Logistics Technology and Processes Assignment
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essential_supply_chain_textbook.pdf
ESSENTIALS of Supply Chain Management
Third Edition
Essentials Series The Essentials Series was created for busy business advisory and corpo- rate professionals. The books in this series were designed so that these busy professionals can quickly acquire knowledge and skills in core busi- ness areas.
Each book provides need-to-have fundamentals for those profes- sionals who must:
• Get up to speed quickly, because they have been promoted to a new position or have broadened their responsibility scope
• Manage a new functional area • Brush up on new developments in their area of responsibility • Add more value to their company or clients
Books in this series include: Essentials of Business Ethics by Denis Collins Essentials of Corporate and Capital Formation by David H. Fater Essentials of Corporate Fraud by Tracy L. Coenen Essentials of Corporate Governance by Sanjay Anand Essentials of Enterprise Compliance by Susan D. Conway and Mara E. Conway Essentials of Financial Risk Management by Karen A. Horcher Essentials of Foreign Exchange Trading by James Chen Essentials of Intellectual Property, Second Edition by Alexander I.
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by David Montague Essentials of Risk Management in Finance by Anthony Tarantino with
Deborah Cernauskas Essentials of Sarbanes-Oxley by Sanjay Anand Essentials of Supply Chain Management 3rd Edition by Michael Hugos Essentials of Technical Analysis for Financial Markets by James Chen Essentials of Venture Capital by Alexander Haislip Essentials of Working Capital Management by James Sagner
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ESSENTIALS of Supply Chain Management Third Edition
Michael Hugos
John Wiley & Sons, Inc.
Copyright © 2011 by John Wiley & Sons. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
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Library of Congress Cataloging-in-Publication Data:
Hugos, Michael H. Essentials of supply chain management / Michael Hugos. -- 3rd ed. p. cm. -- (Essentials series) Includes index. ISBN 978-0-470-94218-5 (paperback); ISBN 978-1-118-10060-8 (ebk); ISBN 978-1-118-10061-5 (ebk); ISBN 978-1-118-10062-2 (ebk) 1. Business logistics. I. Title. HD38.5.H845 2011 658.7--dc22 2011008883 Printed in the United States of America
10 9 8 7 6 5 4 3 2 1
To my wife, Venetia
Contents
Book Manifesto ix
Preface xiii
Chapter 1 Key Concepts of Supply Chain Management 1
Chapter 2 Supply Chain Operations: Planning and Sourcing 39
Chapter 3 Supply Chain Operations: Making and Delivering 75
Chapter 4 Using Information Technology 109
Chapter 5 Metrics for Measuring Supply Chain Performance 147
Chapter 6 Supply Chain Coordination 183
Chapter 7 Supply Chain Innovation for the Real-Time Economy 213
Chapter 8 Defi ning Supply Chain Opportunities 241
Chapter 9 Creating Supply Chains for Competitive
Advantage 273
Chapter 10 The Promise of the Real-Time Supply Chain 307
About the Author 323
Index 325
vii
Book Manifesto
This book is dedicated to the idea that there is a set of highly effec-
tive concepts and practices that supply chain professionals can use to
signifi cantly increase the competitiveness and profi tability of their com-
panies. Even though supply chains and the technology they employ are
changing rapidly, these concepts and practices remain highly relevant
over time—they are the essentials of supply chain management.
From decades of personal experience in the fi eld and from many
conversations and reading the works of other supply chain professionals
and researchers, I have distilled out these supply chain essentials. I know
you are busy and your time is valuable so I make every attempt to get
to the point quickly and explain things clearly and concisely. This book
provides a framework to understand the structure and operation of any
supply chain. It also provides guidance in how to make effective use of
the fl ood of new supply chain technologies, and how to operate the
constantly changing real-time supply chains that support our global
economy.
Supply Chains as Massively Multi-Player Online Role Playing Games
One of the most promising new technologies for designing and coor-
dinating the operation of supply chains comes from the world of online
gaming. I’m referring to a type of game called a “massively multi-player
ix
x
Book Manifesto
online role playing game” (MMORPG). In these online games, players
from all over the globe log into virtual worlds via the Internet; they learn
different roles and skill sets, and come together in self-selecting teams to
carry out missions in pursuit of common goals. Question: How is this
any different than the challenges that await us in the global real-time
economy we now inhabit?
If you’re part of the generation just starting out in business, answers
to this question probably seem pretty obvious. If you’re part of a gener-
ation that’s already been in business for a while, answers might not seem
so obvious (at fi rst). Unfortunately, the word “game” is associated with
activities that seem frivolous or unimportant. That is not what I mean
here; please hold your judgement while I explain. Popular MMORPGs
such as EVE-Online and World of Warcraft bring together hundreds
of thousands of simultaneous online players from countries around the
globe to interact in complex, realistic three dimensional worlds. What if
we did the same to design, monitor and operate the global supply chains
that support our real-time economy?
