cloud computing in SCIS is a progressive three-stage proposition. At the most basic level, cloud computing is an extension of the on-demand software-as-a-service strategy, providing access to applications and infrastructure without owning them. The sec- ond stage plugs multiple users into the same applications, platform, or infrastructure, which allows all the participants to share in the costs and benefits. The third stage takes advantage of the collaborative nature of supply chain management. According to the cofounder of GT Nexus, a logistics technology provider, this could have revolutionary implications for the supply chain industry. Ultimately, cloud computing will allow for the automation of hundreds of processes between companies along the supply chain. 32

Mobile Computing The rapid advent of smartphones and tablet computers such as the iPad has spawned

an entire industry of applications that can be quickly downloaded at little or no cost to the user. While many of these “apps” are little more than entertaining time wasters (think Angry Birds), there is a growing focus on productivity tools and features. The ability to use a camera to capture barcode data for price lookup and the Internet connec- tion for mobile commerce both have supply chain implications. Consumers can now shop any time, anywhere. Retail supply chains must have agile fulfillment capabilities to support these customers.

Supply chain capabilities are emerging with data collection and transmission tools leading the way. An add-on feature turns an iPod Touch into the EasyPay Touch that has a barcode scanner and a credit card magnetic strip reader. It can be used for point- of-sale checkout and price lookup. Industrial add-on scanners have been developed so that smartphones and tablets can be used in distribution operations instead of higher cost handheld data terminals.33 Supply chain execution and event management tools are also going mobile with basic visibility and traceability functionality for smartphones starting to appear in the marketplace.34 Additional trends and opportunities are dis- cussed in the Supply Chain Technology feature below.

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Supply Chain Technology

Smartphones and SCM

Smartphones are all the rage with consumers, but is there a place for the technology in supply chain operations? Yes, according to a recent study by the ARC Advisory Group. Nearly 70 percent of the 60 high-level supply chain executives surveyed said they are using smartphones such as BlackBerrys and iPhones in their daily operations.

That information surprised even the analysts who conducted the study. “Overall, the adoption among managers is much, much faster than I would have expected,” says ARC analyst Steve Banker, who cowrote the study, Mobile Technologies Used in SCM Today, with colleague Adrian Gonzalez.

In fact, the survey indicated that in the upper echelons of supply chain management at least, smartphones are fast becoming the technology of choice, edging out older, better established systems. When survey participants were asked to identify the mobile technologies they were using in their logistics and supply chain operations, smartphones were mentioned by 69 percent of the respondents—supply chain vice presidents and directors working for companies with annual revenues of over $1 billion. Handhelds and cellular data/voice networks came in a distant

3PLs as Technology Providers Many organizations are looking to lower their supply chain technology costs. This has

prompted interest in on-demand solutions, engagement of technology companies in sup- ply chain activities, and the use of integrated software suites. Another emerging option is to outsource technology activities to third-party logistics (3PL) providers.

Traditional providers of product handling and movement services, 3PLs are taking on more managerial roles and strategic activities. In the SCIS area, organizations are most likely to outsource information requirements related to transportation management, warehouse management, and global trade management.35

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second (both cited by 54 percent of the respondents), followed by mobile barcode scanners (47 percent).

As for what supply chain folks are doing with these smartphones, barcode scanning (22 percent) and taking and transmitting photos of delivered goods (also 22 percent) garnered the most men- tions. The popularity of scanning was a striking finding, considering that software developers only recently began introducing apps that allow smartphones to double as barcode scanners.

Banker cautions against reading too much into that finding, however. There was nothing in the results to indicate that managers are using their phones for high-volume scanning applications on the DC floor, he says. He adds that it is more likely that managers are “experimenting”with the technology.

The third most common response to the question on how smartphones were being used may come as something of a surprise: 21 percent of the respondents said they used their phones “to access social media sites like LinkedIn, Twitter, and Facebook.” That’s not to say they are playing Farmville during business hours. As Banker points out, a likelier explanation is that they are using social media for networking and keeping up with market developments. “Linked In can be a valuable resource for connecting to other logistics professionals and for keeping your eye on what your competitors are doing—like new hires and departures,” he says.

Survey respondents are also using smartphones for a number of more traditional logistics-related tasks. These include transmitting proofs of delivery (13 percent), signature capture (11 percent), accessing performance dashboards and reports (10 percent), tracking/tracing orders and ship- ments (8 percent), accessing and executing transactions in TMS/WMS (6 percent), tendering shipments to carriers (4 percent), and rate shopping for transportation services (2 percent).

When asked what benefits they obtained from using mobile technologies in their supply chain operations, survey participants homed right in on service and productivity. Fifty-nine percent cited “improved customer service” (for example, enhanced visibility into the status of orders or shipments). An equal share of respondents—59 percent—mentioned “increased productivity of mobile work force” (like drivers and technicians). And 53 percent cited “increased productivity of warehouse workers.”

So what does Banker make of the survey results? Although he admits to being caught off guard by the rapid rate of smartphone adoption, he says he considers the findings to be otherwise in line with expectations. “Managers have become more mobile,” he says.

Source: James A. Cooke, “In Supply Chain World, Smart Phones are Taking Care of Business,” DC Velocity (February 2011): 45. Reprinted with permission.

Cost is one reason for the interest in using 3PLs as technology providers. Another is systems capabilities. The 3PLs have systems that may be better integrated than those of their clients, resulting in improved efficiency, data integrity, and visibility. Like any other technology purchase, organizations must analyze the flexibility and functionality of the 3PL technology as well as implementation issues before moving to this emerging model.

Will any of these technology innovations gain additional traction and fundamentally change supply chain management as we know it today? Only time and organizations’ investment in these innovations will tell. Of course, the technology landscape is con- stantly changing. New tools may render existing ones obsolete and supplant emerging innovations. The only way to keep up with the latest advances in supply chain technol- ogy is to monitor industry developments. Table 6.2 provides a list of Web sites that focus on information technology innovations and issues.

Table 6.2 Sources of Additional Information: Supply Chain Technology

NAME WEB ADDRESS DESCRIPTION SIMILAR SOURCES

Aberdeen Group

www.aberdeen.com Provides fact-based research and insights focused on the global, technology-driven value chain.

www.arcweb.com www.forrester.com www.gartner.com

Logistics Viewpoints

www.logisticsviewpoints.com Provides logistics professionals with clear and concise analyses of logistics trends, technologies, and services.

www.scdigest.com www.scmr.com www.supplychainbrain.com

RFID Update

www.rfidupdate.com Newsletter highlighting breaking news and analysis pertinent to RFID technology and implementations.

www.discoverrfid.org www.rfidjournal.com www.rfid24-7.com

Source: Brian J. Gibson, Ph.D. Used with permission.

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SUMMARY Information is critical to the success of a supply chain and must flow freely between

supply chain partners. Without accurate, timely information, it is extremely difficult for supply chain managers to make effective decisions regarding the purchase, production, and distribution of materials. To facilitate the knowledge links and foster supply chain visibility, most organizations rely upon computer hardware, SCIS, and supportive Internet-based technologies. They realize that real-time information and the ability to dynamically respond to changing conditions in the supply chain are critical to the suc- cess of the organization. Industry leaders are using SCIS to create whole chain visibility, adaptive capabilities, and substantial competitive advantages in their respective markets.

Harnessing information technology in support of supply chain excellence is an ongo- ing challenge, given the continuing evolution of SCIS capabilities. Supply chain managers must work diligently to appreciate the growing role of information, understand each type of supply chain software, choose solutions wisely, and overcome key implementation challenges to gain maximum benefit from information technology. Key concepts from the chapter include:

• In order for supply chain managers to utilize information, it must be readily accessible, relevant to their decision-making needs, accurate, timely, and in a format that can be shared.

• When properly implemented, information technology supports critical supply chain capabilities and strategies, including supply chain connectivity, product visibility, part- ner collaboration, and process optimization.

• A well-designed SCIS framework links people, processes, and technology in a manner that provides actionable information and enhances decision making.

• Timely data collection and synchronization support supply chain visibility, exception management, and effective responses to changing customer requirements.

• Supply chain software falls into four general categories: (1) planning tools for forecast- ing and related activities, (2) execution systems for management of day-to-day pro- cesses, (3) event management tools to monitor supply chain flows, and (4) business intelligence applications that help organizations analyze performance.

• Given the potential stumbling blocks, software selection and implementation are not a minor undertaking. Needs must be assessed, software options studied, technical issues addressed, and important questions asked before major SCIS investments are made.

• Change is the norm when it comes to supply chain technologies. It is critical that developments related to RFID and other innovations are understood so that organiza- tions can take full advantage of worthwhile technologies.

STUDY QUESTIONS 1. Discuss the role of information in the supply chain and how it supports supply chain

planning and execution.

2. Describe the components of information quality and how they impact supply chain decision making.

3. What are the primary capabilities created by supply chain technology? How can they drive supply chain excellence?

4. Describe a supply chain information system in terms of its key elements, require- ments, and capabilities.

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5. Identify the four primary categories of supply chain management software and dis- cuss their primary functions.

6. Using company Web sites, develop a profile (types of supply chain software offered, annual sales, and recent news) of the following organizations:

a. SAP (http://www.sap.com) b. Manhattan Associates (http://www.manh.com) c. Logility (http://www.logility.com)

7. What is the role of enterprise resource planning systems in supply chain management?

8. Discuss the relative advantages of best-of-breed software versus supply chain suites.

9. Why would companies choose to use on-demand software versus licensed software?

10. When preparing to purchase and implement SCIS components, what issues and questions must managers address?

11. Why is there so much interest in radio-frequency identification? What supply chain benefits does RFID facilitate?

12. How will mobile computing and the Internet impact supply chain information management?

NOTES 1. Mary Shacklett, “Supply Chain Software: The Big Spend,” World Trade (October 1, 2010). Retrieved March 16, 2011 from

http://www.worldtrademag.com/Articles/Cover_Story/BNP_GUID_9-5-2006_A_10000000000000913085

2. Marc Ferranti, “Wall Street Beat: IT Spending Forecast to Rise in 2011,” CIO (January 7, 2011). Retrieved March 16, 2011 from http://www.cio.com/article/652713/Wall_Street_Beat_IT_Spending_Forecast_to_Rise_in_2011?page=1&taxon omyId=3000

3. “Enterprises Increasing Technology Spending to Drive Supply Chain Innovation, Says New Aberdeen Report,” PR Newswire (May 23, 2006).

4. Robert Premus and Nada Sanders, “Modeling the Relationship Between Firm IT Capability, Collaboration, and Perfor- mance,” Journal of Business Logistics 26, No. 1 (2005): 1–23.

5. Mary Holcomb, “The Five Drivers of Sustainable Supply Chain Management Practice,” Public Policy and Sustainability (March 22, 2010). Retrieved March 16, 2011 from http://www.freightpublicpolicy.org/2010/03/the-five-drivers-of-sustain able-supply-chain-management-practice/

6. Mary C. Holcomb, Karl B. Manrodt, Belinda Griffin, and Kevin Schock, The 2008 Supply Chain Playbook: 17th Annual Report on Trends and Issues in Logistics and Supply Chain Management (New York: Capgemini, 2008), 3.

7. Lynette Ferrara and Alex Mayall, “Successful Business Relationship Management,” CSC World (January–March 2006): 18–21.

8. Mark Smith, “Improving Supply Chain Performance,” Achieving Supply Chain Excellence through Technology (San Fran- cisco, CA: Montgomery Research, 2004).

9. Jose Favilla and Andrew Fearne, “Supply Chain Software Implementations: Getting it Right,” Supply Chain Management (October 2005): 241–43.

10. Major portions of this section have been adapted from Jeff Abott, Karl Manrodt, and Peter Moore, From Visibility to Action: Year 2004 Report on Trends and Issues in Logistics and Transportation (New York: Capgemini, 2004); and Peter Moore, Karl Manrodt, and Mary Holcomb, Collaboration: Enabling Synchronized Supply Chains, Year 2005 Report on Trends and Issues in Logistics and Transportation (New York: Capgemini, 2005).

11. Kenneth C. Laudon and Jane P. Laudon, Management Information Systems, 11th ed. (Upper Saddle River, NJ: Prentice Hall, 2010).

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12. Scott Wilson, “Extending Visibility?” Metal Producing and Processing, (January 2003): 36–37.

13. “Improving Sales and Operations Planning at SanDisk Corporation” JDA Case Study (2010): 1–3. Retrieved March 16, 2011 from http://www.jda.com/company/display-collateral/pID/880/

14. David Maloney, “More than Paper Savings,” DC Velocity (January 2006): 62–64.

15. William Atkinson, “Good to Grape: Welch’s Juices Up Its Inventory Management,” Supply and Demand Chain Executive (February/March 2010): 16–17.

16. Bob Trebilcock, “Supply Chain Software Basics,” Modern Materials Handling (April 2009): 26–28.

17. “Del Monte Food,” Infor Case Study (2010). Retrieved March 17, 2011 from http://www.infor.com/content/casestudies/ delmonte.pdf/?location=LHM

18. Michael Totty, “Technology Special Report: Business Intelligence,” Wall Street Journal (April 3, 2006): R6.

19. Frank Smietana, “Enhancing Supply Chain Visibility with Pervasive Business Intelligence,” Business Intelligence Journal (First Quarter 2010): 30–38.

20. For an extensive discussion of enterprise resource planning systems, see Joel Wisner, G. Keong Leong, and Keah-Choon Tan, Principles of Supply Chain Management: A Balanced Approach, 3rd ed. (Mason, OH: South-Western, 2011), chap. 6.

21. Bob Trebilcock, “A Tale of Two ERP Systems,” Modern Materials Handling (December 2005): 27–29.

22. Connie Venema, ed., “The Evolution of Hosted Supply Chain Software,” The Supply Chain Digest Newsletter (April 2010): 4–10.

23. “Top Five Reasons to Purchase-and-Install,” Inbound Logistics (March 2011). Retrieved March 17, 2011 from http://www. inboundlogistics.com/newsletter/transite0311.html

24. Michael Levans, “Get More Bang for Your IT Bucks,” Logistics Management 45, No. 4 (April 2006): 32–35.

25. Dave Roos, “How to Leverage an API for Conferencing,” HowStuffWorks.com. Retrieved March 17, 2011 from http:// communication.howstuffworks.com/how-to-leverage-an-api-for-conferencing1.htm

26. This section is adapted from the following presentation: Chris Norek, “Using Evolving Technology to Manage Complex Supply Chains,” Transformation ’06: A Business and Logistics Conference (Las Vegas, February 1, 2006).

27. Jim Welch and Peter Wietfeldt, “How to Leverage Your Systems Investment,” Supply Chain Management Review 9, No. 8 (November 2005): 24–30.

28. Maida Napolitano, “RFID Revisited,” Logistics Management (February 2010): 45–47.

29. Bridget McCrea, “RFID/Wireless: Race to Utopia,” Logistics Management (July 2010): 37–39.

30. Napolitano, 45–47.

31. “Cloud Computing,” NIST.gov (updated August 27, 2010). Retrieved March 18, 2011 from http://csrc.nist.gov/groups/SNS/ cloud-computing/

32. “Shippers’ IT: Supply Chain Cloud Formation,” American Shipper (June 2010): 28.

33. James Cooke, “Comparing Apples to … Handhelds?” DC Velocity (December 2010): 47.

34. Bridget McCrea, “There’s an ‘App’ for That!” Logistics Management (January 2011): 40.

35. Michael Levans, “2010 Technology Roundtable: Achieving Perfect Pitch,” Logistics Management (May 2010): 22–27.

Supply Chain Technology—Managing Information Flows 209

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CASE 6 .1

Bazinga Licensing Ltd. Bazinga Licensing Ltd. (BLL) is an authorized manufacturer of products based on

famous Japanese anime characters. The Seattle-based company produces collectibles, toys, and other novelty items in its factory outside Kaohsiung, Taiwan. The majority of sales are made to small retailers in the United States and Latin America.

Interest in BLL products has grown thanks to some timely product placements on popular television shows. Shelly Coopers, the company’s CEO, just received a call from Mega-Mart about carrying the BLL product line for the upcoming holiday season. The call went very well until the Mega-Mart executive asked about BLL’s supply chain tech- nology platform and order fulfillment system. Shelly had little idea what the person was talking about and provided a somewhat ambiguous response.

The truth of the matter is that BLL has no formal SCIS. The company is small and everything has been managed manually. From forecasting and inventory control to order fulfillment and customer invoicing, everything has been done by hand on preprinted forms, with this information later entered into Excel spreadsheets.

The Mega-Mart executive sensed the lack of technological sophistication and closed the call by saying: “We really want to carry your products this year but we do have spe- cific standards for digital transfers of orders, point of sale data, and invoices. If you can’t effectively interact with our supply chain information system, then we won’t be able to do business with Bazinga.”

CASE QUESTIONS 1. To obtain the necessary technological capabilities should BLL license software or use

on demand tools? Explain.

2. What types of software does BLL need to support the Mega-Mart business? What features and capabilities are needed?

3. What roles can the Internet play in BLL’s move from manual methods to technology- based information management?

Source: Brian J. Gibson, Ph.D. Used with permission.

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CASE 6 .2

Catnap Pet Products Catnap Pet Products (CPP) of Saskatoon, Saskatchewan, in Canada manufactures

fancy pet kennels. Unlike traditional wire cage kennels, the Catnappers synthetic wicker kennels are attractive and functional. They are available in six colors and six sizes to accommodate all sizes of cats and dogs. Annual sales have averaged 50,000 units over the past three years. CPP has no sizable competitors and sells the product directly via the Internet on http://www.catnapping.ca and through five home furnishings mail order catalogs at prices ranging from $99.95 to $279.99 CDN plus shipping and handling.

