Business Operations Management Assignment

Learning Objectives

After completing this chapter, you should be able to:

• Define supply chain management.

• Explain the consequences that occur when information is not shared, and describe some of the information that can be shared in a supply chain.

• Discuss various options in supply chain structure.

• Compare insourcing, outsourcing, and vertical integration.

• Compare agile supply chains to lean supply chains.

• Discuss the impact of e-commerce on supply chain management.

• Explain how ERP facilitates e-commerce.

• Describe some supply chain performance measures.

• Discuss global issues in supply chain management.

5 .John W Banagan/Getty Images

Supply Chain Management: A Strategic Perspective

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CHAPTER 5Section 5.1 Foundations of Supply Chains

5.1 Foundations of Supply Chains

The term supply chain is commonly used to refer to the network of organizations that participate in producing goods or provid- ing services. A supply chain encompasses all activities associated with the flow and transfer of goods and services, from raw material extrac- tion through use by the final consumer. The actions of the participants in the supply chain are coordinated by the focal firm, which directs the flow of information much like a conductor coor- dinates the activities of an orchestra. The better the focal firm is at moving information among participants, the better the supply chain will per- form. The focal firm is often, but not always, the firm that interfaces with the final consumer. The focal firm designs and manages the supply chain by selecting suppliers. For example, Apple is the focal firm in its supply chain. Apple is primarily a product design and marketing focused firm with no manufacturing activities, yet it is the focal firm because its brand dominates the market. There are also cases where the most important firm does not sell directly to the consumer. For example, the oil industry is shifting from a model in which one firm owns the oil fields, pipelines, refineries, and retail gasoline stations to a model in which inde- pendent companies operate the retail operations. British Petroleum, commonly known as BP, has been reducing the number of retail outlets in the United States for several years. In this example, the company that owns the refinery and the oil fields is the focal firm because it controls the key resource in the supply chain.

A supply chain may be contained within a single organization as shown in Figure 5.1. Exxon Mobil owns oil fields, refineries, distribution networks, and retail gasoline sta- tions that deliver fuel to the consumer. Owning multiple assets in a supply chain is called vertical integration. The more assets a company owns, the greater the degree of vertical integration.

.Associated Press/AP Images

Apple is the focal firm in its supply chain. A focal firm is the most important organization in the supply chain and the firm that often interfaces with the final consumer.

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CHAPTER 5Section 5.1 Foundations of Supply Chains

Figure 5.1: Example of a vertically integrated internal supply chain

Traditional Supply Chains In most cases, different companies own the assets in a supply chain as shown in Figure 5.2. For example, suppose a consumer purchases a DVD player from a retailer. The retailer obtained that DVD player through a distributor, which originally purchased the player from the manufacturer. All of those different companies, as well as the consumer, are part of the supply chain. However, the supply chain does not end there. The manufacturer purchased component parts from various tier 1 suppliers, who have purchased materials from tier 2 suppliers, such as companies that produce the chemicals for making plastic. Finally, those tier 2 suppliers could have also purchased the raw materials to make those chemicals from tier 3 suppliers who extract petroleum from the earth. The supply chain also includes companies that move these items, such as trucking companies, railroads, and shipping companies, as well as warehouses or distribution centers where items may be temporarily stored during movements within the supply chain. Logistics involves man- aging the movement of materials and components from point to point in the supply chain.

Figure 5.2: Example of an external supply chain

Refinery

Pipeline

Retail Gas Station

Retail Gas Station

Retail Gas Station

Retail Gas Station

Oil Fields

Upstream Side Downstream Side

Material Flows

Tier 3 Tier 2 Suppliers

Tier 1 Manufacturer Echelon 1 Distributor

Echelon 2 Retailer

Consumer

Information Flows

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CHAPTER 5Section 5.2 Overview of Supply Chain Management

In addition to materials, information flows through a supply chain. If a DVD player model is selling extremely well and the retailer wants to stock more of them, then that retailer provides information to the distributor to ship more of that model. The distributor informs the manufacturer to make more, and the manufacturer notifies its suppliers to provide more of the component parts. Ideally, the information would be shared with the entire supply chain simultaneously, not only those companies with which each member deals directly. Taking actions to have all members of the supply chain work together, coordinate their activities, and share information is known as supply chain management.

When it is necessary to return defective products to the manufacturer for repair or replace- ment, the process is known as reverse logistics. Reverse logistics includes efforts to reuse and recycle materials. In Europe, the role of reverse logistics is being expanded beyond traditional recycling. The notion is that manufacturers who create a good are responsible for it at the end of the product’s useful life. This requires that producers of goods have a vested interest in creating designs, selecting materials, and using manufacturing pro- cesses that facilitate recycling. Because firms are responsible for the end-of-life recycling cost, they will make decisions that lower the cost of recycling. There is no legal require- ment for companies to do this in the United States, but the idea of designing to facilitate recycling is sound.

Walmart, Dell, Toyota, and The Home Depot have fine-tuned their supply chains to pro- vide a strong competitive advantage in terms of service and price. This chapter discusses how these companies and others have used supply chain management to their advantage.

5.2 Overview of Supply Chain Management

Traditionally, each company in a supply chain acted in its own best interests, not those of the entire supply chain. Information was not adequately shared among members of the supply chain. Only limited information was shared between a company and its immediate suppliers and between that company and its customers. As a result, impor- tant decisions including how much to produce, store, and move along the supply chain were based on local conditions rather than what was best for the supply chain. Several factors have emerged that encourage companies to adopt supply chain management as part of their competitive strategy. Those factors are:

• Increasing globalization • More intense competition • Shorter product life cycles • Developments in information technology and data communication

Globalization has led to new markets, but also to more companies producing and selling competing products—Toyota sells cars in the United States, Intel sells computer chips worldwide, Goldman Sachs provides financial services in the United Kingdom, and Cater- pillar sells construction equipment in China. These are but a few examples of the increase in global competition and global trade since the 1960s. Established markets have become more competitive as companies identify new ways of winning market share through pro- cess improvements that lower cost, improve product performance, and increase product

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CHAPTER 5Section 5.3 The Role of Information Sharing

quality. Some firms have opted to increase mar- ket share by introducing new products. As firms introduce new products and their competitors respond, market change accelerates and product life cycles become shorter. This means that new products must be profitable quickly and pay the needed return on investment in less time than prior products. Better supply chain management is one way to do this. Information and commu- nication technologies have opened up new ways of buying and selling through the Internet and mobile devices. This has also allowed compa- nies to obtain and disseminate information much more rapidly than before, thereby providing the consumer with more information—not just price and features, but availability, delivery options and timing, service after the sale, repair services, and more.