As a companion to this book I have collaborated with a group of
people to create a massively multi-player online role playing game to use
for gaining a better understanding of the dynamics that underlie supply
chains and their operations. This game allows people from all over the
world to collaborate in the design and operation of supply chains. In effect,
the game creates one big “sandbox” where people can experiment with
the effects of different supply chain designs. It can be used to model real
or imaginary supply chains and simulate their operations. It will show the
performance characteristics and operating costs of these supply chains un-
der different circumstances. The purpose of this game is to engage people
in an interactive experience that accelerates their learning and increases
their mastery of the skills involved in supply chain management.
xi
Book Manifesto
The ideas behind this game and its operation are explored in more
detail in Chapter 7—Supply Chain Innovation for the Real-Time
Economy. The game is titled “SCM Globe” and it can be accessed
through my web site at www.MichaelHugos.com.
A Real-Time Supply Chain Simulation System SCM Globe is a simulation game that provides a map of the world and
on that map, people working together in supply chains can draw in their
factories, warehouses, retail stores, and the transportation routes such as
roads, railways, and harbors that connect those locations. Then people
can defi ne the production volumes of the factories, storage capacity of
the warehouses, and movement capacity of the different modes of trans-
portation. And fi nally, they can associate operating costs with each facil-
ity and each mode of transportation.
This supply chain game has some pretty challenging dynamics. Play-
ers need to fi gure out how to deliver products where and when they are
needed to meet demand while at the same time minimizing inventory
levels and holding down transportation and manufacturing costs. If you
succeed in keeping down inventory levels and costs but fail to meet
product demand, you lose. And if you always deliver the products but fail
to keep the other factors under control, then your costs get out of hand
and you don’t make any money.
If supply chain professionals and researchers can literally draw supply
chain designs on an electronic map display and simulate the operations
of those supply chains over some time period, they will quickly learn
what designs produce the best results. And in the process, they will be-
come immersed and involved in exploring supply chain dynamics. How
long would it be before the people playing such a game developed high
xii
Book Manifesto
levels of skill in designing and operating high performance supply chains
that responded effectively to changing market conditions? I invite you
to try this game and see for yourself. This game is an evolving work in
progress and I invite your feedback. Your feedback on what you like and
what additional features you would like to see will guide the enhance-
ment of this system.
To explore this real-time supply chain simulation system (or supply
chain MMO depending on how you look at it) please visit my website,
www.MichaelHugos.com, and click on the link to “SCM Global.”
MICHAEL HUGOS
Chicago, IL USA
www.MichaelHugos.com
Email: [email protected]
Preface
xiii
In this book my intention is to provide a clear framework for under-
standing the essential concepts of supply chain management. Then build
on that understanding and show how to develop and deploy supply
chains to achieve success in the fast-paced, global economy we all live in.
Chapters 1, 2, and 3 provide an introduction to the basic principles and
business activities that drive supply chain operations. Chapters 4, 5, and
6 discuss techniques, technologies, and metrics for use in managing a
company’s internal supply chain operations and coordinating them with
those of its supply chain partners.
Chapter 7 is an exploration of the ways that new technologies
and new operating procedures can be used to signifi cantly impact and
improve the way supply chains are monitored and managed. Specifi c
examples for this kind of innovation are provided.
Chapters 8 and 9 provide a pragmatic approach based on personal
experience for defi ning supply chain opportunities and designing and
building systems to effectively respond to those opportunities. I present
two business case studies and show how a company in those situations
could develop supply chain capabilities to best support its strategic
goals. I am glad to answer your questions and discuss the merits of other
ideas in addition to the ones I have presented. I can be contacted at my
website, www.MichaelHugos.com.
The last chapter, Chapter 10, outlines the opportunities available to
companies and alliances of companies that learn to work together to
harness the power and potential of real-time supply chains. Real-time
xiv
Preface
supply chains are the next step in the evolution of supply chains; they
deliver a new level of operating effi ciency and responsiveness to mar-
kets and customers. Real-time supply chains will support much of the
world’s economic activity in the years to come.
MICHAEL HUGOS
Center for Systems Innovation
Chicago, Illinois USA
June 2011
ESSENTIALS of Supply Chain Management
Third Edition
1
CHAPTER 1
Key Concepts of Supply Chain Management
After reading this chapter you will be able to
● Appreciate what a supply chain is and what it does
● Understand where your company fits in the supply chains it participates in and the role it plays in those supply chains
● Discuss ways to align your supply chain with your business strategy
● Start an intelligent conversation about the supply chain management issues in your company
T his book is organized to give you a solid grounding in the “nuts and
bolts” of supply chain management. The book explains the essen-
tial concepts and practices and then shows examples of how to put
them to use. When you fi nish you will have a solid foundation in supply
chain management to work from.