Catnappers consist of four primary components: the wire frame and door (sourced from Nampa, Idaho), a plastic floor pan (Calgary, Alberta), weaved resin panels (Tijuana, Mexico), and shipping boxes (from nearby Regina, Saskatchewan). The components are assembled, packaged, and warehoused at CPP’s Saskatoon facility. CPP management develops quarterly forecasts using Excel macros and shares them via email with each supplier along with the monthly orders for components.

Approximately 35 percent of customer orders are placed through CPP’s Web site with the remaining 65 percent coming through its mail order partners. The two largest sellers place daily orders using Internet-based EDI, two others send weekly orders via e-mail, and the smallest catalog company periodically faxes in orders. All customer orders are sent from CPP via small package carriers as no inventory is held by the catalog companies.

Over the years, the company has cobbled together a variety of technology tools to support its efforts. Key components include an e-commerce package to manage the Web site and order taking, a basic warehouse management system that helps CPP moni- tor inventory levels and manage order picking, and shipment management tools from its primary package carrier to help with routing, documentation, labeling, and tracking. Other processes are managed using a structured query language (SQL) database, spread- sheets, and an accounting software package.

At a recent trade show, CPP executives were approached by two major retailers, PETCO and Target, about carrying the Catnappers product line. The projected volume of these two customers would take annual sales to 250,000 units. While company execu- tives were initially ecstatic, they quickly realized that the current capabilities of the Sas- katoon facility and the CPP “information system” could not sustain such volume. Still, they did not want to turn down the business windfall and began working on a plan to handle their new customers.

The first planning meeting generated a basic strategy. The company would continue to serve its current customers through existing facilities and processes. In terms of the additional volume, CPP would manage the sourcing of components and use a contract manufacturer in China to produce the Catnappers for PETCO and Target. The product would be shipped to San Diego, California, via ocean container service and a third-party logistics company would warehouse the inventory and manage final delivery to PETCO and Target stores.

Supply Chain Technology—Managing Information Flows 211

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CASE QUESTIONS 1. Given its volume growth and supply chain process changes, what technology chal-

lenges will CPP face?

2. As the scope of the CPP supply chain expands, which information technology capa- bilities will be most important for the company to pursue?

3. From an information-sharing standpoint, how will the requirements of PETCO and Target differ from CPP’s current customer base? How should CPP respond to these requirements?

4. What type(s) of software will be most beneficial for CPP to adopt? Why?

Source: Brian J. Gibson, Ph.D. Used with permission.

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Part III

Up to this point, the topics in this text have provided a basic under- standing of the supply chain, how it managed and measured, and the technology used to help manage information, product, and cash flows. Part III will focus on the concept of fulfillment, starting with the development of a forecast and ending with the shipment being received by the customer. This is also referred to as the order to cash cycle. The focus of this section will be on how firms deliver products to customers while minimizing cost and maximizing customer satisfaction.

Chapter 7 begins by discussing the typical imbalance between supply and demand for an organization and how this imbalance can be mitigated by understanding the various factors that affect demand. Following this discussion, an in-depth presentation of various forecast- ing methods is given in an attempt to help organizations estimate future customer demands. Basic collaborative techniques, such as the sales and operations (S&OP) process and collaborative planning, forecasting, and replenishment (CPFR), are introduced to show how they can be expanded to include other functional areas within an organization as well as other channel partners. Finally, this chapter presents some basic processes and network designs that can be used in the fulfillment process.

Chapter 8 focuses on the concepts of customer service and order management and how they are related and managed within organiza- tions. The basic elements of customer service are identified and discussed from the perspective of how they affect both buyers and sellers. The concept of stockout costs is introduced. Finally, this chapter presents the major outputs of order management, how they are measured, and their financial impacts on buyers and sellers.

Chapter 9 offers a detailed examination of the concept of inventory man- agement. This chapter begins with a general discussion of the roles of inventory in the economy, why organizations carry inventory, and the various types of inventory held in the supply chain. Next, an in-depth

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discussion is offered on the various techniques for managing inventory, with a special focus on the economic order quantity (EOQ). Other inven- tory management techniques, such as just-in-time (JIT), materials requirements planning (MRP), distribution requirements planning (DRP), and vendor-managed inventory (VMI) are also discussed. Also covered in this chapter are methods used to classify inventory and the impact on inventory when changing the number of stocking points. Finally, the chapter appendix offers several derivations on the basic EOQ model.

The final two chapters present a detailed discussion on the two logistics areas critical to fulfillment—transportation and distribution. Chapter 10 first discusses the importance of transportation to the economy followed by a general analysis of the transportation market and the various modes of transportation. Next, this chapter offers a perspective on transporta- tion decision making—the planning, execution, and control of freight flows. Transportation metrics and technology discussions conclude the chapter. Appendices provide detailed coverage of transportation regula- tion and costing.

The focus of Chapter 11 is on the roles of distribution operations in the supply chain. Special attention is given to distribution planning, strat- egy, and execution with a focus on the role of warehousing and fulfill- ment operations. The chapter ends with a discussion of distribution metrics and technology in distribution. An appendix provides insight into materials handling strategies and equipment used in distribution operations.

214 Part III

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Chapter 7

DEMAND MANAGEMENT

Learning Objectives After reading this chapter, you should be able to do the following: • Understand the critical importance of outbound-to-customer logistics systems.

• Appreciate the growing need for effective demand management as part of an organization’s overall logistics and supply chain expertise.

• Know the types of forecasts that might be needed and understand how collabo- ration among trading partners will help the overall forecasting and demand management processes.

• Understand the basic principles underlying the sales and operations planning process.

• Identify the key steps in the order fulfillment process and appreciate the various channel structures that might be used in the fulfillment process.

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Supply Chain Profile LuAnn’s Chocolates

LuAnn’s Chocolates (LC) was founded by LuAnn Jaworski and her husband Denny in 1975. Located in Bellefonte, Pennsylvania, LC produced a relatively small number of chocolate products that catered to normal consumer demand (e.g., chocolate bars) as well as specialty consumer markets (e.g., special boxed assortments). With current annual revenues hovering around $3 million, LC has seen growing revenues, and the seasonal demand for chocolates is beginning to cause some problems in inventory levels and production scheduling.

CURRENT PLANNING PROCESS Traditionally, LC relied on keeping its only manufacturing plant operating at a steady level throughout the year. Forecasting was done manually with small annual increases in volume applied to demand evenly throughout the year. Forecasts of demand were supplied by the two sales representatives LC employed to call on local retailers. The sales reps’ compensation consisted of a base salary plus com- mission. Manufacturing would then change these forecasts to allow the plant to run smoothly while minimizing changeovers. The plant manager was measured on total manufactured cost per pound. Although the plant kept running at a steady rate, inventory levels would fluctuate wildly throughout the year. To complicate matters, LC often had high levels of the wrong inventory in place in its distri- bution center, resulting in stockouts. Although finance was concerned about “making the numbers” every quarter, it had little or no input to the forecasting and production scheduling processes.

CURRENT DISTRIBUTION PROCESS LC makes its chocolate and stores it in its distribution center (DC), also located in Bellefonte. When orders arrive from retail customers, the DC fills them and adjusts the inventory levels in the inventory tracking system. When the inventory level for a product in the DC reaches a predetermined level, the DC places an order on the plant for replenishment. If the plant has inventory for that product on site or if it is currently making that product, a replenishment order is sent to the DC. If neither of these two situations exists, the DC waits for its order until the plant is scheduled to make that product. No advance information is provided to LC by its customers of anticipated demand.

THE MEETING Every Monday morning, LC holds an executive staff meeting with representatives from sales, logis- tics, manufacturing, and finance to review the activity from the previous week. This morning’s meeting turned into a rather contentious debate about the company’s inventory levels and resulting stockouts. Beth Bower, one of the sales reps, voiced her concern over the lack of proper inventory to satisfy the demands of her customers. “I took a beating from my customers last week. Every order I took was cut short or not filled at all because the DC did not have the right inventory.” Teresa Lehman, DC manager, had a hasty reply to Beth: “I ship what I have. Don’t blame me if I don’t have the inventory. My DC is full. Why can’t you sell what I have in inventory? That’s your job. I take what manufacturing gives me. If you want to blame someone, blame the plant.” Vinny Coglianese, plant manager, was upset at this finger-pointing. “If I would make what you ordered when you ordered it, my costs would go through the roof. I get the production schedule and I run it.” Jean Beierlein, vice president of finance, was quick to add her comments: “We did not hit our revenue numbers last quarter and the way things are going now, we are going to miss them this quarter. Somebody needs to assess what we are doing or we are going to lose money this year.”

Needless to say, LuAnn was perplexed by this conversation. When the company was first started, things were a lot simpler. However, growth has brought with it a wide variety of operating problems she had not anticipated. The reality of losing money for the first time in company history was a situation for which LuAnn was not ready. If you were LuAnn, what would you do to fix the problems at LC?

Source: Robert A. Novack, Ph.D. Used with permission.

216 Chapter 7

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Introduction In an effort to better serve their customers, many organizations place significant

emphasis on what might be termed their outbound-to-customer logistics systems. Also referred to as physical distribution, this essentially refers to the processes, systems, and capabilities that enhance an organization’s ability to serve its customers. For example, the ways in which retailers such as Walmart, Target, and L.L.Bean fulfill their customers’ orders are examples of outbound logistics. This topic has been of significant historical interest in the study of logistics and supply chain management. This chapter will high- light key areas of concern related to this general topic.

Correspondingly, the topic of inbound-to-operations logistics systems refers to the activities and processes that precede and facilitate value-adding activities such as pro- curement (Chapter 13), manufacturing (Chapter 14), and assembly. Other terms that focus on these elements of the supply chain include materials management and physical supply. A typical example would be movements of automotive parts and accessories that need to move from supplier locations to automotive assembly plants. Although many of the principles of inbound logistics are conceptually similar to those of outbound logistics, some important differences must be recognized. Thus, the topic of inbound logistics sys- tems will be the focus of Chapter 13, which is titled “Sourcing Materials and Services.”

Considering the complexity of the topic at hand, this chapter has a relatively aggres- sive agenda of topics to be discussed. First, a discussion of demand management pro- vides an overview of the importance of effectively managing outbound-to-customer processes. Second, the topic of forecasting is addressed. Third, an introduction to the sales and operations planning (S&OP) process is provided. Fourth, the recent emphasis on collaborative forecasting approaches is covered. Finally, attention is focused on the fulfillment process and the processes and methods used to effectively distribute goods in outbound-to-customer logistics systems.

Demand Management According to Blackwell and Blackwell, demand management might be thought of as

“focused efforts to estimate and manage customers’ demand, with the intention of using this information to shape operating decisions.”1 Traditional supply chains typically begin at the point of manufacture or assembly and end with the sale of product to consumers or business buyers. Much of the focus and attention has been related to the topic of product flow, with significant concern for matters such as technology, information exchange, inventory turnover, delivery speed and consistency, and transportation. This notwithstanding, it is the manufacturers—many times far removed from the end user or consumer market—who determine what will be available for sale, where, when, and how many. If this seems to reflect a disconnect between manufacturing and demand at the point of consumption, that is exactly what it is. Thus, any attention paid to demand management will produce benefits throughout the supply chain.

The essence of demand management is to further the ability of firms throughout the sup- ply chain—particularly manufacturing through the customer—to collaborate on activities related to the flow of product, services, information, and capital. The desired end result should be to create greater value for the end user or consumer. There are a number of ways in which effective demand management will help to unify channel members with the common goals of satisfying customers and solving customer problems:2

• Gathering and analyzing knowledge about consumers, their problems, and their unmet needs

Demand Management 217

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• Identifying partners to perform the functions needed in the demand chain

• Moving the functions that need to be done to the channel member that can perform them most effectively and efficiently

• Sharing with other supply chain members knowledge about consumers and customers, available technology, and logistics challenges and opportunities

• Developing products and services that solve customers’ problems

• Developing and executing the best logistics, transportation, and distribution methods to deliver products and services to consumers in the desired format

As organizations identify the need for improved demand management, several problems occur. First, the lack of coordination between departments (i.e., the existence of “functional silos”) results in little or no coordinated response to demand information. Second, too much emphasis is placed on forecasts of demand, with less attention on the collaborative efforts and the strategic and operational plans that need to be developed from the forecasts. Third, demand information is used more for tactical and operational purposes than for strategic ones. In essence, since in many cases historical performance is not a very good predictor of the future, demand information should be used to create collective and realistic scenarios for the future. Primary emphasis should be on understanding likely demand scenarios and map- ping their relationships to product supply alternatives. The end result will be to better match demand as it occurs with appropriate availability of needed product in the marketplace.

Figure 7.1 provides an overview of how supply and demand misalignment might impact overall supply chain effectiveness. Using the personal computer (PC) industry as an example, this figure charts production, channel orders, and true end-user demand over the life cycle of a product. Ignoring the early adopters, end-user demand for PCs typically is at its highest level at the time new products are launched, which is also the

Figure 7.1 Supply/Demand Misalignment

Channel orders

End of life

Launch date

U ni

t p er

p er

io d

1 True end-customer demand

1 True end-customer demand.

3 Channel partners over-order in an attempt to meet demand and stock their shelves. 4 As supply catches up with demand, orders are canceled or returned. 5 Financial and production planning are not aligned with real demand; therefore, production continues. 6 As demand declines, all parties attempt to drain inventory to prevent write-down.

2 Real shortage

5 Over-supply

4

6

Production

3 Channel fill and phantom demand

Returns/ cancellations

2 Production cannot meet initial projected demand, resulting in real shortages.

Source: Accenture, Stanford University, and Northwestern University, Customer-Driven Demand Networks: Unlocking Hidden Value in the Personal Computer Supply Chain (Accenture, 1997): 15.

218 Chapter 7

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time that availability is most precarious. As new, competing products become available, end-user demand begins to taper off, eventually reaching a modest level, at which time the product, now much more available, is generally phased out.

Looking more closely at Figure 7.1, we see that in the first phase of a new product launch, when end-user demand is at its peak and opportunities for profit margins are greatest, PC assemblers are not able to supply product in quantities sufficient to meet demand—thus creating true product shortages. Also during this time, distributors and resellers tend to “over-order,” often creating substantial “phantom” demand. In the next phase, as production begins to increase, assemblers ship product against this inflated order situation and book sales at the premium, high-level launch price. As channel inven- tories begin to grow, price competition sets in, as do product overages returns. This further depresses demand for the PC product, and the PC assemblers are the hardest hit.

In the final phase noted in Figure 7.1, as end-user demand begins to decline, the situation clearly has shifted to one of oversupply. This is largely due to the industry’s planning processes and systems, which are primarily designed to use previous period demand as a gauge. Since much of the previous period’s demand was represented by the previously mentioned phantom demand, forecasts are distorted. The net result of aligning supply and demand is that a large majority of product is sold during the declin- ing period of profit opportunity, thereby diminishing substantial value creation opportu- nities for industry participants. Adding insult to injury, substantial amounts of inventory are held throughout the supply chain as a hedge against supply uncertainty.

Table 7.1 How Demand Management Supports Business Strategy

STRATEGY EXAMPLES OF HOW TO USE DEMAND MANAGEMENT

Growth strategy • Perform “what if” analyses on total industry volume to gauge how specific mergers and acquisitions might leverage market share.

• Analyze industry supply/demand to predict changes in product pricing structure and market economics based on mergers and acquisitions.

• Build staffing models for merged company using demand data.

Portfolio strategy • Manage maturity of products in current portfolio to optimally time overlapping life cycles.

• Create new product development/introduction plans based on life cycle.

• Balance combination of demand and risk for consistent “cash cows” with demand for new products.

• Ensure diversification of product portfolio through demand forecasts.

Positioning strategy • Manage product sales through each channel based on demand and product economics.

• Manage positioning of finished goods at appropriate distribution centers, to reduce working capital, based on demand.

• Define capability to supply for each channel.

Investment strategy • Manage capital investments, marketing expenditures, and research and development budgets based on demand forecasts of potential products and maturity of current products.

• Determine whether to add manufacturing capacity.

Source: Jim R. Langabeer II, “Aligning Demand Management with Human Strategy,” Supply Chain Management Review (May/June 2000): 58. Copyright © 2000 Reed Business Information, a division of Reed Elsevier. Reproduced by permission.

Demand Management 219

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According to Langabeer, there is growing and persuasive evidence that understanding and managing market demand are central determinants of business success.3 Aside from this observation, relatively few companies have successfully linked demand management with strategy. Table 7.1 provides a view of how demand data might be used strategically to enhance an organization’s growth, portfolio, positioning, and investment strategies. As suggested, effective use of demand data can help organizations to guide strategic resources in a number of important ways.

Balancing Supply and Demand The essence of demand management, as previously stated, is to estimate and manage

customer demand and use this information to make operating decisions. However, demand and supply in an organization will more than likely never be balanced to allow for zero stockouts and zero safety stocks. Many methods to manage this imbalance exist. However, there are four methods that are commonly used across many industries. Two of those, price and lead time, are referred to as external balancing methods. The other two, inventory and production flexibility, are called internal balancing methods.

External balancing methods are used in an attempt to change the manner in which the customer orders in an attempt to balance the supply-demand gap. Dell has found these methods to be relatively effective in smoothing demand to meet supply. For example, Dell frequently refreshes its Web site with price changes and availability changes based on the demand for an item and its supply. If customer demand exceeds the current supply, Dell can increase the lead time for that item for customer delivery. By doing so, one of two results can occur. First, if the customer finds the increased lead time unacceptable, she or he might decide to specify an alternative item from Dell for which there is sufficient inventory. Second, if the customer decides the increased lead time is acceptable, Dell now has the opportunity to wait for the next delivery of that item from suppliers. If customer demand is less than current inventory levels for a particular item, a price reduction for that item will appear on the Web site, hopefully increasing demand for the item. Using both methods allows Dell to manage stockouts while minimizing safety stock inventories.