Because of these changes, companies have been forced to be more competitive. Supply chain management can make a company more competi- tive by coordinating all supply chain activities to ensure that the customer obtains the desired prod- uct at the desired time for a competitive price. Companies should work together to minimize costs over the entire supply chain, thus benefiting all the members. Supply chain management is the

integrated coordination of all components of the supply chain—from raw materials to the final customer—so that information and materials flow smoothly.

5.3 The Role of Information Sharing

Traditionally, limited information has been shared between adjacent supply chain pairs. For example, a retailer may order a certain number of units from a distributor, informing the distributor only of the number of units wanted at that time and when those units should be delivered. Very little information, such as expected future changes in demand, would be shared between the retailer and the distributor. The small amount of information that was shared would be shared only by those two members of the supply chain. This limited approach to information sharing does not optimize the performance of the supply chain, and can even lead to detrimental results such as the “bullwhip effect.”

The Bullwhip Effect The bullwhip effect is an example of what can happen when information is not fully shared in a supply chain or when forecasts are updated, causing an unanticipated shift in expected demand. This effect is further complicated by batching orders that concentrate

.Liu xianglong–Imaginechina/AP Images

Globalization allows products and services to reach all corners of the world and results in increased competition. Few companies have been as successful at globalizing their brands as Coca-Cola.

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CHAPTER 5Section 5.3 The Role of Information Sharing

demand at one point in time, price fluctuations that change demand, and attempts to ration product or otherwise game the system. The bullwhip effect is caused when a retailer experiences a slight increase in demand and increases its order quantity to avoid run- ning out of a product. The distributor also notices the increased order from its customer (the retailer) and, also to avoid running out, increases its order to the factory by a larger amount. The factory, in turn, will further increase its orders to suppliers of raw materi- als. The end result is that a slight increase in demand at the retail level increases nearly exponentially, creating a huge demand increase at the supplier level, as shown in Figure 5.3. This increase in demand may cause the supplier to work overtime, thereby increasing costs. When the retailer places the next order, which is the same size as the prior order (more or less), each participant in the supply chain will have too much inventory, so a cut back is required. The supplier, who overestimated the most (see Figure 5.3), will drasti- cally reduce production. As a result, the supplier may lay off staff because much of the demand can be met from inventory. In this system that uses sequential communication, the supplier at the end of the chain is “whipped” from one extreme to the other, from high demand requiring overtime costs to low demand leading to layoffs or excess inventory. Both of these options increase the supplier’s costs.

Figure 5.3: The bullwhip effect

To avoid problems such as the bullwhip effect, information must be shared via real-time communication methods rather than time delayed, sequential communication. The hub and spoke approach is one way to do this. Each spoke represents a connection to a mem- ber of the supply chain. All members of the supply chain transmit information to a central hub, and each member has access to the information. The focal firm often determines the information that must be shared in this manner. For example, if a company wants to sup- ply components to a Chrysler assembly plant, it must provide the information determined by Chrysler, or the supplier will not be accepted. By sharing this information, all supply chain partners see changes occurring anywhere in the supply chain, and respond to those changes accordingly. The following sections indicate some ways for data to be shared. Electronic data interchange (EDI) is a method of exchanging relevant information between suppliers and customers in real time. Collaborative planning, forecasting, and replenishment (CPFR) goes beyond the exchange of data to include joint planning efforts.

Supplier Manufacturer Distributor Retailer

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CHAPTER 5Section 5.3 The Role of Information Sharing

CPFR (pronounced C-P-Far) requires that all supply chain parties be committed to the plans developed jointly and that they be committed to updating the plan on a regular basis. A retailer will share information about demand forecasts and planned product pro- motions with its suppliers. Likewise, the suppliers share information about possible limi- tations on supply or periods during which production facilities may be shut down. Once a plan is developed, suppliers can begin production knowing that their customers in the supply chain have committed to those orders. Plans must be revisited regularly to ensure that adjustments are made when appropriate.

Real World Scenarios: Eroski Supermarkets

Eroski operates supermarkets and hypermarkets in Spain and France. Henkel, a German company, is one of the suppliers for Eroski stores. Although Henkel had utilized EDI with its customers to improve inventory reordering, Eroski stores continued to run out of Henkel products on a regular basis. The two companies decided to pursue CPFR, beginning with joint demand forecasting, which requires them to work together to estimate demand. Before implementing CPFR, about one-half of Henkel’s forecasts of demand had been miscalculated by 50% or more. As a result, Eroski’s supermarkets ran out of Henkel’s products. After implementation of CPFR, 75% of forecasts were within 20% of actual demand, and Henkel products were in stock at Eroski stores 98% of the time.

Electronic Data Interchange

Electronic data interchange (EDI) connects the databases of different companies. In one early use, EDI allowed companies utilizing material requirements planning (MRP) to inform suppliers of upcoming orders by providing them with access to the database of planned orders. Although this approach was innovative at the time, it still represented only limited sharing of information between adjacent links in the supply chain. In sup- ply chain management, EDI is a way to share information among all members of a sup- ply chain. Shared databases can ensure that all supply chain members have access to the same information, providing visibility to everyone and avoiding problems such as the bullwhip effect.

Collaborative Planning, Forecasting, and Replenishment (CPFR)

Theoretically, information is shared easily among all partners in a supply chain. In prac- tice, however, the process often does not work very smoothly. As a result, members of the supply chain may make assumptions about future actions of other supply chain members. For example, each supplier must forecast the demand of its customers. Collaborative planning, forecasting, and replenishment (CPFR) is a process that accomplishes more than data exchange. It seeks to minimize the lack of information through enabling col- laboration among supply chain partners that jointly develop a plan specifying what is to be sold and how, where, and during what time period it will be marketed and promoted. Sharing of information is facilitated by using a common set of communication standards. All partners are involved in the development of plans and forecasts for the entire group. Because these plans and forecasts have been jointly agreed upon, considerable uncertainty is removed from the process.