The fi rst three chapters give you a working understanding of the key
principles and business operations that drive any supply chain. The next
four chapters present the techniques, technologies, and metrics to use to
improve your internal operations and coordinate more effectively with
your customers and suppliers in the supply chains your company is a part of.
Chapter 7 presents specifi c ideas for using technologies such as social media
and real-time simulation gaming to promote supply chain collaboration.
Essentials of Supply Chain Management, Third Edition by Michael Hugos
Copyright © 2011 John Wiley & Sons
2 ESSENTIALS of Supply Chain Management
The last three chapters show you how to fi nd supply chain oppor-
tunities and respond effectively to best capitalize on these opportunities.
Case studies are used to illustrate supply chain challenges and to present
solutions for those challenges. These case studies and their solutions
bring together the material presented in the rest of the book and show
how it applies to real-world business situations.
Supply chains encompass the companies and the business activities
needed to design, make, deliver, and use a product or service. Businesses
depend on their supply chains to provide them with what they need to
survive and thrive. Every business fi ts into one or more supply chains
and has a role to play in each of them.
The pace of change and the uncertainty about how markets will
evolve has made it increasingly important for companies to be aware
of the supply chains they participate in and to understand the roles that
they play. Those companies that learn how to build and participate in
strong supply chains will have a substantial competitive advantage in
their markets.
Nothing Entirely New...Just a Signifi cant Evolution The practice of supply chain management is guided by some basic under-
lying concepts that have not changed much over the centuries. Several
hundred years ago, Napoleon made the remark, “An army marches on
its stomach.” Napoleon was a master strategist and a skillful general and
this remark shows that he clearly understood the importance of what we
would now call an effi cient supply chain. Unless the soldiers are fed, the
army cannot move.
Along these same lines, there is another saying that goes, “Amateurs
talk strategy and professionals talk logistics.” People can discuss all sorts
of grand strategies and dashing maneuvers but none of that will be poss-
ible without fi rst fi guring out how to meet the day-to-day demands of
providing an army with fuel, spare parts, food, shelter, and ammunition.
Key Concepts of Supply Chain Management 3
It is the seemingly mundane activities of the quartermaster and the sup-
ply sergeants that often determine an army’s success. This has many ana-
logies in business.
The term “supply chain management” arose in the late 1980s and
came into widespread use in the 1990s. Prior to that time, businesses
used terms such as “logistics” and “operations management” instead.
Here are some defi nitions of a supply chain:
• “A supply chain is the alignment of fi rms that bring products or services to market.”—from Lambert, Stock, and Ellram.
(Lambert, Douglas M., James R. Stock, and Lisa M. Ellram,
1998, Fundamentals of Logistics Management, Boston, MA: Irwin/
McGraw-Hill, Chapter 14).
• “A supply chain consists of all stages involved, directly or indi- rectly, in fulfi lling a customer request. The supply chain not only
includes the manufacturer and suppliers, but also transporters,
warehouses, retailers, and customers themselves.”—from Chopra
and Meindl (Chopra, Sunil, and Peter Meindl, 2003, Supply
Chain, Second Edition, Upper Saddle River, NJ: Prentice-Hall,
Inc., Chapter 1).
• “A supply chain is a network of facilities and distribution op- tions that performs the functions of procurement of materials,
transformation of these materials into intermediate and fi nished
products, and the distribution of these fi nished products to cus-
tomers.”—from Ganeshan and Harrison (Ganeshan, Ram, and
Terry P. Harrison, 1995, “An Introduction to Supply Chain
Management,” Department of Management Sciences and Infor-
mation Systems, 303 Beam Business Building, Penn State Uni-
versity, University Park, Pennsylvania).
If this is what a supply chain is then we can defi ne supply chain
management as the things we do to infl uence the behavior of the supply
4 ESSENTIALS of Supply Chain Management
chain and get the results we want. Some defi nitions of supply chain
management are:
• “The systemic, strategic coordination of the traditional business functions and the tactics across these business functions within
a particular company and across businesses within the supply
chain, for the purposes of improving the long-term perfor-
mance of the individual companies and the supply chain as a
whole.”—from Mentzer, DeWitt, Keebler, Min, Nix, Smith, and
Zacharia (Mentzer, John T., William DeWitt, James S. Keebler,
Soonhong Min, Nancy W. Nix, Carlo D. Smith, and Zach G.
Zacharia, 2001, “Defi ning Supply Chain Management,” Journal
of Business Logistics, Vol. 22, No. 2, p. 18).