Internal balancing methods utilize an organization’s internal processes to manage the supply-demand gap. Production flexibility allows an organization to quickly and effi- ciently change its production lines from one product to another. This is one principle of lean manufacturing. Being able to react quickly to changing demand by altering produc- tion schedules will allow for a minimum of safety stocks while reducing the possibility of a stockout. The tradeoff here is between production changeover costs and safety stock costs. Inventory is probably the most common, and maybe the most expensive, method used to manage the imbalance between supply and demand. Many organizations pro- duce product to a forecast that includes safety stock to smooth the effects of both demand and lead time variability. This allows an organization to minimize the number of changeovers it needs to make in production but also results in high inventory levels. In these cases, stockout costs are usually high as are production changeover costs.

These four methods are not mutually exclusive in most organizations. Some combina- tion of all of them is used to manage safety stocks and stockouts. Their use and level of implementation will be determined by the nature of the product and the cost of stocking out. Also affecting their use will be the organization’s ability to properly forecast customer demand. Forecasting will be the topic of the next section.

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Traditional Forecasting A major component of demand management is forecasting the amount of product that

will be purchased, when it will be purchased, and where it will be purchased by customers. Although various statistical techniques exist to forecast demand, the common thread for all forecasts is that they will ultimately be wrong. The key to successful forecasting is to minimize the error between actual demand and forecasted demand. Although this sounds simple, many factors can arise in the marketplace that will change demand contrary to the forecast. However, forecasts are necessary because they serve as a plan for both marketing and operations to set goals and develop execution strategies. These goals and strategies are developed through the sales and operations planning (S&OP) process. This concept will be covered in a later section in this chapter. The remainder of this section will focus on the various basic types of forecasting techniques used throughout industry.

Factors Affecting Demand Two types of demand exist: (1) independent demand, which is the demand for the

primary item, and (2) dependent demand, which is directly influenced by the demand for the independent item. For example, the demand for bicycles would be called indepen- dent. It is the demand for the primary, or finished, product and is directly created by the customer. The demand for bicycle tires would be called dependent, because the number of tires demanded is determined by the number of bicycles demanded. Most forecasting techniques focus on independent demand. For example, a bicycle manufacturer will fore- cast the demand for bicycles during a given period. Given that level of demand, the manufacturer knows that two tires will be required for each bicycle demanded. As such, there is no need for the bicycle manufacturer to forecast the demand for tires. From a different perspective, the tire manufacturer will need to forecast the demand for tires, because these are its independent demand items. However, the tire manufacturer will not need to forecast the demand for rims since each tire requires one rim. So, each organization in a particular supply chain will have different definitions for independent and dependent demand items. Forecasting, however, will still usually be done at the independent demand item level.

Normally, the demand for independent demand items is known as base demand, that is, normal demand. However, all demand is subject to certain fluctuations. One type of demand fluctuation is caused by random variation, a development that cannot be antici- pated and is usually the cause to hold safety stocks to avoid stockouts. For example, the hurricanes that devastated parts of Louisiana caused an unexpected surge in the demand for building supplies in that region. A second type of demand fluctuation is caused by trend—the gradual increase or decrease in demand over time for an organization. The demand for advanced electronic components in the consumer market (for example, iPods and DVD players) is trending upwards. The demand for VCR players is trending downwards. A third type of demand fluctuation is caused by seasonal patterns, which will normally repeat themselves during a year for most organizations. For example, chocolate manufacturers are normally faced with several seasonal patterns during the year, such as Valentine’s Day, Easter, and Halloween. Finally, demand fluctuations can be caused by normal business cycles. These are usually driven by the nation’s economy and can be growing, stagnant, or declining. These patterns usually occur over periods of more than one year. Almost every firm is subject to all of these demand influences, mak- ing forecasting an even more challenging task. The next section will briefly examine some of the more popular forecasting methods and will show how some of these demand variations can be included in an organization’s forecasts.

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Simple Moving Average The simple moving average is probably the simplest to develop method in basic time

series forecasting. It makes forecasts based on recent demand history and allows for the removal of random effects. The simple moving average method does not accommodate seasonal, trend, or business cycle influences. This method simply averages a predeter- mined number of periods and uses this average as the demand for the next period. Each time the average is computed, the oldest demand is dropped and the most recent demand is included. A weakness of this method is that it forgets the past quickly. A strength is that it is quick and easy to use.

Table 7.2 presents an example of using the simple moving average technique on the demand for chocolate candy made by LuAnn’s Chocolates (LC). The average demand in

Table 7.2 Simple Moving Average Forecast

(1) t PERIOD

(2) Dt

DEMAND

(3) At

THREE-PERIOD MOVING AVERAGE

(4) Ft

THREE-PERIOD FORECAST

(5) Et

Dt – Ft ERROR

January 560

February 1,300

March 750 870.0

April 1,465 1,171.7 870.0 +595.0

May 725 980.0 1,171.7 −446.7

June 675 955.0 980.0 −305.0

July 575 658.3 955.0 −380.0

August 815 688.3 658.3 +156.7

September 1,275 888.3 688.3 +586.7

October 1,385 1,158.3 888.3 +496.7

November 950 1,203.3 1,158.3 −208.3

December 1,425 1,253.3 1,203.3 +221.7

Total 11,900

x 991.7

Bias �(Dt – Ft) +716.8

Bias x �(Dt – Ft)/n +79.6

Absolute Deviation �|Dt − Ft | 3,396.8

Absolute Deviation x �|Dt − Ft |/n 377.4

Source: Robert A. Novack, Ph.D. Used with permission.

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cases per month for LC’s most popular candy bar is shown in column 2. This example will use a three-period moving average. To determine the forecast for April’s demand, the demand for January, February, and March is averaged. This calculation is shown in Formula 7.1.

At ¼ Sum of last n demandsn ¼ Dt þ Dt�1 þ Dt�2 þ… Dt�nþ1 7:1

where

Dt ¼ Actual demand in period t n ¼ Total number of periods in the average At ¼ Average for period t

This would result in the following calculation:

ð560þ 1,300þ 750Þ=3 ¼ 870 cases The demand for May drops the demand for January from its calculation and adds the

demand for April. The calculation is as follows:

ð1,300þ 750þ 1,465Þ=3 ¼ 1,171:7 cases This process repeats itself until all forecasts are made. The three-period moving aver-

age is shown in column 3, and the forecast is shown in column 4. The error term is simply the difference between the forecast and the actual demand and can be seen in column 5. Adding together the error terms for the forecasts results in what can be called bias—a measure of how accurate the forecast is compared to actual demand. A positive bias means that the demand was higher than forecast during the forecast period, result- ing in stockouts; a negative bias means the demand was lower than the forecast, resulting in excess inventories. The closer the bias term is to zero, the better the forecast. In this example, the bias is +716.8 units or +79.6 units per forecast period (+716.8/9 periods). This means that the forecast was lower than actual demand by 716.8 cases in total and lower than actual demand per month by 79.6 cases. Absolute deviation removes the positive and negative signs from the error terms and is a measure of how accurate the overall forecast is. The closer to zero, the better the forecast is at estimating demand. This measure will be used later when the concept of mean absolute deviation is dis- cussed. Recall that the simple moving average technique does not incorporate seasonal influences into its forecasts. As previously mentioned, the chocolate candy industry is subject to dramatic seasonal influences. As such, this method might not be appropriate for this type of demand data. The next technique will attempt to improve on this forecast accuracy.

Weighted Moving Average In the simple moving average method, each previous demand period was given an

equal weight. The weighted moving average method assigns a weight to each previous period with higher weights usually given to more recent demand. The weights must be equal to one. The weighted moving average method allows emphasis to be placed on more recent demand as a predictor of future demand. For example, Table 7.3 shows the monthly demand for LuAnn’s candy bar. Assume that the weights to be used will be 0.60 for the most recent period, 0.25 for the second most recent, and 0.15 for the third most recent. The average for the next period will be calculated using Formula 7.2.

Demand Management 223

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At ¼ 0:60Dt þ 0:25Dt�1 þ 0:15Dt�2 7:2 Column 3 in Table 7.3 shows the results of this formula. The weighted moving aver-

age for period 3 would be calculated as follows:

ð0:60� 750Þ þ ð0:25� 1,300Þ þ ð0:15� 560Þ ¼ 859:0 cases This becomes the forecast for period 4. These forecasts can be seen in column 4. Once

again, the error term is calculated and shown in column 5. The bias term for this method is +658.75 cases with an average bias per period of +73.2 cases. The results shown for this method are better than those found by using the simple moving average method. This is primarily because the weighted moving average method does not assume equal weights for each period in the calculation. However, the results from the weighted moving average method are still not very good forecasts of demand. There are three possible causes for

Table 7.3 Weighted Moving Average Forecast

(1) t PERIOD

(2) Dt

DEMAND

(3) At

THREE-PERIOD MOVING AVERAGE

(4) Ft

THREE-PERIOD FORECAST

(5) Et

Dt – Ft ERROR

January 560

February 1,300

March 750 859.0

April 1,465 1,261.5 859.0 +606.0

May 725 913.75 1,261.5 −536.5

June 675 806.0 913.75 −238.75

July 575 622.5 806.0 −231.0

August 815 734.0 622.5 +192.5

September 1,275 1,055.0 734.0 +541.0

October 1,385 1,272.0 1,055.0 +330.0

November 950 1,107.5 1,272.0 −322.0

December 1,425 1,300.25 1,107.5 +317.5

Total 11,900

x 991.7

Bias �(Dt − Ft) +658.75

Bias x �(Dt − Ft)/n +73.2

Absolute Deviation �|Dt – Ft | 3,315.3

Absolute Deviation x �|Dt – Ft |/n 368.4

α Dt =0.60, α Dt−1 = 0.25, α Dt−2 = 0.15

Source: Robert A. Novack, Ph.D. Used with permission.

224 Chapter 7

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this. First, the weights assigned to the three periods might not accurately reflect the patterns in demand. Second, using three periods to develop the forecast might not be the appropriate number of periods. Finally, the weighted moving average technique does not easily accommodate demand patterns with seasonal influences. In an attempt to improve on this forecast, another technique will be applied to LuAnn’s demand data.

Exponential Smoothing Exponential smoothing is one of the most commonly used techniques because of its

simplicity and its limited requirements for data. Exponential smoothing needs three types of data: (1) an average of previous demand, (2) the most recent demand, and (3) a smoothing constant. The smoothing constant must be between 0 and 1. Using a higher constant assumes that the most recent demand is a better predictor of future demand. Formula 7.3 is used to calculate the forecast.

At ¼ aðDemand this periodÞ þ ð1� aÞðForecast calculated last periodÞ ¼ aDt þ ð1� aÞAt�1 7:3

Using the data contained in Table 7.2, the forecast using exponential smoothing is generated and can be seen in Table 7.4. Assume that the average for the previous period (the average of the 12 periods was used for convenience) is 992 cases. Table 7.4 shows the forecasts and the bias for two scenarios, one with a constant of 0.1 and the other with a constant of 0.3. The forecast for January is simply the average from the previous period (992 cases). The forecast for February is calculated as follows:

Forecast ¼ ð0:1� 1300Þ þ ð0:9� 992Þ ¼ 1022:8 cases The forecast for March follows the same calculation.

Forecast ¼ ð0:1� 750Þ þ ð0:9� 1022:8Þ ¼ 995:5 cases This same methodology is used to calculate the forecasts using 0.3 as the constant,

except 0.3 is used in the formula instead of 0.1. The resulting bias terms show that using 0.1 results in a better forecast than using 0.3 as a smoothing constant. The resulting average bias per period (12 periods were used here) shows that using exponential smoothing with a constant of 0.1 has so far produced the best forecast. However, exponential smoothing forecasts will lag actual demand. If demand is relatively constant, exponential smoothing will produce a relatively accurate forecast. However, highly seasonal demand patterns or patterns with trends can cause inaccurate forecasts using exponential smoothing. The next method will attempt to introduce the concept of trend into the forecast.

Adjusting Exponential Smoothing for Trend As previously mentioned, exponential smoothing will tend to cause severe lags in fore-

casts for demand patterns that contain trends. As such, exponential smoothing can be adjusted to accommodate trends by estimating the magnitude of the trend. This is done by computing the average of the series in the previous period to the average computed last period.4 To adjust the forecast for trend, the estimates for both the average and the trend are smoothed by constants. Formula 7.4 calculates the average demand for a period.

At ¼ aðDemand this periodÞ þ ð1� aÞðAverage þ Trend estimate last periodÞ

¼ aDt þ ð1� aÞðAt�1 þ Tt�1Þ 7:4

Demand Management 225

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Formula 7.5 calculates the average trend for a period.

Tt ¼ bðAverage this period� Average last periodÞ þ ð1� bÞðTrend estimate last periodÞ

¼ bðAt � At�1Þ þ ð1� bÞTt�1 7:5 where:

At ¼ Exponentially smoothed average of the series in period t Tt ¼ Exponentially smoothed average of the trend in period t a ¼ Smoothing parameter for the average b ¼ Smoothing parameter for the trend

The smoothing parameters for both average demand and average trend must be between 0 and 1. Estimates for average demand and the trend can be made from histori- cal data. Table 7.5 presents an application of this method to the LuAnn’s Chocolates

Table 7.4 Exponential Smoothing Forecast*

(1) t PERIOD

(2) Dt

DEMAND

(3) Ft

a = 0.1 FORECAST

(4) Et

Dt – Ft ERROR

(5) Ft

a = 0.3 FORECAST

(6) Et

Dt – Ft ERROR

January 560 992.0 −432.0 992.0 −432.0

February 1,300 1,022.8 +277.2 1,084.4 +215.6

March 750 995.5 −245.5 984.1 −234.1

April 1,465 1,042.5 +422.5 1,128.4 +336.6

May 725 1,010.75 −285.75 1,007.4 −282.4

June 675 977.2 −302.2 907.7 −232.7

July 575 936.98 −361.98 807.9 −232.9

August 815 924.8 −109.8 810.03 +4.97

September 1,275 959.8 +315.2 949.5 +325.5

October 1,385 1,002.3 +382.7 1,080.2 +304.8

November 950 997.1 −47.1 1,041.1 −91.1

December 1,425 1,039.9 +385.1 1,156.3 +268.7

Total 11,900

x 991.7

Bias �(Dt – Ft) −1.63 −49.03

Bias x �(Dt – Ft)/n −0.1358 −4.09

Absolute Deviation �|Dt – Ft | 3,567.03 2,961.37

Absolute Deviation x �|Dt – Ft |/n 297.25 246.8

*Assume F1 ¼ 992 Source: Robert A. Novack, Ph.D. Used with permission.

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data. Column 1 shows the month, and Column 2 shows the demand. This example starts with the smoothed average equaling the demand for period 1. A trend estimate of 50 cases will be used. A smoothing parameter for both the average and trend of 0.2 will be used. To calculate the smoothed average for February, the following calculation is used (see above formula):

Smoothed Average ¼ ð0:2� 1,300Þ þ ð0:8Þð560þ 50Þ ¼ 748 units The trend estimate is also calculated using the above formula as follows:

Smoothed Trend ¼ ð0:2Þð748� 560Þ þ 0:8ð50Þ ¼ 77:6 With these calculations and similar ones for the remaining periods, values for columns 3

and 4 can be estimated. The forecast is simply calculated by adding the smoothed average and the smoothed trend. The results can be seen in column 5. Column 6 contains

Table 7.5 Trend-Adjusted Exponential Smoothing Forecast

(1) t PERIOD

(2) Dt

DEMAND

(3) At

SMOOTHED FORECAST

(4) Tt

TREND ESTIMATE

(5) Ft

At + Tt FORECAST

(6) Et

Dt – Ft ERROR

January 560 560.0 50.0 0 0

February 1,300 748.0 77.6 825.6 +474.4

March 750 810.5 74.6 885.1 −135.1

April 1,465 1,001.1 97.8 1,098.9 +366.1

May 725 1,024.1 82.8 1,106.9 −381.9

June 675 1,020.5 67.0 1,087.5 −412.5

July 575 985.0 46.5 1,031.5 −456.5

August 815 988.2 37.8 1,026.0 −211.0

September 1,275 1,075.8 47.8 1,123.6 +151.4

October 1,385 1,175.9 58.3 1,234.2 +150.8

November 950 1,177.4 46.9 1,224.3 −274.3

December 1,425 1,264.4 54.9 1,319.3 +105.7

Total 11,900

x 991.7

Bias �(Dt – Ft) −622.9

Bias x �(Dt – Ft)/n −56.6

Absolute Deviation �|Dt – Ft | 3,119.7

Absolute Deviation x �|Dt – Ft V n 283.6

α = 0.20, β = 0.20

Source: Robert A. Novack, Ph.D. Used with permission.

Demand Management 227

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the error figure, which is the difference between the forecast and actual demand. The results of applying this technique to the data for LuAnn’s Chocolates show a total bias of –622.9 cases or –56.6 cases per forecast period. Whereas the previous techniques resulted in positive bias figures, the trend-adjusted exponential smoothing method resulted in a negative. Normally, the smoothing constant can be adjusted in numerous trials in an attempt to reduce the bias of the forecast. With a positive bias, stockouts will occur. Management must decide whether or not this is acceptable based on the cost of a stockout. One more technique will be examined that will incorporate the concept of seasonality into the forecast.