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CHAPTER 5Section 5.3 The Role of Information Sharing

Real World Scenarios: Walmart

Walmart is one company that has used EDI to improve forecast accuracy. Vendors who provide prod- ucts to Walmart can use Walmart’s satellite network system to directly access real-time, point-of- sale (POS) data coming in from the cash registers at Walmart stores. Vendors can use this up-to-the- minute information to improve forecasts by spotting trends the moment they occur.

Also, most forecasters know that it is easier to forecast demand as the time horizon is shorter. If the supplier has Walmart’s up-to-the-minute demand for Sauder television stands, it can respond quickly to any demand change. There is no time delay in getting an order because Sauder has the most recent sales data. If Sauder can combine this with a shorter lead time—that is, they can be more responsive—errors in forecasting will be less important. If Sauder takes two weeks from the time it receives an order until it delivers the product, a forecasting error is more likely to cause a sup- ply disruption than if Sauder can respond in three days. With a two-week response time, Sauder’s customer may be out of stock for several days to as much as two weeks. With a three-day response time, Walmart is far less likely to be out of stock, and if an inventory shortage occurs, it is likely to be only a day or two before more inventory arrives at the retail outlet.

Forecast Accuracy One problem with sharing infor- mation is that some of that infor- mation may not be accurate, especially forecasts. For example, a retailer may forecast future sales of a particular clothing line. When demand actually occurs, it may differ significantly. If the forecast was too high, then the retailer may be left with excess inventory that must eventually be sold at a loss. On the other hand, a forecast that is too low can mean unmet demand and lost sales.

Simply realizing that forecasts are likely to be inaccurate can lead to improving supply chain management. For instance, quick response is one technique that the fashion industry has devel- oped to address uncertainty in demand. In general, any time a firm can reduce the lead time between a customer order and its delivery, responsiveness is improved and forecast- ing errors become less relevant.

Historical information about forecast accuracy can be used to develop a confidence inter- val for demand. The supplier may be able to predict that there is a certain probability that demand will not vary from the forecast by more than a specific amount. This information can help the supplier to plan for a certain range of possible demand values.

.Brian Snyder/Reuters/Corbis

Like long-range forecasts offered in the annual Old Farmer’s Almanac, companies also predict forecasts for the future. The conditions predicted can be dramatically different from what actually happens.

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CHAPTER 5Section 5.4 Structure of Supply Chains

Highlight: TMD and Chrysler Toledo Assembly Complex

TMD’s Toledo facility is the sole source of instrument panels for the Jeep Wrangler, which is produced at Chrysler’s Toledo Assembly Complex (CTAC). All of the output from TMD’s Toledo operations is delivered to CTAC, which is located less than three miles from the assembly facility, thereby keeping shipping costs low. Because of close interaction and very short travel time, the inventory of instru- ment panels is enough to satisfy demand at CTAC for only a couple of hours. These two organiza- tions have developed such a close relationship that there have been very few supply disruptions, administrative and accounting costs are low, and quality is high. The relationship has worked well for both. Because these companies are highly dependent, they have worked hard to develop contin- gency plans to deal with unexpected problems.

5.4 Structure of Supply Chains

As shown in Figure 5.2, the upstream supply chain includes suppliers, which may be tier 1, tier 2, or tier 3. Each tier of the upstream supply chain may include multiple suppliers for the same good or service. The upstream side of the supply chain also includes production planning and purchasing as well as logistics, which is responsible for moving materials between supply chain members. On the downstream side, supply chain partners are divided into echelons. For example, echelon 1 includes organizations, such as distributors, importers, or exporters that receive the product directly from the organi- zation that produces it. Echelon 2 organizations would receive the product from those at echelon 1. Echelon 2 may include retailers, dealers, or final consumers.

It is important to realize that Figure 5.2 is a greatly simplified diagram of a supply chain. There are many more organizations that provide required goods and services and move materials and information than can be shown in Figure 5.2. How these numerous organi- zations are arranged and relate to one another is what determines supply chain structure. The next section will briefly discuss how supply chains can be structured.

Number of Suppliers At each tier of the upstream supply chain, companies can decide whether to use many suppliers for a particular good or service or few suppliers. Using many suppliers often allows a company to take advantage of competition among those suppliers to meet the company’s demands for cost, quality, and delivery. If one supplier goes out of business or is unable to provide the good or service as requested, it is a simple matter to use another supplier.

On the other hand, there are some advantages to having only a few suppliers, or even one supplier for a good or service. Chief among these is the long-term partnership arrange- ments that can be developed. Such relationships enable both parties to work together for greater integration of the supply chain and for development of methods that can improve quality and lower costs. These close partnerships often lead to high levels of dependency between the customer and the supplier.

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CHAPTER 5Section 5.4 Structure of Supply Chains

Insourcing Versus Outsourcing Organizations use a wide range of goods and services when making and delivering products. If those goods and services are provided by the organization itself, they are insourced. Goods and services obtained from outside suppliers are outsourced. One rea- son companies decide to outsource is that the goods or services can often be obtained less expensively from outside suppliers. Outside suppliers may specialize in producing that

good or service, enabling them to maintain high quality while keeping costs low. Suppliers may have proprietary technol- ogy that provides them a com- petitive advantage.

In the past decade or more, global outsourcing has grown dramatically as firms seek to find low-cost suppliers. This push, driven primarily by low labor costs in developing econ- omies such as Mexico, China, India, and Vietnam, has length- ened the supply chain, which increases transportation and inventory costs. With longer supply chains as well as political uncertainty and cultural differ- ences, there is also an increased

risk of supply chain disruption. Yet, the allure of lower costs is a powerful force. As some of the disadvantages of global sourcing are being examined, including concerns about quality and rising labor costs in some developing countries, there are signs of production returning to the United States. It is too early to tell if these instances are the beginning of a growing trend. It should be clear that global outsourcing is not just a manufacturing phenomenon. Engineering work, information systems development, and examination of medical images are being outsourced to developing countries.

Vertical Integration Supply chain management requires close coordination with suppliers, but if those suppli- ers are separate organizations, there may be difficulty coordinating among one another. One way to promote coordination is for a company to own its suppliers. This is called backward vertical integration.

.Thinkstock

Due to low labor costs in developing nations, global outsourcing has drastically increased in the past decade as firms seek to find low-cost suppliers.