Seasonal Influences on Forecasts Many organizations are faced with seasons that repeat themselves during a particular

period. These seasons might be by time of day (for example, demand for hamburgers at a fast-food outlet), by day of the week (for example, the demand for gasoline), by week, by the month, or by some combination of these. Adjusting a forecast for seasons basically uses a combination of seasonal factors and average demand to arrive at an adjusted forecast. Assume that LuAnn’s Chocolates experiences five separate seasons per year: Valentine’s Day, Easter, Summer, Halloween, and Christmas. Table 7.6 shows that each season is defined by several months: (1) Valentine’s Day includes January and February; (2) Easter includes March and April; (3) Summer includes May, June, July, and August; (4) Halloween includes September and October; and (5) Christmas includes November and December. Three years’ worth of data will be used to calculate the forecast using this technique. To calculate the forecast, a four-step process will be used.5

The first step is to calculate the average demand for each season for each year. For example, column 2 in Table 7.6 shows the demand for year 1, which is 11,900 cases. Since there are five seasons, divide total demand per year (11,900) by the number of sea- sons (5) to arrive at the average demand per season for that year. For year 1, the average demand per season is 2,380 cases. Table 7.6 shows the results of Step 1 for the three years’ worth of data. The second step requires that the total demand for a season in a year is divided by the average demand per season for that year. For example, for year 1, the Valentine’s Day actual demand is 1,860 cases. This is divided by the average demand per season for year 1 (2,380 cases) and results in an index of 0.7815 for season 1 (Valen- tine’s Day) for year 1. Step 2 results for all three years, worth of data can be seen in Table 7.7. The third step requires that an average seasonal index is calculated for all of the years in the data. For season 1 (Valentine’s Day), the three-year average seasonal index is 0.7836. This is calculated by adding together the three indices for this season (0.7815, 0.7869, and 0.7824) and dividing by three (the number of years of data). The resulting seasonal index for Valentine’s Day is 0.7836. The results of this step can be seen in Table 7.7. The final step estimates the average demand per season for the next period (year 4) by multiplying each season by its seasonal index. The results of this step can be seen in Table 7.8. For example, total demand for year 4 has been estimated to be 13,237 cases. The average demand per season is then 13,237 cases divided by five seasons, resulting in an average demand per season of 2,647.4 cases. Multiplying this sea- sonal average by the seasonal index for season 1 (Valentine’s Day) of 0.7836 results in a forecast of 2,075 cases. The actual demand for this season is 2,012 (Column 4) cases resulting in an error of –63.0 cases. As can be seen, this method results in a bias value of −398.0 for the year and an average bias per season of –79.6. This means that each season will have excess inventories using this forecasting technique. Again, management must decide if this inventory policy is acceptable based on the cost of a stockout versus the cost of holding excess inventory.

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This section provided several examples of forecasting techniques commonly used in industry. As can be seen from these examples, none of them were perfectly accurate. This is the nature of forecasting: all forecasts are wrong. What these examples did show is that different techniques will provide different results. Organizations must decide which technique and what level of data best fit their business demands. The idea here is that management must choose the method that minimizes forecast error, either posi- tively or negatively. Measuring forecast error is the focus of the next section.

Forecast Errors As previously mentioned, almost all forecasts will be wrong. Some forecasts will

be higher than demand, and some will be lower. Managing the forecasting process requires minimizing the errors between actual demand and forecasted demand. The key

Table 7.6 Seasonal Influenced Forecast: Step 1

STEP 1 (1) t PERIOD

(2) D1

YEAR 1 DEMAND

(3) D2

YEAR 2 DEMAND

(4) D3

YEAR 3 DEMAND

(5) TOTAL DEMAND

January 560 588 600 1,748

February 1,300 1,365 1,392 4,057

Total 1,860 1,953 1,992 5,805

March 750 795 819 2,364

April 1,465 1,553 1,600 4,618

Total 2,215 2,348 2,419 6,982

May 725 740 733 2,198

June 675 689 682 2,046

July 575 587 581 1,743

August 815 831 823 2,469

Total 2,790 2,847 2,819 8,456

September 1,275 1,326 1,392 3,993

October 1,385 1,440 1,512 4,337

Total 2,660 2,766 2,904 8,330

November 950 998 1,038 2,986

December 1,425 1,496 1,556 4,477

Total 2,375 2,494 2,594 7,463

Total Demand 11,900 12,408 12,728 37,036

Demand per Season 2,380 2,482 2,546 7,407

Source: Robert A. Novack, Ph.D. Used with permission.

Demand Management 229

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to successful forecasting is to choose the technique that provides the least amount of forecast error. To determine which forecasting technique is best for a set of data, the forecast error must be measured.

Four types of forecast error measures can be used. The first is called the cumulative sum of forecast errors (CFE) and can be calculated using Formula 7.6.

CFE ¼ ∑n t�1

et 7:6

CFE calculates the total forecast error for a set of data, taking into consideration both negative and positive errors. This is also referred to as bias and was used in Tables 7.2 through 7.8. This gives an overall measure of forecast error. However, taking into consid- eration both negative and positive errors, this method can produce an overall low error total although individual period forecasts can either be much higher or much lower than actual demand.

The second measure of forecast error is mean squared error (MSE). This measure is introduced in Table 7.9 and can be calculated using Formula 7.7.

MSE ¼ ∑E 2 t

n 7:7

This measure squares each period error so the negative and positive errors do not cancel each other out. MSE also provides a good indication of the average error per period over a set of demand data. Closely related to MSE is the third type of forecast error measure: mean absolute deviation (MAD). It can be calculated using Formula 7.8.

MAD ¼ ∑|Et| n

7:8

This measure is also calculated in Table 7.9. By taking the absolute value of each error, the negative and positive signs are removed and a good indication of average error per period is calculated. This measure is popular because it is easy to understand and provides a good indication of the accuracy of the forecast.

The final measure of forecast error is mean absolute percent error (MAPE). MAPE can be calculated using Formula 7.9.

MAPE ¼ ∑ð|Et|=DtÞ100 n

7:9

Table 7.9 shows the MAPE as well. MAPE relates the forecast error to the level of demand so different types of forecasts can be compared.

Table 7.10 provides a summary of the five types of forecasts used on LC’s data and resulting forecast error measures for each. For the most part, the forecasts became more accurate as they progressed from using simple moving average in the first exam- ple to the seasonal influenced forecast in the last example. However, exponential smoothing with alpha = 0.1 produced the best forecast if bias is used as the measure of forecast error. Using MAPE as the forecast measure, Table 7.10 shows that the fore- cast became more accurate as it moved from using simple moving average to seasonal influenced. This would also be true if MAD was used as the forecast error measure. So, in this example, the type of forecast error used will determine the best forecasting method.

230 Chapter 7

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231

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Supply Chain Technology

Delivering APS Value in Six Months

To support its strategic goal of becoming a leader in supply chain management, a large electron- ics equipment company initiated a massive transformation of its supply chain operations. Detailed assessment of its operations showed that the current operating model would not be capable of meeting the company’s needs over the next five to seven years. Revenues were expected to double, and the company faced increased product complexity and the need to improve operational efficiencies in an increasingly competitive market.

Based on this assessment, the executive team developed guidelines for the operating model of the future and identified the key capabilities required to support that model. The critical capabil- ities included real-time visibility into customer demand and inventory positions; ability to optimally balance supply and demand across the company’s extensive network of contract manufacturers and suppliers; and improved ability to plan and respond rapidly to changing market conditions. The company chose an APS technology to enable these capabilities. The vendor provided tool-specific expertise for installation and configuration of the application while the company’s own IT group managed the system integration.

Given its importance, the project had executive sponsorship from both the planning and IT organizations. The implementation team had co-heads from both business and IT. Team members were drawn from supply planners, IT resources, vendor resources and consultants. The team was challenged to deploy the APS solution and supporting processes within six months in order to drive the transformation of the company’s operating model; this is two-thirds of the minimum implementa- tion time typical. The project approach incorporated all the strategies described in this article.

First, specific individuals were chosen from the planning organization to form the modeling team. This team worked closely with the solution vendor to design the planning model and to configure it into the system.

Second, to maximize user adoption over the long term, all supply chain planners were included in the project implementation activities in various capacities. For example, planners were assigned specific data elements related to the products they were responsible for and led small “tiger teams” to identify and resolve data-quality issues. In addition to tackling data issues on an ongo- ing basis, the planners gained a deep understanding of the planning model and the data used.

Third, a small core team, derived from the modeling team, was established around the business solution to manage the continued evolution and enhancements to the planning model, processes, and business roadmap.

This approach helped the project team meet an aggressive six-month schedule set by the executive team. The solution was implemented and rolled out on time, including support for the user—the supply planners. The solution adoption process went smoothly compared to the typical APS project. Planners have not returned to old habits of planning on offline spread- sheets and processes. Instead, they are actively involved in defining enhancements to the model and in rolling out these enhancements in a phased manner.

Eleven months after the implementation, significant new business capabilities are now in place. For example, planners are able to respond quickly to demand upsides, allocate more supply ratio- nally, and spend more time on what-if analyses to proactively identify and resolve issues. The complete and integrated supply and demand visibility allows planners to project a component shortage at a board-assembly site all the way to the end demand, thus allowing them to manage customer requirements and expectations significantly more effectively than before. The company is now well-placed to support much higher growth rates.

Source: “Delivering APS Value in Six Months,” Supply Chain Management Review (July/August 2008): 35. Reproduced by permission.

Table 7.7 Seasonal Influenced Forecast: Steps 2 and 3

STEP 2 t SEASON

(2) YEAR 1

(3) YEAR 2

(4) YEAR 3

1 1,860/2,380 = 0.7815 1,953/2,482 = 0.7869 1,992/2,546 = 0.7824

2 2,215/2,380 = 0.9307 2,348/2,482 = 0.9460 2,419/2,546 = 0.9501

3 2,790/2,380 = 1.1723 2,847/2,482 = 1.1471 2,819/2,546 = 1.1072

4 2,660/2,380 = 1.1176 2,766/2,482 = 1.1144 2,904/2,546 = 1.1406

5 2,375/2,380 = 0.9979 2,494/2,482 = 1.0048 2,594/2,546 = 1.0189

Step 3 Season Average Seasonal Index

1 (0.7815 + 0.7869 + 0.7824)/3 = 0.7836

2 (0.9307 + 0.9460 + 0.9501)/3 = 0.9423

3 (1.1723 + 1.1471 + 1.1072)/3 = 1.1422

4 (1.1176 + 1.1144 + 1.1406)/3 = 1.1242

5 (0.9979 + 1.0048 + 1.0189)/3 = 1.0072

Source: Robert A. Novack, Ph.D. Used with permission.

Table 7.8 Seasonal Influenced Forecast: Step 4

STEP 4 (1) SEASON

(2) YEAR 4 AVERAGE

DEMAND

(3) SEASONAL INDEX

(4) Dt

ACTUAL DEMAND

(5) Ft

FORECAST

(6) Et

Dt – Ft ERROR

1 2,647.4 0.7836 2,012 2,075 −63.0

2 2,647.4 0.9423 2,420 2,495 −75.0

3 2,647.4 1.1422 2,931 3,024 −93.0

4 2,647.4 1.1242 2,888 2,976 −88.0

5 2,647.4 1.0072 2,587 2,666 −79.0

Total Demand 13,237

Bias �(Dt – Ft) −398.0

Bias x �(Dt – Ft)/n −79.6

Absolute Deviation �|Dt – Ft | 398.0

Absolute Deviation x �|Dt – Ft |/n 79.6

Source: Robert A. Novack, Ph.D. Used with permission.

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Forecasting demand is a highly scientific art. Rigorous quantitative techniques exist to manipulate historical data to predict the future. However, the assumption made here is that the future will repeat the past. This is normally not the case. As such, it is important to choose the technique that best fits the data in order to minimize the forecast error. Minimizing this error will result in the most accurate forecast.

Table 7.9 Forecast Error*

(1) t PERIOD

(2) Dt

DEMAND

(3) Ft

FORECAST

(4) Et

ERROR

(5) Et2

ERROR2

(6) |Et |

ABSOLUTE ERROR

(7) (|Et | / Dt)100 ABSOLUTE %

ERROR

January 560 992 −432.0 186,624 432.0 77.1

February 1,300 1022.8 +277.2 76,839.8 277.2 21.3

March 750 995.5 −245.5 60,270.25 245.5 32.7

April 1,465 1,042.5 +422.5 178,506.25 422.5 28.84

May 725 1,010.75 −285.75 81,653.06 285.75 39.4

June 675 977.2 −302.2 91,324.84 302.2 44.8

July 575 936.98 −361.98 131,029.52 361.98 62.9

August 815 924.8 −109.8 12,056.04 109.8 13.6

September 1,275 959.8 +315.2 99,351.04 315.2 24.7

October 1,385 1,002.3 +382.7 146,459.29 382.7 27.6

November 950 997.1 −47.1 2,218.41 47.1 4.9

December 1,425 1,039.9 +385.1 148,302.01 385.1 27.0

Total 11,900 1,214,634.6 3,567.03 404.8%

x 991.7

CFE −1.63

CFEx −0.1358

Mean Squared Error : MSE ¼ ∑E 2 t

n ¼ 1,214,634:612 ¼ 101; 219:55

Standard Deviation: a ¼ ffiffiffiffiffiffiffiffiffiffi

MSE p

¼ ffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi101,219:55p ¼ 318:2

Mean Absolute Deviation: MAD ¼ ∑|E t |n ¼ 3,567:0312 ¼ 297:3

Mean Absolute Percent Error : MAPE ¼ ∑ð|E t |Dt Þ100n ¼ 404:812 ¼ 33:7%

*Uses exponential smoothing forecast (α = 0.1) from Table 7.4.

Source: Robert A. Novack, Ph.D. Used with permission.

Demand Management 233

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Sales and Operations Planning The previous section discussed statistical methods for arriving at a preliminary

demand forecast for an organization. Historically, many organizations developed several functional forecasts for the same products during the same time period. It would not be unusual for a manufacturer to have a financial forecast, a manufacturing forecast, a mar- keting forecast, and a distribution forecast. What compounds the complexity of having multiple forecasts is that most times these functional forecasts did not agree. Marketing would forecast higher demands that neither manufacturing nor distribution could exe- cute. Finance forecasts would be higher than marketing would be able to meet. It is nec- essary for an organization to arrive at a forecast internally that all functional areas agree upon and can execute. A process that can be used to arrive at this consensus forecast is called sales and operations planning (S&OP). The S&OP Benchmarking Consortium in the Center for Supply Chain Research adopted a five-step process in arriving at this con- sensus forecast.6 Figure 7.2 illustrates this process. Step 1 (Run sales forecast reports) requires the development of a statistical forecast of future sales. This would be done using one or more of the forecasting techniques discussed in the previous section.

Step 2 (Demand planning phase) requires the sales and/or marketing departments to review the forecast and make adjustments based on promotions of existing products, the introductions of new products, or the elimination of products. This revised forecast is usually stated in terms of both units and dollars since operations are concerned with units and finance is concerned with dollars.

Step 3 (Supply planning phase) requires operations (manufacturing, warehousing, and transportation) to analyze the sales forecast to determine if existing capacity is adequate to handle the forecasted volumes. This requires analyzing not only the total volumes but also the timing of those volumes. For example, existing manufacturing capacity might be adequate if demand is stable over the forecast period. However, heavy promotions might produce a “spike” in demand that might exceed existing capacity. Two options to solve this capacity constraint are available. First, the promotional activity could be curtailed to bring demand to a more stable level. This could result in lost revenue. Second, additional

Table 7.10 Forecast Accuracy Summary

(1) n

(2) CFE

�(Dt – Ft) BIAS

(3) �(Dt – Ft)/n BIAS X

(4) �|Dt – Ft | ABSOLUTE DEVIATION X

(5) �|Dt – Ft | /n ABSOLUTE DEVIATION X

(6) MAPE

1. Simple Moving Average 9 +716.8 +79.6 3,396.8 377.4 39.1%

2. Weighted Moving Average 9 +658.75 +73.2 3,315.3 368.4 37.4%

3. Exponential Smoothing

α = 0.1 12 −1.63 −0.1358 3,567.03 297.25 33.7%

α = 0.3 12 −49.03 −4.09 2,961.37 246.8 28.2%

4. Trend-Adjusted Exponential Smoothing 11 −622.9 −56.6 3,119.7 283.6 32.5%

5. Seasonal Influenced 5 −398.0 −79.6 398.0 79.6 3.1%

Source: Robert A. Novack, Ph.D. Used with permission.

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manufacturing could be secured either by investing in more manufacturing capacity internally or securing contract manufacturing capacity externally. This would result in additional costs. The same types of capacity issues would need to be considered for both warehousing space and transportation vehicle capacity with similar resulting options if capacity does not meet demand: either curtail demand or invest in additional capacity. The decisions to these capacity issues are addressed in the next step.

Step 4 (Pre-S&OP meeting) asks individuals from sales, marketing, operations, and finance to attend a meeting that reviews the initial forecast and any capacity issues that might have emerged during Step 3. Initial attempts will be made during this meeting to solve capacity issues by attempting to balance supply and demand. Alternative scenarios are usually developed to present at the executive S&OP meeting (Step 5) for consider- ation. These alternatives would identify potential lost sales and increased costs associated with balancing supply and demand. The sales forecast is also converted to dollars to see if the demand/supply plan meets the financial plan of the organization.