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CHAPTER 5Section 5.4 Structure of Supply Chains

Virtual Organizations Today, outsourcing is gaining popularity because of cost advantages and the opportuni- ties for greater coordination that have been provided by the improved communication technologies of e-commerce. The application of this technology has led to virtual corpo- rations, that is, companies that exist only as an administrative shell, with all other func- tions outsourced. Outsourcing provides a great deal of flexibility because the company can change sources as the requirements of its products or markets change. Apple is not a virtual corporation because it has product design capabilities, marketing, accounting, and other functions. Apple does have virtual manufacturing operations through suppliers from around the globe.

Highlight: Henry Ford and Backward Vertical Integration

The early Ford Motor Company provides a classic example of backward vertical integration. Henry Ford believed that owning his sources of supply was the best way to guarantee an uninterrupted supply of competitively priced component parts and raw materials to build his Model T. He pur- chased iron mines, rubber plantations, and shipping companies. In order for this complex system to be efficient without the information and communication technology that is present today, it required centralized planning with long lead times to move product from raw materials to create the finished automobile. As a result, Ford’s massive system eventually became unwieldy and inflexible, result- ing in severe problems when competitors began offering product variety that Ford was unable to provide. Could Ford’s approach work today given that information and communication technologies give real-time access to data that supports decision making? There are still significant issues to over- come including the level of expertise required to manage diverse holdings such as iron mines and rubber plantations. Demand must be large enough to generate economies of scale when producing each component or raw material. It is challenging to build an efficient and responsive organizational structure that can manage such a large organization, so in some cases it is better to let market forces drive competition between suppliers.

At the other end of the supply chain, a company can own the distribution systems and retail outlets that sell their products; this is forward vertical integration. Many large grocery chains, such as Kroger, Publix, and Safeway, own their distribution networks as well as the retail stores. These companies may own all aspects of the distribution system, including transportation.

Highlight: La-Z-Boy Furniture and Forward Vertical Integration

La-Z-Boy Furniture has used its worldwide brand appeal to build a chain of retail outlets in approxi- mately 50 countries including Jakarta, Indonesia and Bogotá, Colombia. Its strong brand recognition draws customers into these retail outlets to buy La-Z-Boy products as well as products from other companies. Its high level of demand is the foundation for generating a high level of sales in each store. These two factors, high brand recognition and sales volume, provide La-Z-Boy with the oppor- tunity for forward vertical integration.

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CHAPTER 5Section 5.5 Supply Chain Strategies

Real World Scenarios: Amazon.com as a Virtual Retailer

Amazon.com is a large online retailer that buys and sells books and hundreds of other items. Ama- zon.com acts like a virtual organization when it opens its website to other companies who want to list their products. Amazon.com holds the information about the location and the cost of books or other items, but it never takes possession or owns the items. When a customer locates an item on Amazon .com’s website, the order is placed with Amazon.com and payment is collected by Amazon.com. The information about the order, including the item identifier, the ship to address, and the payment (less Amazon.com’s commission), is sent to the firm that owns and possesses the merchandise. The firm then sends the item to the customer. In this example, Amazon.com took no risk, owned no property, and incurred no cost except those related to listing the item on its site. It has used the power of its brand to drive both buyers and sellers to its site, thereby acting as an intermediary.

Real World Scenarios: Travelocity

Travelocity has created a successful business by using the Internet to provide travelers with easily accessible information from airlines, hotels, and car rental companies. The advantage of Travelocity is that it enables a customer to compare prices offered by many different travel service suppliers on one single website. In response, a group of major airlines began competing directly with Travelocity through its own website, Orbitz. Orbitz was started by American Airlines, United Airlines, and Delta Air Lines and promised to provide airfares that are lower than those through Travelocity, thus seek- ing to eliminate Travelocity as an intermediary. Kayak, Expedia, and Cheapflights have also begun to compete in this market. With limited barriers to entry, this space has become crowded.

Disintermediation An intermediary is a business entity that exists between a customer and a supplier. For example, travel agents are an intermediary between the travelers who buy airline tickets and the airlines that sell those tickets. A growing trend today is to achieve efficiencies in the sup- ply chain by eliminating some intermediaries. This process is known as disintermediation. Airlines now have their own websites through which travelers can purchase tickets directly from the airline, without using a travel agent’s services. For the traveler, this process may be advantageous because the traveler can readily compare all different flight times and routing options, browse special promotions that are currently being offered by the airline, and even compare prices among different airlines by visiting other websites. Getting flight informa- tion and pricing from a travel agent may be more difficult. Some companies have made the search process more efficient by putting nearly all airline prices on one website.

5.5 Supply Chain Strategies

As top managers have begun to understand the value of effective supply chain man-agement, it has gained recognition as a strategically important issue. Becoming successful when managing supply chains requires the support and involvement of top management. Various approaches to managing supply chains have been developed. Many of these strategies can be used together, although some may be more relevant to certain types of supply chains or certain structures.

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CHAPTER 5Section 5.5 Supply Chain Strategies

Agile Supply Chains Markets such as fashion and technology are char- acterized by frequent innovation, making product demand unpredictable and, therefore, requiring the entire supply chain to respond quickly as new products are introduced and demand changes. The supply chain must be able to transmit cus- tomer responses to new products and informa- tion about what customers would like to see in future products.

A particular type of supply chain, known as an agile supply chain, is needed to meet these requirements. Members of such a supply chain are selected based upon their speed and flexibil- ity, and their capacity to transit information reli- ably, accurately, and quickly from the marketplace to supply chain members. An agile supply chain attempts to assess in great detail the needs of its customers so it can provide customized products that better meet the customers’ expectations. An agile supply chain is more than transferring data between companies (EDI) or replenishing inven- tory more effectively and efficiently (CPFR). An agile supply chain is a cooperative relationship; supplies help to design and develop new prod- ucts that can meet individual customer needs bet- ter. It creates a flexible and responsive production process that allows the supply chain to deliver differentiated products. It also allows companies to work on quality improvement projects that affect the company and its suppliers, and allows all members of the supply chain to work together to keep costs aligned with cus- tomer expectations. Agile supply chains are frequently used in the fashion industry.

.iStockphoto/Thinkstock

The fashion industry is continuously evolving; therefore, an agile supply chain is utilized because it is able to rapidly respond to new products and changes in demand.

Real World Scenarios: Sport Obermeyer

Sport Obermeyer is a maker of fashion skiwear. When designs are created, suppliers help Sport Ober- meyer to identify new material that can be used in its innovative and fashionable designs, and to create production systems that can respond to changing customer demands. Product mix flexibil- ity is the agility to shift production from one product to another with very limited lost time or very small cost increases. Product volume flexibility is the agility to increase production levels if demand is greater than expected or to reduce production volume if demand is less than expected. This agility in the supply chain allows Sport Obermeyer to respond quickly and efficiently once customers vote with their money and decide that they like one style and color of ski equipment over another. Agility allows Sport Obermeyer to keep inventory at optimum levels. When production begins, the company can only estimate how many units of each product will actually be sold. If the supply chain cannot adjust, Sport Obermeyer will have too many units of products that are not selling well and not enough of high-demand items, resulting in excessive inventory, high inventory carrying costs, and lost sales.

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CHAPTER 5Section 5.5 Supply Chain Strategies

Vendor Managed Inventory (VMI) Instead of a retailer following the traditional approach of placing inventory replenishment orders with its suppliers, the suppliers can use information from the retailer regarding product sales to determine when they should replenish the supplier’s inventory. Walmart and other larger retailers, in conjunction with suppliers such as Procter & Gamble, have implemented vendor managed inventory (VMI). Under VMI, the vendor, or supplier, can better coordinate its own production with the replenishment of supplier inventory, thus reducing costs and improving delivery performance between the supplier and the retailer. To make this work, the suppliers receive daily point-of-sale (POS) data from the retail stores, and they also have access to retailer’s inventory files. In this way, the supplier (Procter & Gamble) has sales data and on-hand inventory at the retailer (Walmart). The supplier can plan production to keep the retailer stocked with its product and effectively manage its production to keep costs low. Customers benefit because the product they want is in stock, the retailer benefits because it has product to sell and inventory cost is low, and the supplier benefits because it sells more product while keeping production costs low.

Some companies such as Bose, which manufactures audio components, have further uti- lized vendor managed inventory by having personnel from their suppliers work within Bose’s purchasing department. Bose has called this approach Just-in-Time II (JIT II). In the past, Bose’s purchasing personnel handled all purchasing from outside suppliers. But, because the Bose personnel worked with many different suppliers, they were not fully knowledgeable about the full range of products offered by each supplier, nor were they

aware of the inventory levels and production plans of those suppliers. Under JIT II, employees of major suppliers work in the Bose purchasing department and handle all purchases from their companies. These employees are aware of all products offered by their companies. Thus, they are often able to suggest better alternatives. Furthermore, because these personnel are employees of the suppliers, they are aware of all supplier information, such as current inventory levels of products and plans for future production. This knowledge enables personnel to foresee possible shortages and avoid problems before they occur.

Lean Supply Chains A very different approach is needed for products that are standard functional items, such as power drills or can openers. These products have long product life cycles, stable and predictable demand, and minimal innovation. They are also often char- acterized by low profit margins. For these products, the supply chain must focus on operating efficiently to minimize costs. Such supply chains are known as lean supply chains, and the members are cho- sen based upon their ability to keep costs down and minimize inventory in the system.

.BananaStock/Thinkstock

Products such as can openers that have a long product life cycle, stable demand, and a low profit margin use lean supply chains because they keep costs down.

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CHAPTER 5Section 5.5 Supply Chain Strategies

Real World Scenarios: Black & Decker’s Lean Supply Chain

Black & Decker produces a variety of small appliances and hand tools for use in the home. Success in that market is predicated on manufacturing standard products that have high quality and low cost and a modest amount of variety. Designs for these appliances and tools change slowly and demand for these products can be characterized as steady. A lean supply chain focuses on operating issues as it attempts to eliminate non-value-added operations. A lean supply chain supports the reduction of setup times to enable the economic production of small quantities. This enables the supply chain to keep inventory costs low and achieve manufacturing cost reductions, in part, by enabling operations to switch quickly among products.

Consider Black & Decker’s 3/8-inch variable speed reversing drill, which is one of its most popular products. This tool is sold primarily to homeowners who use it infrequently to hang a shelf or repair a table. Each major component in the drill is a standard product. To create a successful supply chain, component suppliers must adopt lean manufacturing and its continuous improvement philosophy. These suppliers must achieve an efficient combination of flexibility and cost reduction. Flexibility is needed because there are several different models of drills as well as other hand tools and appli- ances that require similar components. Cost reduction is also essential because products, such as drills, are produced by many competitors, and customers are price sensitive. Cost reductions can be achieved when suppliers purchase large volumes of basic materials, such as steel for the gear manu- facturer, or copper for the electric motor producer. Streamlining the flow of materials and informa- tion through the supply chain to drive out inventory and non-value-added steps can also reduce cost. Because drills have low profit margins maintaining high sales and production volumes is critical for profitability for all members in the supply chain. Black & Decker can switch from one supplier of electric motors to another with relative ease, which is significant motivation for suppliers to seek continuous improvements in both component part cost and quality.

Postponement In an attempt to meet customers’ requests as closely as possible, firms and their supply chains may offer a product with many different options. For example, a particular model of automobile may be able to be built in two million or more combinations of paint color, trim package, engine, transmission, interior colors, and other options. Because of this large number of possibilities, manufacturers find it extremely difficult to accurately fore- cast demand for each possible combination of options. Inaccurate forecasts mean that the company may end up with a large inventory of unsold products consumers do not want, and a small inventory of the products consumers do want. Building sufficient inventory in each of the many options results in excessive inventory levels and costs. Conversely, wait- ing to produce a product until the customer actually wants it may disrupt the efficiency of the production process and entail very long lead times.

To overcome these problems, companies may use either product or process postpone- ment. Electronics manufacturers such as Hewlett-Packard (HP) use product postpone- ment, also known as delayed differentiation, by producing a generic product at the central manufacturing facility, then adding specific components needed to customize the product for the final consumer at the latest possible point in the distribution system. Thus, product postponement delays the final configuration of a product until the last possible step in the supply chain.