Step 5 (Executive S&OP meeting) is where final decisions are made regarding sales forecasts and capacity issues. This is where the top executives from the various func- tional areas agree to the forecast and convert it into the operating plan for the organiza- tion. Consensus among the various functional areas is critical in this meeting. Decisions

Demand Management 235

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Figure 7.2 The Monthly Sales & Operations Planning Process

Step 1

Run sales forecast reports

End of month

Step 2

Demand planning

phase

Statistical forecasts field sales worksheets

Step 3

Supply planning

phase

Management forecast first-pass spreadsheets

Step 4

Pre-S&OP meeting

Capacity constraints second-pass spreadsheets

Step 5

Executive S&OP

meeting

Recommendations and agenda for Executive S&OP

Decisions authorized game plan

Source: Thomas F. Wallace, Sales and Operations Planning: The How-To Book, (Cincinnati, OH: T. F. Wallace and Company, 2000): 43. Copyright © 2000 by Thomas F. Wallace. Reproduced by permission.

regarding tradeoffs between revenue and costs are made here. Once the final plan is approved, it is important that the appropriate metrics are in place for each functional area to encourage compliance to the plan. For example, assume that the traditional operating metric for manufacturing is cost per pound manufactured. The lower the cost per pound, the better is the performance of the manufacturing group. However, the S&OP plan requires additional investment in capacity for manufacturing, which raises the cost per manufactured pound. This would make manufacturing performance unacceptable. While low cost is important, manufacturing has little or no control over the increased cost. A revised metric of compliance to schedule might be more appro- priate. This new metric would reward manufacturing for making the planned quanti- ties at the planned times. The point here is that the appropriate metrics must be in place for each functional area so that it is encouraged and rewarded for achieving the business plan.

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On the Line BASF Credits S&OP as a Cornerstone of Success

BASF is the world’s largest chemical company, with revenues of $82 billion in 2008. “We have doubled our revenues in the last seven years, and we are the world’s most profitable chemical company,” reports Alan Milliken, the firm’s business process education manager. “S&OP has def- initely played a part in this.”

BASF implemented its first S&OP process in 1992. Since that time, it has been expanding the use of the strategy to all of its business units. Currently, the company has implemented S&OP in virtually all of its 75 or so business units. “The only units where it is not in place are those that we have just acquired in the last year or so,” says Milliken.

Why is S&OP so useful to BASF? When people ask Milliken this question, most expect him to respond with one or more of S&OP’s traditional benefits, such as better service, less inventory, and lower cost. Indeed, Milliken admits that these are important.

However, the greatest benefit that S&OP provides the company, according to Milliken, has been the creation of formal and comprehensive cross-functional teamwork and communication. In effect, everyone in the organization now knows what everyone else is doing. “We have really benefited from having a truly integrated organization,” he emphasizes.

Milliken explains the process like this: When you are in difficult economic times like these, and you have the formal structure of the S&OP process, plus the formal cross-functional integration and collaboration structure that S&OP has helped to create, you can respond to market condi- tions so much faster and better. Milliken continues: “If you try to respond with traditional com- munication during tough economic times—the hierarchical route, where you ‘throw it over the fence’ and wait for a responsethat will be a killer. In a siloed organization, you just can’t deal with the problems that occur in an economy like this.”

For BASF, its ability to respond effectively during any economic conditions is a result of having built a cohesive cross-functional teamwork and communication network. And the root of that, Milliken emphasizes, has been the S&OP process.

Source: “BASF Credits S&OP as a Cornerstone of Success,” Supply Chain Management Review (September 2009): S52. Reproduced by permission.

Collaborative Planning, Forecasting, and Replenishment

The S&OP process described how organizations are structuring their planning processes to arrive at a consensus forecast internally. The next logical step would be for members of a supply chain to also agree upon a consensus forecast. Many industry initiatives have attempted to create efficiency and effectiveness through the integration of supply chain activities and processes. They have been identified by such names as quick response (QR), vendor-managed inventory (VMI), continuous replenishment planning (CRP), and efficient consumer response (ECR). All of these have had some success at integrating replenishment between supply chain members. However, they were all somewhat deficient in that they did not include a strong incentive for collabora- tive planning among supply chain members.

One of the most recent initiatives aimed at achieving true supply chain integration is collaborative planning, forecasting, and replenishment (CPFR).7 CPFR has become rec- ognized as a breakthrough business model for planning, forecasting, and replenishment. Using this approach, retailers, distributors, and manufacturers can utilize available Internet-based technologies to collaborate on operational planning through execution. Transportation providers have now been included with the concept of collaborative transportation management (CTM). Simply put, CPFR allows trading partners to agree to a single forecast for an item where each partner translates this forecast into a single execution plan. This replaces the traditional method of forecasting where each trading partner developed its own forecast for an item and each forecast was different for each partner.

The first attempt at CPFR was between Walmart and Warner-Lambert (now a part of Johnson & Johnson) in 1995 for its Listerine product line. In addition to rationalizing inventories of specific line items and addressing out-of-stock occurrences, these two organizations collaborated to increase their forecast accuracy, so as to have the right amount of inventory where it was needed, when it was needed. The three-month pilot produced significant results and improvements for both organizations. This resulted in the adoption of CPFR by both Walmart and many of its other suppliers to manage inventories through collaborative plans and forecasts.

Figure 7.3 shows the CPFR model as a sequence of several business processes that include the consumer, retailer, and manufacturer. The four major processes are (1) strat- egy and planning, (2) demand and supply management, (3) execution, and (4) analysis. Two aspects of this model are important to note. First, it includes the cooperation and exchange of data among business partners. Second, it is a continuous, closed-loop pro- cess that uses feedback (analysis) as input for strategy and planning.

Figure 7.4 demonstrates how the process shown in Figure 7.3 is executed. As shown in Figure 7.4, CPFR emphasizes a sharing of consumer purchasing data (or point-of-sale data) as well as forecasts at retail among and between trading partners for the purpose of helping to manage supply chain activities. From these data, the manufacturer analyzes its ability to meet the forecasted demand. If it cannot meet the demand, a collaborative effort is undertaken between the retailer and manufacturer to arrive at a mutually agreed-upon forecast from which execution plans are developed. The strength of CPFR is that it provides a single forecast from which trading partners can develop manufactur- ing strategies, replenishment strategies, and merchandising strategies.

Demand Management 237

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The CPFR process begins with the sharing of marketing plans between trading part- ners. Once an agreement is reached on the timing and planned sales of specific products, and a commitment is made to follow that plan closely, the plan is then used to create a forecast, by stock-keeping unit (SKU), by week, and by quantity. The planning period can be for 13, 26, or 52 weeks. A typical forecast is for seasonal or promotional items that represent approximately 15 percent of sales in each category. The regular turn items, or the remainder of the products in the category, are forecast statistically. Then the forecast is entered into a system that is accessible through the Internet by either trading partner. Either partner may change the forecast within established parameters.

Theoretically, an accurate CPFR forecast could be translated directly into a produc- tion and replenishment schedule by the manufacturer since both quantity and timing are included in the CPFR forecast. This would allow the manufacturer to make the pro- ducts to order (based on the quantity and timing of demand) rather than making them

Figure 7.3 The CPFR Model

Strategy & Planning

Demand & Supply Management

Execution

Analysis

Manufacturer

Consumer

Retailer

Customer Scorecard

Supplier Scorecard

Execution Monitoring

Account Planning

Vendor Managment

Market Planning

Performance Assessment

Collaboration Arrangement

Joint Business

PlanCategory Management

Exception Management Store

Execution

Logistics/ Distribution

Order Fulfillment

Logistics/ Distribution

Order Generation

Production & Supply Planning

Demand Planning

Order Planning/

Forecasting

Buying/ Rebuying

Replenishment Planning

Market Data

Analysis

Sales Forecasting

Point-of-Sale Forecasting

Source: Larry Smith, “West Marine: A CPFR Success Story,” Supply Chain Management Review (March 2006): 31. Copyright © 2006 Reed Business Information, a division of Reed Elsevier. Reproduced by permission.

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Figure 7.4 CPFR Business Model

Develop Front-End Agreement

Distributor Business Development Activities

Manufacturer Business Development Activities

Create Joint Business Plan

Create Sales Forecast

Create Order Forecast

Order Generation ProduceProduct

Order Filling/ Shipment ExecutionDelivery Execution

Consumer

Retail Store

Distributor Receiving

Identify Exceptions for Sales Forecast

Manufacturer Materials & Production

Planning

Constraints

Unresolved Supply Constraints

Identify Exceptions for Order Forecast

Resolve/Collaborate On Exception Items

Resolve/Collaborate On Exception Items

1

2

3

4

5

6

7

8

9

Distributor Exception Triggers

Distributor Exception Triggers

Manufacturer Exception Triggers

Manufacturer Decision Support Data

Manufacturer Decision Support Data

Updated Data for Exception Items

Manufacturer Exception Triggers

Order Forecast

Frozen Forecast

Feedback

Product

Order/PO

Order filling feedback

Distributor Decision Support Data

Distributor Decision Support Data

POS Data

Long Term Short

Term

Exception Items

Exception Items

Exception Criteria

Exception Criteria Planning

Forecasting Replenishm

ent

Key: Distributor Activities

Either/Joint Activities

Manufacturer Activities

Source: CPFR® is a registered trademark of the Voluntary Interindustry Commerce Standards (VICS) Association. Reproduced by permission of the Voluntary Interindustry Commerce Standards (VICS) Association.

Demand Management 239

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to inventory, thus reducing total inventories for the manufacturer. The retailer would enjoy fewer out-of-stocks at the retail shelf. Although CPFR has not yet fully developed into a make-to-order environment, it has enjoyed the benefits of reduced supply chain inventories and out-of-stocks. West Marine employed the CPFR model with its suppliers and reaped some amazing results. More than 70 of its top suppliers are loading West Marine order forecasts directly into their production planning systems. In-stock rates at stores are close to 96 percent, forecast accuracy has risen to 85 percent, and on-time shipments are better than 80 percent.8 So, the use of collaborative efforts among supply chain partners can have positive results on the service and cost performance of these partners.

Fulfillment Models The beginning of this chapter emphasized the planning and forecasting aspects

of demand management. Once these elements of demand management are agreed upon, the plan needs to be executed. This will be done through the fulfillment process. Chapter 8 will discuss in more depth the concept of order management. The remainder of this chapter, however, will highlight the various distribution channel strategies that can be used to deliver on the demand forecast.

Channels of Distribution A channel of distribution consists of one or more organizations or individuals who

participate in the flow of goods, services, information, and finances from the production point to the final point of consumption. A channel of distribution can also be thought of as the physical structures and intermediaries through which these flows travel. These channels encompass a variety of intermediary firms, including those that can be classi- fied as distributors, wholesalers, retailers, transportation providers, and brokers. Some of these intermediary firms take physical possession of the goods, some take title to the goods, and some take both. Thus, it is critical in the design of a distribution channel to take into consideration both the logistics channel and the marketing channel.

The logistics channel refers to the means by which products flow physically from where they are available to where they are needed. The marketing channel refers to the means by which necessary transactional elements are managed (for example, customer orders, billing, accounts receivable). These two channels are illustrated in Figure 7.5.

Effective channel management requires a good grasp of the different alternatives avail- able to deliver a product and the resulting benefits of each. The four basic functions of the logistics channel are (1) sorting out, (2) accumulating, (3) allocating, and (4) assorting. Channel systems can be classified as either direct or indirect and can be further subdivided into traditional and vertical marketing systems (VMS). With the VMS, some degree of implicit or explicit relationship exists among the organizations in the channel and channel members have considerable opportunities to coordinate their activities.

Using the grocery industry as an example, Figure 7.6 shows the numerous channels of distribution that are responsible for delivering products to consumers. While it is true that several of these channels might compete with one another, collectively they provide the consumer with a significant number of choices as to where and how to purchase grocery products. Each individual channel represents a unique path from grocery manufacturer to consumer, and a set of effective logistics strategies must be developed for each channel.

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Figure 7.5 Logistics and Marketing Channels

Wholesaler/ Distributor

Logistical channel Marketing channel

Supplier

Manufacturer

Distribution center

Retail store

E-Procurement

National account sales

Retail customer

Transportation

Transportation

Transportation

Consumer

Source: Robert A. Novack, Ph.D. Used with permission.

Figure 7.6 Examples of Channels of Distribution for the Food Products Manufacturing Industry

Internet retailer

Internet (direct)

Food manufacturing firms

Food service distributors

Grocery wholesalers

Food brokers

Retail chains (national)

Institutional buyers

Retail grocers

(independent)

Retail chains (local and regional)

Specialty (airlines,

etc.)

Consumers of manufactured food products

Restaurants

Source: C. John Langley Jr., Ph.D. Used with permission.

Demand Management 241

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An important observation to note about channel structure involves the elements of fixed costs versus variable costs. Using Figure 7.6 as an example, assume that a food man- ufacturer uses a traditional channel to deliver its product to a retail store. One channel would include the manufacturer, the manufacturer’s distribution center, the retailer’s dis- tribution center, and the retailer’s store. This channel involves a significant amount of fixed costs in the form of distribution centers and stores. However, variable costs, in the form of transportation, are relatively low since most shipments would be made in large volume quantities between channel members. Assume that the food manufacturer decided to begin Internet fulfillment direct to the consumer (this is the second channel from the right in Figure 7.6). While much of the fixed cost in this channel is significantly reduced (eliminating the need for the retailer’s distribution center and stores), the variable trans- portation costs will increase significantly. This occurs because the origin (food manufac- turer) and ultimate destination (consumer) in both channels are the same, resulting in approximately the same distance to move product, but the shipment size is reduced signif- icantly. The lower the shipment size the higher the transportation cost per pound, holding constant commodity and distance. So a rule of thumb in channel design is, assuming that the origin and destination remain the same, the more intermediaries used to deliver the product the higher the fixed cost and the lower the variable cost, and vice versa.

Direct-to-Customer (DTC) Fulfillment As previously mentioned, many different types of channel structures are available in an

industry to deliver product to the point of consumption. This section will offer a brief dis- cussion of several models that can and are being used in the retail industry. Figure 7.7 shows

Figure 7.7 Direct-to-Customer (DTC) Fulfillment

Delivery, Parcel Carrier or Pick-up

Retail Store

Consumer

Parcel Carrier

Current Retail DC

Dedicated DC

Third-party DC

Supplier/ Manufacturer

Insource Outsource

Retail Store

Current Retail DC

1

Integrated Fulfillment

2

Dedicated Fulfillment

3

Outsourced Fulfillment

4

A B

Drop-shipped Fulfillment

5

Store Fulfillment

6

Flow-through Fulfillment

Direct-to-customer (DTC) fulfillment

Call Center Options

Physical Fulfillment Models

Source: Robert A. Novack, Ph.D. Used with permission.

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several of these channels and will provide the basis for discussion in the remainder of this section.

Integrated Fulfillment Many retailers today maintain both a “bricks-and-mortar” and “clicks-and-mortar”

presence to the consumer. That is, retailers have both retail stores as well as Internet sites where consumers can buy direct. One example would be Office Depot with its large num- ber of retail outlets as well as its presence with Office Depot.com. Integrated fulfillment means the retailer operates one distribution network to service both channels.

This fulfillment model can be seen in Figure 7.8. In a typical distribution center for this model, both store orders and consumer orders are received, picked, packed, and shipped. One advantage to this model is low start-up costs. If the retailer has an established distri- bution network that handles store orders and then decides to develop an Internet pres- ence, the existing network can service both. In other words, new distribution centers need not be built. This would also eliminate the need to have a duplicate inventory to han- dle the Internet orders. Another advantage to this model is workforce efficiency because of consolidated operations. The existing workforce now has an opportunity to move more volume through a fixed-cost facility. However, this model has several challenges. First, the order profile will change with the addition of consumer Internet orders. While store orders would probably be picked in case and/or pallet quantities, consumer orders would require consumer units (eaches) in smaller order quantities. Second, products might not be available in eaches. While cases and inner-packs might be the minimum order quan- tity for a store, an individual unit (each) might be required for a consumer order. Third, the addition of unit pick (each pick) would require a “fast pick,” or broken case, opera- tion to be added to the distribution center. Case pick operations are usually very

Figure 7.8 Integrated Fulfillment

Retailer Distribution Center

Manufacturer Distribution Center

Picking Picking

Retail Store

Truckload

Case

Each

Consumer

Consumer

Source: Robert A. Novack, Ph.D. Used with permission.

Demand Management 243

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efficient because of the use of automation in the form of conveyors to move a large vol- ume very quickly. Unit picks are very labor intensive and will not be able to move very much volume. Finally, a conflict might arise between a store order and an Internet order. If both orders want the same item and there is not sufficient inventory to fill both, which gets priority? Some would argue that the Internet order should be filled because the retailer has already received the money for the items. Others might argue that the store should get the inventory since it is also a customer of the distribution cen- ter and each store is a separate profit and loss center. So, this model presents some econ- omies because it can use existing resources to satisfy the needs of two channels. However, it presents some operating challenges that must be addressed.

Dedicated Fulfillment Another option for the retailer that desires to have both a store and an Internet pres-

ence is called dedicated fulfillment, which achieves the same delivery goals as integrated fulfillment but with two separate distribution networks. An example would be Walmart with separate networks for its stores and Internet orders. This model can be seen in Figure 7.9. Having a separate distribution network for store delivery and consumer deliv- ery eliminates most of the disadvantages of integrated fulfillment. However, now the retailer is faced with duplicate facilities and duplicate inventories. This assumes that the retailer offers exactly the same product offering through both channels. However, many retailers offer many more products on their Internet sites than they offer in their stores. This makes dedicated fulfillment a more logical choice.

Outsourced Fulfillment While both integrated and dedicated fulfillment assume that the retailer will perform

the fulfillment itself, outsourced fulfillment assumes that another firm will perform the

Figure 7.9 Dedicated Fulfillment

Consumer Retailer

Distribution Center

Retailer Distribution Center

Manufacturer Distribution Center

Picking

Picking

Picking

Retail Store

Consumer

Source: Robert A. Novack, Ph.D. Used with permission.