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CHAPTER 5Section 5.5 Supply Chain Strategies

The elements of a printer, which are common to all configurations of the printer, are pro- duced and assembled at a central location. These undifferentiated units are shipped to distribution centers around the world as needed. At the distribution centers, the electric module with the correct voltage, amperage, plug, software, and instructions are added to the unit. In this example, differentiation takes place just prior to a product’s arrival at retail operations rather than at the factory that assembles the printers. In this way, the production process is very efficient and inventories are kept very low. If demand is unex- pectedly high in China and low in Europe, HP can adjust shipments at its factory because the product is still undifferentiated.

Product postponement is also utilized to some extent by automobile manufacturers. Cer- tain options are added to automobiles, customizing them for the U.S. market after the cars are received in the United States. Carmakers in the United States offer detail packages that add special trim or increase performance. These upgrades can take place after the vehicle exits the assembly line and before it reaches the dealer, or they may happen after purchase from the dealership and before the customer takes delivery.

In process postponement, certain steps in the production process are delayed until the last possible moment. Instead of maintaining an inventory of finished products, a com- pany will maintain inventory of component parts and then process the products when orders are received. Ideally, the finished product will be produced only after customer orders have been received. This is commonly used in “sit-down” restaurants rather than in fast-food restaurants. For example, if the menu lists a perch dinner, the customer may be able to choose whether the fish is fried, baked, broiled, or blackened, and whether the accompanying potatoes are deep fried, baked, or home fried. Restaurants can offer these options because the time that a customer expects to be in the restaurant is long enough to fix the food using a different process.

When process postponement is implemented there are many options for finished prod- ucts with few components so less diverse inventory is held. A restaurant can offer four different fish options and three different potato options, or 12 different meal choices, and it only needs to inventory perch and potatoes. For this approach to work effectively, the lead times for making finished products must be short enough that they will be acceptable to customers. That is why process postponement does not work in fast-food restaurants.

Cross Docking One objective of supply chain management is to reduce inventory throughout the supply chain. Distribution centers, which receive shipments from a factory, break down those shipments into smaller quantities that are shipped to retailers, who are the customers of distribution centers. This represents a major investment in inventory because receipt of shipments from the factory is not coordinated with shipments to retailers. Thus, a large shipment of a product may be received from the factory. Next, it is placed into inventory until orders are received from retailers that gradually decrease the inventory.

Cross docking seeks to coordinate inbound and outbound shipments so that little inven- tory is kept at the distribution center. As a shipment is received from the factory and bro- ken down, each unit of the inbound shipment is moved to a location awaiting outbound shipment to a retailer. After each outbound shipment is fully assembled, it is sent on to the

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CHAPTER 5Section 5.5 Supply Chain Strategies

Radio Frequency Identification (RFID) Radio frequency identification (RFID) is a wireless system that uses radio frequencies to transmit data from a small device that is attached to an item to a receiver that tracks the item. The small device contains information that can be read from a distance of a few inches to 100 feet or more, depending upon the power output. Hospitals use this to track medical equipment, patients, and medication. While data transmission systems like bar codes require a scanner and a line of sight, RFID does not need to be within a line of sight.

Real World Scenarios: Penske and Navistar Strike up a Partnership

Penske Logistics and Navistar truck producers have formed a 3PL partnership under which Pen- ske Logistics is responsible for reducing supply chain costs and improving performance. The new approach has included centralizing shipping operations, improving supplier training, establishing new bidding requirements for carriers, and implementing a proprietary logistics management sys- tem. Navistar chose 3PL because Penske Logistics has expertise and experience that Navistar does not have. Navistar could develop this expertise, but the cost of doing so would be higher than using Penske Logistics and the results may not be as good. The advantage of 3PL is that companies such as Penske Logistics have specialized knowledge regarding the best methods and techniques to move parts from one place to another. Furthermore, Penske Logistics is able to combine shipments from many different suppliers and many different customers, taking advantage of opportunities for cross docking and reduced transportation costs.

retailer. Consequently, the distribution center primarily serves as a location for breaking down incoming shipments and redistributing the items into outgoing shipments. Unlike the traditional approach, the distribution center used for cross docking does not serve as a site for storing inventory. Target is one of dozens of retailers that have used cross docking effectively to decrease costs and reduce inventory. Distribution centers that use cross docking will have many items that never leave the conveyor system. A pallet of Gatorade may go from the delivery truck onto a high-speed automated conveyor system to the truck taking the product to the retail store. Scanners, cameras, and bar code readers sort and direct the pallet through the distribution center. As a result, more than 50% of products fed into the system spend a few minutes to a couple of hours in the distribution center, and never leave the conveyor. Much of the product, 70–80%, leaves the distribution center in 24 hours or less.

Third Party Logistics (3PL) To improve the efficiency of supply chains, some companies have developed partnerships with third party logistics (3PL). An outside supplier, also known as a third party, handles all of the logistics activities between supplier and customer. Third party logistics (3PL) is, therefore, the outsourcing of logistic services. These logistics activities can include inven- tory control, material handling, and transportation. United Parcel Service (UPS) is a 3PL provider for health care, retail, and automotive operations. It often makes good financial sense to allow specialists who know the best ways to move goods from place to place to handle logistics.

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CHAPTER 5Section 5.5 Supply Chain Strategies

RFID is used on automated toll lanes such as E-ZPass and to pay for gasoline at the gas pump using Speedpass. It is also used to secure items so they cannot be moved without the owner’s knowledge, such as when secur- ing expensive clothing in a shopping mall, moving critical parts within a chemical supply chain, or storing laptop comput- ers at an office. The use of RFID in supply chains is growing rapidly.

Enterprise Resource Planning (ERP) Supply chain management aims to achieve better integration, coordination, and communication among members of the supply chain. These efforts, however, are often stymied by the separate databases used by the individual members of the supply chain. Enterprise resource planning (ERP) can eliminate delays caused by separate databases either by allowing companies to access one another’s databases or, ide- ally, through the use of one common database.

To understand the problems that can be experienced when separate databases are used, consider a company that directly sells to the final customer. Suppose a customer calls the company’s marketing department to inquire about the status of an order. The marketing database will probably show only information specific to marketing, such as the date the order was entered. If that order is in production, then either someone from marketing or the customer will need to contact the production department to find out the status of the order. Suppose the order has been completed and shipped. The production data- base would probably show only completion of the order, but no shipping information. To obtain the shipping information someone would need to contact distribution or logistics. Because the company uses separate databases, no one in any area of the company has access to all company information. Thus, the customer is bounced from one department to another to get the answer to a simple question about order status.

A second problem with separate databases is that they may contain conflicting informa- tion. For example, suppose the customer order described above has been shipped, and the logistics database indicates this, but the production database has not yet been updated, so it shows the order is still at the last processing operation. Production may tell the cus- tomer that the order is still in processing when, in reality, it was already shipped.

The purpose of ERP is to avoid the problems described in this example by combining databases into one common database for the entire organization—and possibly for the entire supply chain. The advantage of a common database is that all personnel within the organization have access to all information. For example, someone in marketing could

.Associated Press

Radio frequency identification (RFID) is used on automated toll lanes like E-ZPass and to pay for gas using Speedpass.

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CHAPTER 5Section 5.5 Supply Chain Strategies

see if an order was delayed in production awaiting a component part from a supplier. Furthermore, if the ERP system integrates the entire supply chain, then personnel in mar- keting could determine the location of the part within the supplier’s production system. Using one common database can effectively eliminate problems caused by conflicting information among separate databases.

Figure 5.4 shows part of a typical ERP system configuration. Information is stored cen- trally in the database servers, which are accessed by individual servers. Users access infor- mation on their personal computers. Newer configurations of ERP are Internet-based. The database servers shown in Figure 5.4 can be accessed and updated by members of the supply chain via the Internet over secure connections. For example, the German company SAP now offers mySAP.com as its e-business platform.

Figure 5.4: Part of a typical ERP system

ERP can be expensive in terms of purchase cost or in terms of the disruption that such a major change can have on an organization. For example, it took Owens Corning two years to install an ERP system at a cost of $100 million. A recent survey found that the average cost of an ERP system was $15 million, although companies in that survey spent a mini- mum of $400,000 and a maximum of $300 million. There have also been some high-profile ERP failures. The Hershey’s Company spent $112 million only to find that the ERP sys- tem they had installed delayed shipments to customers. Allied Waste Industries stopped implementation of its $130 million ERP system after the company decided the system was too expensive and too complicated to operate.

One complication from ERP implementation results from using a common database, which often requires that procedures be completed differently than they previously were. For example, in the past, personnel in the marketing department may have been respon- sible for selling a product and then entering orders into the computer system. It was the production department’s responsibility to meet the promised delivery data, and finance’s responsibility to decide whether to offer the customer credit. With an ERP system, mar- keting personnel may find that they now are responsible for not only entering orders but also for determining whether a delivery date can be met and whether a customer’s credit rating is sufficient to justify offering credit. Such changes may require extensive retraining and a long break-in period until people can perform their tasks efficiently in the new way.

Sales and Distribution Front-End Servers

Human Resources Front-End Servers

Sales and Distribution Application

Server

Database Servers

Human Resources Application

Server

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CHAPTER 5Section 5.5 Supply Chain Strategies

While ERP systems are often difficult to implement, the advantages of having an inte- grated, real-time system to assist customers and to work with suppliers is very appealing. When success is achieved, the benefits are substantial.

Service Operations Because many people think about supply chain management as moving goods from point to point in the production process, these topics are often associated with manufacturing. However, supply chain, logistics, inventory, and purchasing are important topics in ser- vice operations. Retail and wholesale operations, which are classified as services, move goods from producers to customers via systems of distribution centers, warehouses, brick- and-mortar retail stores, and Internet-based retailers.

Supply chain management is critical in restaurants. A restaurant is like a factory that transforms raw materials into finished goods. It cuts, dices, chops, cooks, and serves food to customers. Some restaurants focus on specialized high-end food, while other

focus on fast food. In either case, the restaurant faces the same challenges with supplier quality, delivery reliability, and costs that are found in manu- facturing. Food has a very short shelf life so delivering in a timely manner and aligning inventory with consumption are essential tasks.

Health care is also becoming a service business where supply chains and supply chain man- agement are important. From a traditional perspective, a hospi- tal has suppliers who provide food, linens, medicine, equip- ment, and maintenance services for facilities. Health care organi-

zations have suppliers, including doctors, who act as service providers to the hospitals. In this environment, patients, doctors, and hospital clinical staff exchange information and work together to understand problems and to develop solutions or treatments. This is a highly interactive process where value is created by all of the participants. It is based on trust, commitment, and a shared vision among the participants. These same elements are vital in a traditional manufacturing supply chain.

.Thinkstock

Because food has a relatively short shelf life, it is essential to keep delivery and inventory aligned with consumption patterns.

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CHAPTER 5Case Study

Chapter Summary

• Supply chain management is an approach in which all members of the supply chain work together, coordinate their activities, and share information.

• The bullwhip effect, in which disruptions in demand are magnified through the supply chain, is one of the consequences of not sharing information. Some of the information that can be shared in a supply chain includes demand information, forecasts, planned orders, and sales.

• Vertical integration allows a company to own various components of the supply chain. Under outsourcing, those components of the supply chain are provided by independent companies.

• Supply chain structure includes having many versus fewer suppliers, insourc- ing versus outsourcing products and services, vertical integration of the supply chain, and the use of virtual organizations and disintermediation.

• Supply chain strategies include agile versus lean supply chains, vendor-managed inventory, postponement, cross docking, 3PL, and radio frequency identification.

• Agile supply chains focus on quickly getting innovative products to market. Efficient supply chains emphasize reducing supply chain costs for functional products.

• Lean supply chains focus on operating efficiently to minimize costs and keep inventory low. They often produce products that have long product life cycles, stable and predictable demand, and minimal innovation.

• Enterprise resource planning (ERP) is an attempt to provide integrated, real-time access to information about the firm and possibly the supply chain. In this way, customers contacting the supply chain can find the answers to questions with one e-mail or phone call.

• Supply chains and supply chain management are applicable in service busi- nesses. Retail and wholesale business, restaurants, and health care establishments are three examples.