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fulfillment. Many retailers, such as Toys “R” Us and Lands’ End, will maintain internal control of store fulfillment and outsource some, if not all, Internet fulfillment to a third party. This can be seen in Figure 7.10. One advantage of this outsourcing is low start- up costs for the retailer to service the Internet channel. Many clothing retailers, such as Lands’ End and Dockers, use Amazon.com for some or all of their Internet fulfillment operations because of their established practices for picking and shipping individual consumer units. Also, possible transportation economies could result from using out- sourced fulfillment for Internet orders. Amazon.com could easily add products from Lands’ End and Dockers to its existing Web site. Consumers, then, would have more choices of products when creating their orders, resulting in more items per order and possibly lower transportation costs. A major disadvantage often cited with outsourcing fulfillment is the loss of control the retailer might experience over service levels. This topic was covered in Chapter 4, where supply chain relationships are discussed. So, the major benefit of outsourced fulfillment is the ability to use existing external expertise in fulfillment. The major disadvantage of this model is the potential loss of control.

Drop-Shipped Fulfillment According to the model known as drop-shipped fulfillment, which is also referred to

as direct store delivery, the manufacturer delivers its product directly to a retailer’s stores, bypassing the retailer’s distribution network, as illustrated in Figure 7.11. A good example of this type of fulfillment is provided by Frito-Lay, a company that manufac- tures its products and stores them in its distribution network. From this central distribu- tion network, products flow to regional storage locations where Frito-Lay delivery vehicles are stocked and then make direct store deliveries in a small geographic area. The driver of the vehicle will restock the retailer’s shelves, rotate stock, merchandize the inventory, and gather competitive pricing and slotting information at the store level. A major advantage of this model is the reduction of inventory in the distribution network.

Figure 7.10 Outsourced Fulfillment

Retailer Distribution Center

Outsourced Distribution Center

Manufacturer Distribution Center

Picking

Picking

Picking

Retail Store Consumer

Consumer

Source: Robert A. Novack, Ph.D. Used with permission.

Demand Management 245

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This occurs because the retailer does not need to stock Frito-Lay’s inventory in its distri- bution centers. Another major advantage to Frito-Lay is the direct control of its invento- ries at the store level. A disadvantage to the retailer is the possible reduction of inventory visibility of Frito-Lay’s products since the retailer does not “touch” these products in its distribution network.

This type of model requires close collaboration and agreement between the manufac- turer and retailer for several reasons. First, not every retailer supplier can do drop-shipped fulfillment. From a practical perspective, if every supplier to a store delivered direct on a daily basis, the number of delivery vehicles and manufacturer personnel in a store would cause overwhelming congestion at the store. Second, the retailer and manufacturer need to agree on the types and timing of information shared on inventory levels to provide the retailer with the proper level of inventory visibility. Finally, drop-shipped fulfillment works best for products that have a short shelf life and/or where freshness is a requirement. As such, this model makes sense for a limited number of products sold in a retail store.

Store Fulfillment For a retailer that has both a storefront as well as an Internet presence, store fulfill-

ment can offer several opportunities. In this model, shown in Figure 7.12, the order is placed through the Internet site. The order is sent to the nearest retail store where it is picked and put aside for the customer to pick up. This works well for large electronic appliances (such as plasma screen televisions) and is used by firms such as Best Buy. Several advantages exist for this type of fulfillment. First, there is a short lead time to the customer if the item is in stock. Second, there are low start-up costs for the retailer. Inventory is already in place in close proximity to the consumer. Third, returns can be

Figure 7.11 Drop-Shipped Fulfillment

Retail Store “A”

Retail Store “B”

Retail Store “C”

Manufacturer Distribution Center

Picking

Manufacturer Regional Warehouse

Picking

LTL

Consumer

Consumer

Consumer

Source: Robert A. Novack, Ph.D. Used with permission.

246 Chapter 7

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handled in the usual manner through the retail store. Finally, the product will be avail- able in consumer units.

Several disadvantages exist for this type of fulfillment. First, there might be reduced control and consistency over order fill since each store will be responsible for its own order picking. Second, conflict may arise between inventories. Stores hold inventories for the shopper, which can result in impulse buys. Now the store is required to remove the item from the shelf for an Internet order, resulting in a possible out-of-stock at the shelf. One method to alleviate this conflict is to adjust the profit of the store so it also gets credit for the Internet sale. Third, the retailer must have real-time visibility to in- store inventories in order to satisfy the Internet order. Finally, stores lack sufficient space to store product. Staging products for customer pickups in any area of the store takes space away to generate additional sales for the store.

Flow-Through Fulfillment The flow-through fulfillment method, illustrated in Figure 7.13, is very similar to store

fulfillment. The main difference between the two is that in flow-through fulfillment the product is picked and packed at the retailer’s distribution center and then sent to the

Figure 7.12 Store Fulfillment

Manufacturer Distribution Center

Picking

Retailer Distribution Center

Picking Picking

Retail Store Consumer

Source: Robert A. Novack, Ph.D. Used with permission.

Figure 7.13 Flow-Through Fulfillment

Picking

Retailer Distribution Center

Picking

Retail Store

Manufacturer Distribution Center Consumer

Source: Robert A. Novack, Ph.D. Used with permission.

Demand Management 247

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store for customer pickup. Again, this is a common method used in the consumer elec- tronics retailing industry. Another example of this practice is Walmart’s “Site to Store” option. The flow-through model eliminates the inventory conflict the store might realize between store sales and Internet sales. Because the consumer is providing the pickup ser- vice, the retailer avoids the cost of the “last mile” transportation. The retailer also does not need store-level inventory status in the flow-through model. Returns can be handled through the existing store network, as in store fulfillment. Storage space at the store for pickup items remains an issue.

In conclusion, the retailing industry offers many models of fulfillment to get product into consumers’ hands. Each one has advantages and disadvantages. The choice of the proper model(s) will depend on both cost considerations and market influences.

248 Chapter 7

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SUMMARY • Outbound-to-customer logistics systems have received the most attention in many companies; but even in today’s customer service environment, outbound and inbound logistics systems must be coordinated.

• Demand management may be thought of as “focused efforts to estimate and manage customers’ demand, with the intention of using this information to shape operating decisions.”

• Although many forecasts are made throughout the supply chain, the forecast of pri- mary demand from the end user or consumer will be the most important. It is essential that this demand information be shared with trading partners throughout the supply chain and be the basis for collaborative decision making.

• Various approaches to forecasting are available, each serving different purposes. The S&OP process has gained much attention in industry today. It serves the purpose of allowing a firm to operate from a single forecast.

• The S&OP process is a continual loop involving participation from sales, operations, and finance to arrive at an internal consensus forecast.

• CPFR is a method to allow trading partners in the supply chain to collaboratively develop and agree upon a forecast of sales. This allows for the elimination of invento- ries held because of uncertainty in the supply chain.

• A number of distribution channel alternatives might be considered by organizations today. Effective management of the various choices requires coordination and integra- tion of marketing, logistics, and finance within the firm, as well as coordination of overall channel-wide activities across the organizations in the channel.

STUDY QUESTIONS 1. What are the differences and similarities between outbound and inbound logistics systems? Which types of industries would place heavier emphasis on outbound systems? On inbound systems? Explain your choices.

2. How do outbound logistics systems relate directly to the needs of the customer?

3. How can demand management help to unify channel members, satisfy customers, and solve customer problems?

4. What are some of the logistics problems that might arise when supply and demand for a product are not aligned properly? What are some of the methods used to soften the effects of this imbalance?

5. What are the basic types of forecasts? What are their strengths and weaknesses?

6. What are the basic elements of the S&OP process? How do marketing, logistics, finance, and manufacturing contribute to each element?

7. What are the critical elements of collaborative planning? What benefits do they provide for the supply chain?

8. What are the similarities between the CPFR and S&OP processes? What are the differences?

9. What are the various retail fulfillment models? What are the strengths and weaknesses of each?

Demand Management 249

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NOTES 1. Roger D. Blackwell and Kristina Blackwell, “The Century of the Consumer: Converting Supply Chains into Demand

Chains,” Supply Chain Management Review, No. 3 (Fall 1999): 22–32.

2. Ibid., 32.

3. Jim R. Langabeer, “Aligning Demand Management with Business Strategy,” Supply Chain Management Review (May/June 2000): 66–72.

4. Lee J. Krajewski and Larry P. Ritzman, Operations Management: Strategy and Analysis, 4th ed. (Reading, MA: Addison- Wesley, 1996), 474.

5. This section was adapted from Krajewski and Ritzman (1996), 477–78.

6. Adapted from Tom Wallace, Sales and Operations Planning: The “How-To” Handbook (Cincinnati, OH: T. F. Wallace, 1999), 43–50. This process will be briefly described in this section.

7. CPFR® is a registered trademark of the Voluntary Interindustry Commerce Standards (VICS) Association.

8. Larry Smith, “West Marine: A CPFR Success Story,” Supply Chain Management Review (March 2006): 20–36.

250 Chapter 7

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CASE 7 .1

Tires for You, Inc. Tires for You, Inc. (TFY), founded in 1987, is an automotive repair shop specializing

in replacement tires. Located in Altoona, Pennsylvania, TFY has grown successfully over the past few years because of the addition of a new general manager, Ian Overbaugh. Since tire replacement is a major portion of TFY’s business (it also performs oil changes, small mechanical repairs, etc.), Ian was surprised at the lack of forecasts for tire con- sumption for the company. His senior mechanic, Skip Grenoble, told him that they usu- ally stocked for this year what they sold last year. He readily admitted that several times throughout the season stockouts occurred and customers had to go elsewhere for tires.

Although many tire replacements were for defective or destroyed tires, most tires were installed on cars whose original tires had worn out. Most often, four tires were installed at the same time. Ian was determined to get a better idea of how many tires to hold in stock during the various months of the year. Listed below is a summary of individual tire sales by month:

PERIOD TIRES USED

2010

October 9,797

November 11,134

December 10,687

2011

January 9,724

February 8,786

March 9,254

April 10,691

May 9,256

June 8,700

July 10,192

August 10,751

September 9,724

October 10,193

November 11,599

December 11,130

Ian has hired you to determine the best technique for forecasting TFY demand based on the given data.

Demand Management 251

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CASE QUESTIONS 1. Calculate a forecast using a simple three-month moving average.

2. Calculate a forecast using a three-period weighted moving average. Use weights of 0.60, 0.30, and 0.10 for the most recent period, the second most recent period, and the third most recent period, respectively.

3. Calculate a forecast using the exponential smoothing method. Assume the forecast for period 1 is 9,500. Use alpha = 0.40. Once you have calculated the forecasts based on the above data, determine the error terms by comparing them to the actual sales for 2012 given below:

PERIOD TIRES USED

2012

January 10,696

February 9,665

March 10,179

April 11,760

May 9,150

June 9,571

July 8,375

August 11,826

September 10,696

October 11,212

November 9,750

December 9,380

4. Based on the three methods used to calculate a forecast for TFY, which method produced the best forecast? Why? What measures of forecast error did you use? How could you improve upon this forecast?

Source: Robert A. Novack, Ph.D. Used with permission.

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CASE 7 .2

ChipSupreme Beginning as a single retail store in 1995, ChipSupreme (Chips) has grown to $50 mil-

lion in annual revenues today. Chips was the brainchild of four entrepreneurial women who wanted to offer baked goods incorporating chocolate chips in both traditional and innovative ways. Traditional products include chocolate chip cookies, chocolate chip pie, and various types of cakes and muffins including chocolate chips. Innovative products include chocolate chip soft pretzels and chocolate chip bread. Chips also offers custom- designed versions of all of its products.

When Chips was a single store operation, all baking was done at the store as was all warehousing for finished products and raw material components. Today, with 30 retail stores, Chips utilizes a single bakery that produces all items that are normally stocked in the stores. Customization of these items (e.g., different colored icing or personalized writing) is still performed at each store. Chips owns and operates two distribution cen- ters that are used to hold and ship different products to each store based on their demand and/or forecast. Picking is done manually because of the small package sizes and small quantities ordered by the stores. Items such as chocolate chip cookies come in 24-count packs and muffins come in 6-count packs. Stores typically do not order in full case quantities of any item, so most picking is broken case. Most shipments are small parcel or LTL based on these small order quantities and small package sizes.

Tami Barnes, manager of store operations for Chips, recently called a meeting with the other three founders to discuss expansion plans. “We’ve established ourselves well in our existing market areas and have very little competition,” explained Tami. “I think it’s time we investigate the expansion of our operations onto the Internet. I’ve seen what other bakery companies like Famous Amos Cookies have done using the Web, and I think we can break into that market.” Beth Bower, manager of transportation and warehousing, was quick to respond. “Tami, we are already at capacity with our existing warehouses and shipping small units to households will drive our transportation costs through the roof.” Teresa Lehman, manager of baking operations, was also skeptical of the idea. “I agree with Beth. Our bakery is currently running two shifts per day right now. Expanding our market using the Internet will really put a squeeze on our baking capacity, especially if you want to expand the product line.” However, Janie Jones, chief financial officer, thought the idea had its merits. “Our growth has leveled off over the past few years. Our balance sheet is in good shape and we have a good line of credit. We really need to think about new markets to spur our growth. The Internet seems to be a natural fit for our products.”

The four women continued to discuss how and if Chips should develop a Web site to sell to individual consumers over the Internet. Beth did agree that Chips certainly has the expertise at picking individual units and shipping by UPS. Teresa acknowledged that as long as the company maintained its current product offering in the short run, the bakery could take on some additional volume. Tami added that because the products sold in stores require no temperature control to maintain their freshness, selling them on the Internet would not cause any additional transportation or warehousing challenges. Tami also suggested that to compete in the on-line market, Chips should be willing to offer free shipping.

Demand Management 253

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After a lengthy discussion, the four women agreed that the Internet was an endeavor worthy of consideration. Tami and Teresa were tasked to investigate which existing pro- ducts and which potential new products should be offered on their Web site. Janie was given the challenge of determining price points for the Web site. And, finally, Beth was asked to determine the feasibility of offering free shipping to Internet consumers.

CASE QUESTIONS 1. You have been hired to design the distribution network for Chips that will allow it to operate in both the “brick-and-mortar” and “click-and-mortar” markets. Your recommendations should address both the start-up of the Web operations as well as its ongoing operations. Chips has asked you to determine the following:

• The pros and cons of using an integrated versus a dedicated network;

• Whether or not the Internet warehousing and/or the store warehousing should be outsourced;

• The feasibility of using store fulfillment or flow-through fulfillment to complement warehouse fulfillment; and

• The mechanics of implementing a “free shipping” policy.

2. You have also been asked to investigate the pros and cons of using an established Internet fulfillment house not only to host the Chips Web site but also to house the inventory and perform the shipping. Companies like Amazon perform these services for other companies. What would your recommendation be for using a company like Amazon to run Chips’ online business?

Source: Robert A. Novack, Ph.D. Used with permission.

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Chapter 8

ORDER MANAGEMENT AND CUSTOMER SERVICE

Learning Objectives After reading this chapter, you should be able to do the following: • Understand the relationships between order management and customer service.

• Appreciate how organizations influence customers’ ordering patterns as well as how they execute customers’ orders.

• Realize that activity-based costing (ABC) plays a critical role in order manage- ment and customer service.

• Identify the various activities in the SCOR process D1 (deliver stocked product) and how it relates to the order-to-cash cycle.

• Know the various elements of customer service and how they impact both buyers and sellers.

• Calculate the cost of a stockout.

• Understand the major outputs of order management, how they are measured, and how their financial impacts on buyers and sellers are calculated.

• Be familiar with the concept of service recovery and how it is being implemented in organizations today.

255 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

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Introduction Chapter 7 (Demand Management) discussed how organizations develop forecasts

from which marketing, production, finance, and logistics plans are created. These plans are used to align the resources of the organization to meet organization and market goals. Chapter 8 will discuss the concepts of order management and customer service, which serve as the mechanisms to execute the plans. Order management defines and sets in motion the logistics infrastructure of the organization. In other words, how an organization receives an order (electronically versus manually), how it fills an order

Supply Chain Profile Tom’s Food Wholesalers

Tom’s Food Wholesalers (TFW) is a family-owned business started by Tom Novack in 1960. TFW services both grocery stores and restaurants with a full array of temperature-controlled as well as with non-temperature-controlled products. TFW is located in Pottsville, Pennsylvania, and its market is primarily east of the Mississippi River. Last year’s sales were approximately $400 million with a pretax operating margin of 4 percent. TFW has always taken great pride in offering excellent service to its client base. This has allowed TFW to develop a high level of loyalty with its clients. The emergence of Walmart Super Centers and Sam’s Clubs in the northeast has put tremendous pressure on TFW’s customer base to increase product availability as well as to cut costs.

THE CHALLENGE At a recent TFW executive board meeting, Tom Novack shared a discussion he had with one of his largest grocery accounts. “Our current service to Tess Groceries is sitting at 92 percent line fill. This high service level to Tess is hurting our margins with them. They want us to increase line fill to 97 percent starting next month with no increase in price. This means more inventory for us and shorter lead times.”

Liz Novack, CFO at TFW, added her comments. “Tom, there is no way we can increase our inven- tories right now. Our current inventory turns in our distribution network average five times per year. Our margins are slim already, without adding additional costs.”

Listening to this discussion was Alex Novack, VP of Sales for TFW. “Tess is one of our largest customers. They are really feeling the pressure from Walmart and Sam’s. If we don’t do some- thing to help them, we are going to lose them as an account. I would suggest that we add inventory for them, shorten our lead times, and help them remain competitive.”