Case Study

Medical Equipment Devices LLC Medical Equipment Devices LLC (MED) currently makes a few dozen different sophisti- cated, high-quality medical devices that are used in surgical, testing, and treatment proce- dures. These items can be customized to the needs of the doctor or hospital and are often purchased in small quantities. MED will sometimes keep a small quantity of finished products on hand, but most sales are made to order. The products are high cost, high profit-margin items that require substantial follow-up and field support. MED’s suppli- ers must respond rapidly to MED’s needs for products because MED’s customers want delivery as fast as possible. In addition to speed, high quality, flexibility, and innovation are essential characteristics of MED’s suppliers. Keeping costs low is always an issue, but it is less important than these factors. MED is doing well and has generated substantial profits, which it is using to seek additional investment opportunities.

Basil Diode, the chief financial officer of MED, has requested proposals for opportunities to start a new business or acquire a business in the medical field. He does not want to go outside of the company’s area of expertise, so he has asked for proposals in the broad area of health care. He has received a proposal to purchase and operate a company called

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CHAPTER 5Discussion Questions

MedSurgItems Corp. (MSI) that produces several hundred different standard medical and surgical items such as syringes, gowns, gloves, and tongue depressors. These items are typically made to stock, profit margins are small, and company profits are driven by sales volumes. MSI suppliers must be able to meet these needs.

To evaluate this and other proposals received, Basil has assembled a cross-functional team of experts from various disciplines including marketing, accounting, finance, and opera- tions and supply chain management. You are the representative of the operations and supply chain management function. Basil has asked you to provide detailed responses with appropriate justification to the following questions. Keep in mind he does not want yes or no answers.

1. Identify the important performance characteristics in MED’s current business, and identify them for the MSI business to be acquired.

2. Are these compatible? Are there economies of scale in production? Will there be synergy in product design?

3. What, if any, problems do you see in managing the supply chains that support MED’s current business and the MSI business to be acquired?

4. Provide a recommendation to Basil with support for that recommendation.

Discussion Questions

1. List the factors that now require companies to emphasize supply chain management.

2. Explain how the bullwhip effect may occur for a fashion retailer. 3. What actions can firms take to prevent the bullwhip effect from occurring? 4. Often forecasts of future demand are not accurate. How can firms address this

problem in its supply chains? 5. Describe the supply chain that might exist for an automobile manufacturer and

discuss some information that might flow through the supply chain. Do the same for a fast-food restaurant.

6. Identify some organizations that are vertically integrated and some that use extensive outsourcing.

7. Should a firm attempt to have fewer or more suppliers? What are the advantages and disadvantages of each approach?

8. Describe agile supply chains, including the characteristics of the products they produce.

9. Describe lean supply chains, including the characteristics of the products they produce.

10. Outsourcing, especially to low labor-cost countries, has grown substantially. What are the advantages and disadvantages of outsourcing?

11. Is Amazon.com a virtual organization? Find as much information as you can about the company, and then use that information to support your argument.

12. List some products that would be most appropriate for an agile supply chain. Do the same for a lean efficient supply chain.

13. Explain how companies that make the materials used in the apparel industry (e.g., denim) may use postponement.

14. How do supply chains and supply chain management impact service operations?

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CHAPTER 5Key Terms

agile supply chain A type of supply chain that focuses on quickly responding to changes in demand for various products.

backward vertical integration When a company owns the organizations that perform activities in the upstream supply chain.

bullwhip effect An example of what can happen when information is not shared in a supply chain. It occurs when a slight increase in demand at the retailer level increases nearly exponentially, resulting in a huge increase in demand at the raw material supplier level.

collaborative planning, forecasting, and replenishment (CPFR) Facilitates coor- dination among supply chain partners by jointly developing plans and schedules for what is to be sold, produced, and delivered.

cross docking Coordination between inbound and outbound shipments so that little, if any, inventory must be kept at a distribution center.

disintermediation The process of elimi- nating some functions in a supply chain to improve its efficiency, such as when a manufacturer sells directly to the final consumer.

downstream A designation for the part of the supply chain through which a com- pany’s products are sold, such as distribu- tors, retailers, dealers, or final consumers.

electronic data interchange (EDI) The use of electronic transmissions, such as tele- phone lines or the Internet, to share data among members of a supply chain.

enterprise resource planning (ERP) The use of one common database for all func- tions of an organization, or all members of a supply chain.

focal firm The most important organiza- tion in the supply chain, and often the firm that interfaces with the final consumer. The focal firm designs and manages the supply chain.

forward vertical integration When a company owns the organizations that con- stitute the downstream side of the supply chain.

insourced When a company internally produces the goods or services that it uses in its own operations.

lean supply chain A type of supply chain that emphasizes cost minimization and efficiency.

logistics The management of the move- ment of materials and components from point to point in the supply chain.

outsourced Contracting with another company to do work that was once done by the organization itself.

point-of-sale (POS) Data collected directly from the cash registers in a store.

process postponement When certain steps in the production process are delayed until the last possible moment such that the fin- ished product will be produced only after customer orders have been received.

Key Terms

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CHAPTER 5Key Terms

product postponement Producing a generic product at the central manufactur- ing facility, then producing specific com- ponents needed to customize the product for the final consumer, which are added at the latest possible point in the distribution system.

radio frequency identification (RFID) A wireless, contact-less system that uses radio frequencies to transfer data from a tag attached to an object to a system that tracks the item.

reverse logistics The ability to return a product to the manufacturer for repair or replacement. It is also being employed to recycle products at the end of their useful life.

supply chain All activities associated with the flow and transfer of goods and services from raw material extraction through use by the organization that sells to the final consumer.

supply chain management The integra- tion of supply chain activities through improved supplier relationships to achieve sustainable competitive advantage for all members in the supply chain.

third party logistics (3PL) An outside supplier that handles all the logistics activities between supplier and customer; the outsourcing of logistics services.

tier 1 suppliers Companies in a supply chain that sell component parts to the com- pany that makes the finished product.

tier 2 suppliers Companies in a supply chain that sell component parts or raw materials to a tier 1 supplier.

tier 3 suppliers Companies in a supply chain that usually sell raw materials to a tier 2 supplier.

upstream A designation for the part of the supply chain that includes suppliers, production planning, and purchasing.

vendor managed inventory (VMI) An inventory replenishment approach in which a supplier makes inventory man- agement decisions about the products it sells for the company that buys those products.

vertical integration When a firm owns the producing assets up and down the supply chain. The more assets owned, the greater the degree of vertical integration.

virtual corporations Companies that provide only coordination activities and outsource all other activities involved in producing and distributing a product.

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