“Alex, how much is this going to cost us?” Tom asked. “What does it cost Tess when we stock out?”

Liz agreed with Tom: “Alex, we need a return on investment figure for the additional inventory. Do you have any ideas?” Alex was not accustomed to dealing with ROI, only with revenue. He was not sure he had the answers to those questions.

The meeting ended with more questions raised than answers provided. Tom was sure of one thing: TFW needed to undertake a rigorous analysis of the tradeoffs between delivery service and TFW costs. He also needed to identify how Tess’s costs were impacted by TFW service levels. There had to be a way to understand the real cost of his service. Without that understanding, the long-term profitability of TFW was in jeopardy.

Source: Robert A. Novack, Ph.D. Used with permission.

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(inventory policy and number and location of warehouses), and how it ships an order (mode choice and its impacts on delivery times) are all dictated by how an organization manages an order. This chapter will present two phases of order management. First, the concept of influencing the order will be presented. This is the phase where an organiza- tion attempts to change the manner by which its customers place orders. Second, the concept of order execution will be discussed. This phase occurs after the organization receives the order.

Customer service, on the other hand, is anything that touches the customer. This includes all activities that impact information flow, product flow, and cash flow between the organization and its customers. Customer service can be described as a philosophy, as performance measures, or as an activity.1 Customer service as a philosophy elevates cus- tomer service to an organization-wide commitment to providing customer satisfaction through superior customer service. This view of customer service is entirely consistent with many organizations’ emphasis on value management, elevates it to the strategic level within an organization, and makes it visible to top executives. Customer service as performance measures emphasizes customer service as specific performance measures, such as on-time delivery and percentage of orders filled complete. These customer ser- vice measures pervade all three definitions of customer service and address strategic, tac- tical, and operational aspects of order management. Finally, customer service as an activity treats customer service as a particular task that an organization must perform to satisfy a customer’s order requirements. Order processing, invoicing, product returns, and claims handling are all typical examples of this definition of customer service.

Most organizations employ all three definitions of customer service in their order management process. Figure 8.1 shows one way in which order management and cus- tomer service are related. As this figure shows, customer service is involved in both

Figure 8.1 Relationship Between Order Management and Customer Service

Customer Relationship Management

(CRM)

Influence the

Order

Execute the

Order

O rd

er M

an ag

em en

t

Service Recovery

As a Philosophy As Performance Measures

Customer Service

As an Activity

Manage to/Measure Performance Levels

Order Execution

Determine Performance

Measures/Levels

Provide Pretransaction

Order Information

Source: Robert A. Novack, Ph.D. Used with permission.

Order Management and Customer Service 257

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influencing a customer’s order as well as in executing the customer’s order. The topics in this figure will be discussed in more detail in this chapter.

The remainder of this chapter will be organized as follows. First, the concept of customer relationship management (CRM) will be explored. Second, the concepts of activity-based costing and customer profitability will be discussed. Third, customer segmentation will be introduced. Fourth, the order execution process will be presented. Fifth, customer service will be discussed. Finally, the concept of service recovery will be explained.

Influencing the Order—Customer Relationship Management

Customer relationship management is the art and science of strategically positioning customers to improve the profitability of the organization and enhance its relationships with its customer base. CRM is not a new concept. It has been used for many years in service industries, such as banking, credit cards, hotels, and airline travel. Frequent-flier programs, used by the airline industry, are typical examples of the use of CRM to segment and reward an airline’s best customers based on number of miles traveled. Similarly, the hotel industry segments its customers by the number of nights stayed and the amount of money spent at a particular hotel. Both CRM strategies target customers that are low in cost to service and who are very profitable. Normally, business travelers would earn a “best” rating in both industries because of the amount of travel and hotel stays involved.

The concept of CRM, however, has not been widely used in the business-to-business environment until lately. Traditionally, manufacturers and distributors are more adept at and actively involved in order execution, which involves filling and shipping what their customers order. Today, more manufacturers and distributors are becoming adept at and actively involved in influencing how their customers order. This shift in philosophy comes from the realization that not all customers are equally profitable for an organiza- tion. How customers order, how much customers order, what customers order, and when customers order all impact an organization’s cost of executing an order. Customers whose ordering patterns maximize the efficiencies of the shipping organization’s logistics network will be the most profitable customers. Using the CRM philosophy allows an organization to identify and reward those customers.

There are four basic steps in the implementation of the CRM process in a business- to-business environment.2

Step 1: Segment the Customer Base by Profitability Most firms allocate direct materials, labor, and overhead costs to customers using a

single allocation criterion, e.g., pounds of product purchased during a particular time period. However, firms today are beginning to use techniques such as activity-based costing (to be discussed in the next section) to more accurately allocate costs to custo- mers based on the specific costs of servicing a customer’s orders based on how, how much, what, and when a customer orders. Normally, a cost-to-serve (CTS) model is developed for each customer. These CTS models are very much like an income statement for the customer.

258 Chapter 8

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Step 2: Identify the Product/Service Package for Each Customer Segment

This step presents one of the most challenging activities in the CRM process. The goal of this step is to determine what each customer segment values in its relationship with the supplier. This decision is usually based on feedback from customers and sales representa- tives. The challenge here is how to “package” the value-adding products and services for each customer segment. One solution is to offer the same product/service offering to each customer segment, while varying the product quality or service levels. For example, Table 8.1 presents a scenario where the offerings for each customer segment do not change, but the level of the offering does. In this table, assume that Customer Segment A is the most profitable and Customer Segment C is the least profitable. As is shown, Customer Segment A receives the best product and the best service, while the other two customer segments receive less quality in product and service. This type of package assumes that all customer segments value the same types of supplier offerings. This could be a disadvantage for this approach. The advantage to this approach is that it is easy for the supplier to manage.

Another solution to this part of the CRM process is to vary the service offerings for each customer segment. An example of this approach can be seen in Table 8.2. In Table 8.2, the offerings for each segment are different, with the top customer segment (A) receiving the most differentiation. The basis for this package is that each segment values different services. The advantage to this method is that it meets the needs of each segment. The disadvantage is that it is much more difficult for the supplier to manage. Of the two methods shown in Tables 8.1 and 8.2, Option A (Table 8.1) is most commonly found in industry today.

Step 3: Develop and Execute the Best Processes In Step 2, customer expectations were determined and set. Step 3 delivers on those

expectations. Organizations many times go through elaborate processes to determine customer needs and set target performance levels, only to fail when it comes to executing on those customer promises. One cause for this might be that organizations fail to recognize that process reengineering might be necessary to meet expected performance tar- gets. For example, the order fill rate promised to Customer Segment A in Table 8.1 might

Table 8.1 Hypothetical Product/Service Offerings: Option A

PRODUCT/SERVICE OFFERING

CUSTOMER SEGMENT A

CUSTOMER SEGMENT B

CUSTOMER SEGMENT C

Product quality (% defects)

Less than 1% 5%–10% 10%–15%

Order fill 98% 92% 88%

Lead time 3 days 7 days 14 days

Delivery time Within 1 hour of request On day requested During week requested

Payment terms 4/10 net 30 3/10 net 30 2/10 net 30

Customer service support

Dedicated rep Next available rep Through Web site

Source: Robert A. Novack, Ph.D. Used with permission.

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not be possible given the current inventory policy of the supplier’s organization. So, inven- tory levels and locations might have to be reconsidered given a target performance rate for order fill of 98 percent. The higher the expectations of the customer are, the more the dissatisfaction if they are not achieved.

Step 4: Measure Performance and Continuously Improve The goal of CRM is to better serve the different customer segments of the supplier orga-

nization, while at the same time improving the profitability of the supplier. Once the CRM program has been implemented, it must be evaluated to determine if (1) the different customer segments are satisfied and (2) the supplier’s overall profitability has improved. Remember, the goal of CRM is to identify those customers who provide the most profit by ordering product in a manner that minimizes the supplier’s costs. So, another measure of the CRM program might be the number of customers who have moved from one customer segment to another by changing their ordering patterns. The goal of CRM is not to eliminate customers; rather, it is to satisfy the customer while maximizing profits for the supplier. If the CRM program is not achieving these goals, it must be reevaluated and/or repositioned to bring it into alignment with performance targets.

The concept behind CRM is simple: align the supplier’s resources with its customers in a manner that increases both customer satisfaction and supplier profits. The execution of a CRM program presents many challenges. CRM implementation is not so much a destination as it is a journey. CRM is a strategic initiative by a supplier organization that requires changes in resource allocation, organizational structure, and market perception.

Table 8.2 Hypothetical Product/Service Offerings: Option B

CUSTOMER SEGMENT A

Product quality (% defects) Less than 1%

Order fill 98%

Lead time 3 days

Delivery time Within 1 hour of request

Payment terms 4/10 net 30

Customer service support Dedicated rep

CUSTOMER SEGMENT B

Product quality (% defects) 5%–10%

Credit hold Less than 48 hours

Return policy Up to 10 days after delivery

CUSTOMER SEGMENT C

Order fill 88%

Ordering process Through Web site

Source: Robert A. Novack, Ph.D. Used with permission.

260 Chapter 8

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This section presented a general overview of CRM. The next section will delve deeper into the details of how customers are segmented using activity-based costing and cus- tomer profitability.

Activity-Based Costing and Customer Profitability Traditional cost accounting is well suited to situations where an output and an alloca-

tion process are highly correlated. Take, for example, a warehouse that receives product in pallet quantities, stores product in pallets, picks product in pallets, and ships product in pallets. Also, assume that the same amount of labor expense, machine expense, and space expense are consumed for each pallet regardless of the type of product on the pal- let. In this scenario, cost accounts such as direct labor, direct machine expense, and direct overhead (space) can be allocated to each product based on the number of pallets moved through the warehouse for a particular time period.

On the other hand, traditional cost accounting is not very effective in situations where the output is not correlated with the allocation base. This is the more likely scenario in logistics. For example, assume that the warehouse just described will need to start picking and shipping in case quantities and in inner-pack quantities as well as in pallet quantities. Using an allocation base of pallets, products shipped in pallets will burden a majority of the direct costs incurred in the warehouse. However, the case pick and inner-pack pick, being very labor intensive, are driving most of the costs in the warehouse. As such, tradi- tional cost accounting in this case would be penalizing the most cost effective method of moving product through the warehouse and subsidizing the least cost effective method of moving product. This is where we can see the effectiveness of activity-based costing (ABC), which can be defined as, “A methodology that measures the cost and performance of activities, resources, and cost objects. Resources are assigned to activities, then activities are assigned to cost objects based on their use. ABC recognizes the causal relationships of cost drivers to activities.”3 Using the ABC methodology in the warehouse example previ- ously discussed would more accurately assign costs to those activities that absorbed the most resources. In other words, ABC would identify that picking and shipping inner- packs is more expensive than picking and shipping pallets.

Another way to look at the difference between traditional cost accounting and ABC can be seen in Figure 8.2. As this figure shows, conventional accounting assigns resources to depart- ment cost centers (for example, warehouse labor is assigned to the warehousing department), then allocates a particular cost to a product (for example, labor dollars per pallet). ABC assigns resources to an activity (for example, labor cost for picking product), identifies the cost drivers (for example, labor cost for picking a pallet versus picking an inner-pack), and then allocates those costs to products, customers, markets, or business units. ABC more accu- rately reflects the actual cost of performing an activity than does traditional cost accounting.

An example of how ABC works might be beneficial here. Assume that a consumer goods distribution center (DC) always receives and stores product in pallet quantities but picks and ships in pallets, tiers, cases, and eaches (individual consumer units). The product flow can be seen in Figure 8.3. The DC receives pallets for both storage and returns from customers. The returns process is separate and will not be discussed here. Once the pallet is received, it is put away (stored) until product is ready to be picked. Customers are allowed to order in quantities from eaches to full pallets. Shipping can be done from eaches to full pallets. After the pallet is stored, ten separate processes can be used to pick and ship product to comply with the customer’s order. Intuitively, the most cost efficient method in this figure is obviously pallet pick and pallet ship. The most expensive method

Order Management and Customer Service 261

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Figure 8.2 Traditional Accounting versus Activity-Based Costing

Resources

Department Cost Center

Allocation Basis

Product

• Accounting Cost <> Actual Cost • Cost pools mirror organization chart • Sometimes little correlation between allocation bases and consumption • Some costs driven to incorrect level

Resources

Activities

Cost Drivers

Products, Customers, Markets, Business

• Accounting Cost = Actual Cost • Cross-functional • Drivers trigger resources consumption • Drives costs to appropriate level

Traditional Accounting Activity-Based Costing

Source: Robert A. Novack, Ph.D. Used with permission.

Figure 8.3 Distribution Center Process Flow Chart

Pallet ReceiptReceipt

Storage

Pick

Ship

Pallet Storage Returns

Pallet Pick

Tier Pick

Case Pick

Each Pick

Back to Conveyor

Pallet Ship

Pallet Ship

Pallet Ship

Each Ship

Pallet ShipFloor-Load Floor-Load

Source: Robert A. Novack, Ph.D. Used with permission.

262 Chapter 8

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in this figure is each pick and each ship. Tier picking means a customer orders a product in “tier” quantities—the number of cases of a product that fits onto a single layer on a pallet. This number is also called “tie.” “High” is the number of layers of products on a pallet. Usually, tier picking results in a “rainbow” pallet, which is a pallet that contains sev- eral layers of different products. In case picking, the case can be picked and assembled onto a pallet for shipping or the case can put onto the conveyor system and eventually floor-loaded (each case loaded separately) in the trailer. In each picking, the each can be combined with other eaches into a reusable shipping case, put back onto the conveyor with other cases, and either floor-loaded or palletized. Each picks can also be shipped as eaches.

With the numerous methods that product can flow through the DC identified, the next step is to identify the activities that absorb the two main costs in a DC: space and labor. Space consumption by activity can be seen in Table 8.3. This table shows that storage absorbs 73 percent of the DC overhead cost. So products that require excess storage space will be allo- cated more of the direct overhead (facility) costs. Table 8.4 shows the number of full-time equivalent employees (FTEs) required to perform the different types of activities shown in Figure 8.3. Picking cases to be placed onto the conveyor requires the most FTEs (19.54).

Combining the costs from these two tables with the product flows identified in Figure 8.3 results in the costs to perform these activities and can be seen in Figure 8.4. Using equivalent case quantities as the allocation basis, it is easy to understand that receiving, storing, picking, and shipping products in pallets results in the lowest cost per case for the DC. Alternatively, receiving and storing products in pallets and picking and shipping eaches results in the highest cost per case. This ABC methodology, then, can be used to determine the costs of the various customer ordering policies and may be used to influence how the customer orders.

Distribution center expenses are but one cost that a shipper incurs in dealing with a customer. Traditional customer profitability analyses would start with gross sales less returns and allowances (net sales) and subtract the cost of goods sold to arrive at a gross margin figure. Although this number might provide a general guideline for the profitability of a customer, it falls short on capturing the real costs of serving a customer. A broader approach to determining customer profitability can be seen in Table 8.5. This is an actual example from a company that shall remain anonymous. This example

Table 8.3 Distribution Center Space Allocation

ACTIVITY PERCENTAGE OF TOTAL NET SQUARE FEET

Storage 73.0

Case pick 10.0

Receiving 5.0

Each pick 4.0

Test location 3.0

Staging 3.0

Returns 2.0

Total 100.0

Source: Robert A. Novack, Ph.D. Used with permission.

Order Management and Customer Service 263

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Table 8.4 Distribution Center Labor Allocation

ACTIVITY FTES*

Receiving 17.73

Storage 6.90

Case pick 19.54

Floor-loading 6.90

Test area 6.90

Each pick 6.90

Back to conveyor 1.28

Courier delivery 1.28

Pallet pick 5.49

Returns 9.71

Total FTEs 82.63

*Full-time equivalent employees. Source: Robert A. Novack, Ph.D. Used with permission.

Figure 8.4 Flow-Through Costing for a Distribution Center

Pallet Storage $0.09/case

$4.50/pallet

Returns $2.69/case

$134.50/pallet

Pallet Pick $0.14/case

$7.00/pallet

Tier Pick $0.53/case

$26.50/pallet

Case Pick $0.26/case

$13.00/pallet

Each Pick $0.06/each $3.00/case

Back to Conveyor $0.90/case

Pallet Ship $0.10/case

$5.00/pallet

Pallet Ship $0.10/case

$5.00/pallet

Pallet Ship $0.10/case

$5.00/pallet

Each Ship $0.04/each $2.00/case

Pallet Ship $0.10/case

$5.00/pallet

$0.43/case $0.82/case $0.55/case $0.88/case $5.19/case $4.19/case $4.52/case

Floor-Load $0.43/case

Floor-Load $0.43/case

Pallet Receipt $0.10/case

$5.00/pallet Receipt

Storage

Pick

Ship

Source: Robert A. Novack, Ph.D. Used with permission.

264 Chapter 8

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Table 8.5 Customer Profitability Analysis

CUSTOMER P&L STATEMENT CUSTOMER A TOTAL U.S. CONSOLIDATED

MAC CODE: 123456 1997 ACTUALS

% TO SALES

1998 QUARTER 1

1998 QUARTER 2

1998 QUARTER 3

1998 QUARTER 4

1998 YTD ACTUALS

% TO SALES

Gross Sales $17,439,088 $15,488,645 $17,382,277 $16,632,060 $66,942,069 102.6%

Returns 78,383 60,150 66,828 143,225 348,587 100.5%

Cash Discounts 348,782 309,773 347,646 332,641 1,338,841 102.1%

Net Sales $17,011,923 $15,118,722 $16,967,803 $16,156,194 $65,254,641 100.0%

Cost of Goods Sold: $ 4,392,341 $ 3,686,569 $ 4,170,382 $ 3,959,373 $16,208,665 24.8%

Standard Costs $ 4,279,660 $ 3,615,837 $ 4,070,518 $ 3,830,855 $15,796,870 24.2%

Royalties $ 112,681 $ 70,732 $ 99,864 $ 128,518 $ 411,795 0.6%

Gross Margin $12,619,582 $11,432,153 $12,797,421 $12,196,820 $49,045,976 75.2%

Promotional Costs: $ 1,366,220 $ 1,476,337 $ 1,624,152 $ 2,210,575 $ 6,677,284 10.2%

Allowances $ 299,893 $ 85,025 $ 110,627 $ 0 $ 495,544 0.8%

Off Invoice $ 957,617 $ 885,877 $ 1,054,432 $ 1,115,520 $ 4,013,447 6.2%

Trade Promotion Funds $ 108,710 $ 505,435 $ 459,093 $ 1,095,055 $ 2,168,293 3.3%

Racks $ 0 $ 0 $ 0 $ 0 $ 0 0.0%

Other $ 0 $ 0 $ 0 $ 0 $ 0 0.0%

Advertising: $ 0 $ 0 $ 0 $ 0 $ 0 0.0%

Market Research $ 0 $ 0 $ 0 $ 0 $ 0 0.0%

Other Variable Expenses:

$ 576,922 $ 396,040 $ 464,740 $ 474,752 $ 1,912,454 2.9%

Bracket Pricing $ 373,099 $ 256,242 $ 300,028 $ 320,522 $ 1,249,892 1.9%

Freight $ 203,822 $ 139,798 $ 164,712 $ 154,229 $ 662,562 1.0%

Direct Profit Contribution

$10,676,440 $ 9,559,776 $10,708,529 $ 9,511,494 $40,456,238 62.0%

Selling Expenses: $ 277,303 $ 288,458 $ 320,217 $ 377,591 $ 1,263,569 1.9%

Headquarters Selling $ 59,690 $ 59,690 $ 59,690 $ 59,690 $ 238,762 0.4%

Retail Selling $ 45,481 $ 45,481 $ 46,843 $ 75,246 $ 213,052 0.3%

Category Management $ 50,238 $ 50,238 $ 50,238 $ 50,238 $ 200,953 0.3%

CBT’s $ 121,893 $ 133,048 $ 163,446 $ 192,416 $ 610,802 0.9%

Operations: $ 192,555 $ 266,837 $ 269,382 $ 269,673 $ 998,447 1.5%

(continued)

Order Management and Customer Service 265

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identifies many other cost drivers that are impacted by customers and how they interact with the shipper. Notice that the DC example just covered falls under the “Operations” section of this customer profitability formula. As can be seen with this example, using gross margin alone as the indicator of profitability understates the costs incurred with serving this customer. Every line item under gross margin is represented by a process model as shown in Figure 8.4. With this information on how a customer’s interaction drives a shippers costs, the shipper can then segment its customers by profitability.

Figure 8.5 shows one method to classify customers by profitability. The vertical axis measures the net sales value of the customer, while the horizontal axis represents the cost to serve. Those customers who fall into the “Protect” segment are the most profitable. Their interactions with the shipper provide the shipper with the most cost efficiencies. Those customers who are in the “Danger Zone” segment are the least profitable and are more than likely incurring a loss for the shipper. For these customers, the shipper has three alternatives: (1) change the manner in which the customer interacts with the shipper so the customer can move to another segment; (2) charge the customer the actual cost of doing business (this would more than likely make the customer stop doing business with the shipper—this is usually not an acceptable strategy employed by most shippers); or (3) switch the customer to an alternative distribution channel (for example, the shipper might encourage the customer to order through a distributor or wholesaler rather than buying direct from the shipper). The customers who fall into the “Build” segment have a low cost to serve and a low net sales value. The strategy here is to maintain the cost to serve but build net sales value to help drive the customer into the “Protect” segment. Finally, the customers who are in the “Cost Engineer” segment have a high net sales value and a high cost to serve. The strategy here is to find more efficient ways for the cus- tomer to interact with the shipper. This might include encouraging the customer to order

Table 8.5 Continued

CUSTOMER P&L STATEMENT CUSTOMER A TOTAL U.S. CONSOLIDATED

MAC CODE: 123456 1997 ACTUALS

% TO SALES

1998 QUARTER 1

1998 QUARTER 2

1998 QUARTER 3

1998 QUARTER 4

1998 YTD ACTUALS

% TO SALES

Warehousing $ 100,632 $ 145,456 $ 142,890 $ 153,564 $ 542,541 0.8%

Order Processing $ 91,923 $ 121,381 $ 126,492 $ 116,109 $ 455,905 0.7%

Operating Profit $10,206,582 $ 9,004,481 $10,118,929 $ 8,864,230 $38,194,223 58.5%

Write Offs: $ 15,791 $ 4,701 $ (820) $ 18,433 $ 38,105 0.1%

Allowance Reserve $ 310 $ 2,939 $ (88) $ 7,792 $ 10,953 0.0%

Claims Reserve $ 15,481 $ 2,688 $ 1,365 $ 6,641 $ 26,175 0.0%

Handling Charges $ 0 $ (926) $ (2,097) $ 4,000 $ 977 0.0%

Adjusted Operating Profit

$10,190,791 $ 8,999,780 $10,119,749 $ 8,845,797 $38,156,118 58.5%

Footnotes:

Items Journaled Requiring Further Investigation

$ 1,034 $ 2,223 $ 2,492 $ 9,125 $ 14,875 0.0%

Unearned Cash Discounts Written Off $ 0 $ 809 $ 0 $ 30,213 $ 31,022 0.0%

Source: Robert A. Novack, Ph.D. Used with permission.

266 Chapter 8

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in tier quantities rather than in case quantities. This switch in ordering policy would reduce the operating cost of the shipper and possibly move the customer into the “Protect” segment.

Combining ABC, customer profitability, and customer segmentation to build profit- able revenue is a strategy being utilized by an increasing number of organizations today. This strategy helps define the true cost of dealing with customers and helps the shipper influence how the customer interacts with the shipper to provide the highest level of cost efficiency for the shipper. Combining these three tools with CRM allows the shipper to differentiate its offerings to its different customer segments, resulting in maximum profit for the shipper and maximum satisfaction for the customer.

This section discussed the methods organizations use to influence how a customer orders. The next section will discuss the methods used by shippers to execute the order once it is received.

Executing the Order—Order Management and Order Fulfillment

The order management system represents the principal means by which buyers and sellers communicate information relating to individual orders of product. Effective order management is a key to operational efficiency and customer satisfaction. To the extent that an organization conducts all activities relating to order management in a timely, accu- rate, and thorough manner, it follows that other areas of company activity can be similarly coordinated. In addition, both present and potential customers will take a positive view of consistent and predictable order cycle length and acceptable response times. By starting the process with an understanding of customer needs, organizations can design order management systems that will be viewed as superior to competitor firms.

The logistics area needs timely and accurate information relating to individual customer orders; thus, more and more organizations are placing the corporate order management function within the logistics area. The move is good not only from the perspective of the logistics process but also from that of the overall organization.

Figure 8.5 Customer Segmentation Matrix

Danger Zone

Cost EngineerProtect

Build

High

High Cost to Serve

N et

S al

es V

al ue

o f C

us to

m er

Low

Low

Source: Robert A. Novack, Ph.D. Used with permission.

Order Management and Customer Service 267

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Order-to-Cash (OTC) and Replenishment Cycles When referring to outbound-to-customer shipments, the term order to cash

(or order cycle) is typically used. The difference between these two terms will be discussed shortly. The term replenishment cycle is used more frequently when referring to the acquisition of additional inventory, as in materials management. Basically, one organization’s order cycle is another’s replenishment cycle. For the remainder of this discussion, the term order to cash (OTC) will be used. Traditionally, organizations viewed order management as all of those activities that occur from when an order is received by a seller until the product is received by the buyer. This is called the order cycle. The OTC cycle is all of those activities included in the order cycle plus the flow of funds back to the seller based on the invoice. The OTC concept is being adopted by many organizations today and more accurately reflects the effectiveness of the order management process.

Figure 8.6 is a representation of the OTC cycle. This figure is also referred to as Process D1: Deliver Stocked Product in the Supply Chain Council’s SCOR Model. It will be used as the basis of discussion for this session. This process represents not only

Figure 8.6 SCOR Model Process D1: Deliver Stocked Product

• Scheduled Deliveries (P)

• Daily Shipment Volume

• Shipping Documents (carrier, cust., gov.) • Delivered End Items (cust.)

• Payment

• Delivery Commit Date

• (P2) Supply Plans • (P3) Production Plans • (P4) Deliver Plans • (S) (M) (D) Inventory • (M) Scheduled Output

• (Customer) Customer Order • (Customer) Deliver Contract Terms • (Customer) Customer Replenish Signal

• (Customer) Inquiry

• Validated Order

• Routing Guide (carrier) • Rated Carrier Data (carrier)

D1.7

Select Carriers and Rate

Shipments

Plan and Build Loads

Receive, Enter & Validate

Order

D1.1

Process Inquiry &

Quote

D1.3 Reserve

Inventory and

Determine Delivery

Date

Consolidate Orders

D1.6

Route Shipments

From Make or Source

• (S) (M) Scheduled Receipts • (D) Inventory

• (D) Consolidated Product

• (D) Advanced Ship Notice

D1.8

Reveive Product

D1.10

Load Vehicle,

Generate Ship Docs

& Ship

D1.13

Invoice & Receive

Payment

D1.12

Install Product

D1.11

Receive & Verify

Product at Customer

Site

D1.9

Pick Product

D1.2D1.5 D1.4

Source: Supply Chain Council, 2011. Reproduced by permission.

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the lead time for delivery of product to the customer but also the flow of funds back to the seller. Thirteen principal activities constitute the OTC cycle. The first seven (D1.1 through D1.7) represent information flows; the next five (D1.8 through D1.12) represent product flows; and the last activity (D1.13) represents cash flow. Each of these will be discussed in the following section.

D1.1: Process Inquiry and Quote This step in the process precedes the actual placement of the order by the customer. In

D1.1, the customer is looking for product, pricing, or availability information from the supplier to determine whether or not to place an order. This step in the process requires that the seller have up-to-date information in a single location to provide quickly and accurately to the prospective buyer. Information availability is critical in this step.

D1.2: Receive, Enter, and Validate Order This step involves the placement and receipt of the order. In many organizations, this

step is accomplished through the application of technology such as electronic data inter- change (EDI) or the Internet. In some organizations, the order is called in to a customer service representative (CSR) who then enters the order into the seller’s order manage- ment system. The application of technology to this step has significantly reduced order errors as well as the OTC cycle. Step D1.2 “captures” the order and prepares it for the next step, order processing.

D1.3: Reserve Inventory and Determine Delivery Date This step in the process has traditionally been referred to as order processing. In the

buyer/seller relationship, this might be the most critical step because it sets delivery expectations for the customer. Once the order has been “captured” in the seller’s order management system, current inventory levels are checked to determine availability and location. If inventory is available in the seller’s distribution network, it is reserved for the order and a delivery date is given to the customer. In the case where the seller has inventory to fill the order, the delivery date is based on the concept of available to deliver (ATD). This means that the seller has the inventory and can promise a delivery date.

In some instances, the seller does not have the inventory but knows when it will be produced internally or delivered from a supplier to the seller’s distribution centers. In this case, the delivery date is based on the concept of available to promise (ATP). This means that even though the seller does not have physical possession of the inventory to fill the order, it can still promise a delivery date. In either case, the customer has no need to know whether the delivery date is based on ATD or ATP. Implementing the ATP concept requires upstream coordination of information systems between the seller and its manufacturing facilities and/or the seller and its supplier’s manufacturing facil- ities or distribution centers. For example, assume that an order for 40 cases of Product A is ordered from the seller. The seller currently has 20 cases of this product in inven- tory but knows that its manufacturing facility will be producing another 20 cases tomorrow. The seller can now set an ATP delivery date because it knows that by tomorrow, 40 cases of Product A will be available for the order. Similarly, if the seller has only 20 cases of Product A in inventory but knows that its supplier will deliver another 20 cases this afternoon, it can still set an ATP delivery date. Critical to the success of the ATP concept is the assurance that the upstream suppliers (internal manufacturing facilities or supplier facilities) will keep their promise of delivery of the

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additional 20 cases. If they cannot meet this promise, either order fill or on-time deliv- ery performance for the seller will suffer.

Once the delivery date is set with the customer, this step will usually transmit the order to the warehouse management system (WMS) for pick scheduling and to the financial system for invoice generation. So this step determines the order execution plan that the seller has determined and communicated to the customer. Its successful completion is critical to internal efficiencies for the supplier (e.g., order fill rate and on- time delivery rate) and external effectiveness for the customer (customer satisfaction).

D1.4: Consolidate Orders This step examines customer orders to determine opportunities for freight

consolidation as well as for batch warehouse picking schedules. Both of these consolida- tion opportunities offer cost efficiencies for the seller. However, consolidation plans will normally add time to the delivery cycle of the order to the customer. These opportu- nities, then, need to be examined taking into consideration the ATD or ATP delivery dates specified in the previous step.

D1.5: Plan and Build Loads This step takes the freight consolidation opportunities identified in D1.4 and the

delivery date given in D1.3 and develops a transportation plan. Many times, this step is used with less-than-truckload (LTL), small package, stop-off, or pool freight operations. The concept is to designate the order to a specific carrier or transportation vehicle to optimize transportation efficiencies while maintaining customer delivery requirements. Many organizations use transportation management systems (TMS) to build loads for customer deliveries.

D1.6: Route Shipments This step can follow or be concurrent with D1.5. Here, the “load” (usually a transpor-

tation vehicle) is assigned to a specific route for delivery to the customer. Again, many organizations use a TMS to complete this step.

D1.7: Select Carriers and Rate Shipments Following or concurrent with D1.5 and D1.6, this step will assign a specific carrier to

deliver an order or a consolidation of orders. This is usually based on the seller’s routing guide that is often contained in the TMS. For example, a seller has 2,000 pounds of freight to be delivered from its distribution center to a destination 1,500 miles away with a two-day delivery window. The routing guide might suggest that a small package air freight carrier (e.g., UPS or FedEx) handle this load. If the delivery window is five days, the routing guide might suggest an LTL carrier (e.g., Yellow/Roadway, FedEx Ground). Once the carrier has been designated, the seller predetermines the freight costs for the shipment based on agreements with the individual carrier. In any situation, this step takes into consideration size of shipment (load), destination (route), and deliv- ery (ATD or ATP) to determine the appropriate carrier and freight costs.

D1.8: Receive Product at Warehouse This step gains importance when an ATP has been given to a customer’s order. In

this step, product is received at the distribution center and the order management system is checked to see if there are any orders outstanding that need this particular product.

270 Chapter 8

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If so, the product is immediately combined with the on-hand inventory in preparation to be picked for the order. If the product is not immediately needed to fill an open order, it is put into storage to await the picking process.

D1.9: Pick Product This step uses the outputs from D1.3, D1.4, and D1.5 to determine the order pick-

ing schedules in the distribution center. With the many order picking strategies that can be used at distribution centers, this step is critical to route orders through the distribution center to optimize order picking efficiency while maintaining delivery schedules.

D1.10: Load Vehicle, Generate Shipping Documents, Verify Credit, and Ship Based on the output from D1.5 and D1.6, the transportation vehicle is loaded in this

step. In some cases, the sequencing of the order or orders in a transportation vehicle might not be important. For example, in a full truckload shipment where there is one order with one destination, the sequencing of the products in the vehicle takes on less importance. However, in an LTL or stop-off transportation vehicle where there are multiple orders with multiple destinations, the sequence is important. In this case, the last delivery would be loaded in the “nose” or front of the vehicle, while the first delivery is located on the rear of the vehicle. The proper loading sequence is critical in delivery efficiencies as well as in meeting delivery requirements.

Although some organizations do a credit check on the buyer in this step, credit checks are normally done in D1.2. “Ability to pay” on the part of the buyer is required by many organizations to set the order fulfillment process in motion.

Finally, this step will generate shipment documents to provide to the carrier to execute the shipment. These documents might include bills of lading, freight bills, way- bills, and manifests for domestic shipments as well as customs clearance documents for international shipments. When the shipment is legally turned over to the carrier, the shipment process can begin. This is also the step where sellers will officially invoice the customer.

D1.11: Receive and Verify Product at Customer Site Once the shipment is delivered to the customer location, the receiving location will

determine whether or not the delivered product is what was ordered. This verification is important because it is at this point in the process where the buyer will begin pro- cessing the seller’s invoice if the delivered order is correct. If it is not correct, the buyer and seller need to agree on how to solve any discrepancies. This step also concludes the traditional order cycle. So the seller’s success in completing all steps in the process up to this point determines the speed at which the seller will receive payment for the order.

D1.12: Install Product If an order involves a product that must be installed at the customer location, it is at

this point in the OTC cycle where installation takes place. An example might be where a buyer ordered a palletizing machine from a seller that required the seller to provide for installation. The success of the installation could also have an impact on the speed of cash flow back to the seller.

Order Management and Customer Service 271

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D1.13: Invoice This step is the culmination of the OTC cycle for the buyer and seller. This is where

the buyer is satisfied with the order cycle performance and has initiated payment to the seller. This cash flow represents the final flow of the three critical flows in the supply chain: information, product, and cash.

Process D1, the OTC cycle, represents those activities necessary in both order man- agement and order fulfillment. The absolute time and reliability of the OTC cycle have implications on both the buyer and seller. This will be discussed in the next section.

Length and Variability of the Order-to-Cash Cycle While interest has traditionally focused more on the ove