• “Supply chain management is the coordination of production, inventory, location, and transportation among the participants in
a supply chain to achieve the best mix of responsiveness and ef-
fi ciency for the market being served.”—my own words.
There is a difference between the concept of supply chain manage-
ment and the traditional concept of logistics. Logistics typically refers to
activities that occur within the boundaries of a single organization and
supply chains refer to networks of companies that work together and
coordinate their actions to deliver a product to market. Also, traditional
logistics focuses its attention on activities such as procurement, distri-
bution, maintenance, and inventory management. Supply chain manage-
ment acknowledges all of traditional logistics and also includes activities
such as marketing, new product development, fi nance, and customer
service.
In the wider view of supply chain thinking, these additional activities
are now seen as part of the work needed to fulfi ll customer requests.
Supply chain management views the supply chain and the organizations
in it as a single entity. It brings a systems approach to understanding
Key Concepts of Supply Chain Management 5
and managing the different activities needed to coordinate the fl ow of
products and services to best serve the ultimate customer. This systems
approach provides the framework in which to best respond to busi-
ness requirements that otherwise would seem to be in confl ict with
each other.
Taken individually, different supply chain requirements often have
confl icting needs. For instance, the requirement of maintaining high lev-
els of customer service calls for maintaining high levels of inventory, but
then the requirement to operate effi ciently calls for reducing inventory
levels. It is only when these requirements are seen together as parts of
a larger picture that ways can be found to effectively balance their dif-
ferent demands.
Effective supply chain management requires simultaneous improve-
ments in both customer service levels and the internal operating ef-
fi ciencies of the companies in the supply chain. Customer service at its
most basic level means consistently high order-fi ll rates, high on-time
delivery rates, and a very low rate of products returned by customers for
whatever reason. Internal effi ciency for organizations in a supply chain
means that these organizations get an attractive rate of return on their
investments in inventory and other assets and that they fi nd ways to
lower their operating and sales expenses.
There is a basic pattern to the practice of supply chain management.
Each supply chain has its own unique set of market demands and oper-
ating challenges and yet the issues remain essentially the same in every
case. Companies in any supply chain must make decisions individually
and collectively regarding their actions in fi ve areas:
1. Production—What products does the market want? How much
of which products should be produced and by when? This
activity includes the creation of master production schedules
that take into account plant capacities, workload balancing,
quality control, and equipment maintenance.
6 ESSENTIALS of Supply Chain Management
2. Inventory—What inventory should be stocked at each stage in a
supply chain? How much inventory should be held as raw mat-
erials, semifi nished, or fi nished goods? The primary purpose of
inventory is to act as a buffer against uncertainty in the supply
chain. However, holding inventory can be expensive, so what
are the optimal inventory levels and reorder points?
3. Location—Where should facilities for production and inventory
storage be located? Where are the most cost effi cient locations
for production and for storage of inventory? Should existing
facilities be used or new ones built? Once these decisions are
made they determine the possible paths available for product to
fl ow through for delivery to the fi nal consumer.
4. Transportation—How should inventory be moved from one
supply chain location to another? Air-freight and truck delivery
are generally fast and reliable but they are expensive. Shipping
by sea or rail is much less expensive but usually involves longer
transit times and more uncertainty. This uncertainty must be
compensated for by stocking higher levels of inventory. When
is it better to use which mode of transportation?
5. Information—How much data should be collected and how
much information should be shared? Timely and accurate
information holds the promise of better coordination and bet-
ter decision making. With good information, people can make
effective decisions about what to produce and how much, about
where to locate inventory, and how best to transport it.
The sum of these decisions will defi ne the capabilities and effective-
ness of a company’s supply chain. The things a company can do and the
ways that it can compete in its markets are all very much dependent on
the effectiveness of its supply chain. If a company’s strategy is to serve
a mass market and compete on the basis of price, it had better have a
supply chain that is optimized for low cost. If a company’s strategy is to
Key Concepts of Supply Chain Management 7
serve a market segment and compete on the basis of customer service
and convenience, it had better have a supply chain optimized for respon-
siveness. Who a company is and what it can do is shaped by its supply
chain and by the markets it serves.
How the Supply Chain Works Two infl uential source books that defi ne principles and practices of
supply chain management are The Goal (Goldratt, Eliyahu M., 1984,
The Goal, Great Barrington, MA: The North River Press Publishing
Corporation); and Supply Chain Management, Fourth Edition by Sunil
Chopra and Peter Meindl. The Goal explores the issues and provides
answers to the problem of optimizing operations in any business system,
whether it be manufacturing, mortgage loan processing, or supply chain
management. Supply Chain Management, Fourth Edition is an in-depth
presentation of the concepts and techniques of the profession. Much of
the material presented in this chapter and in the next two chapters can
be found in greater detail in these two books.
Alexander the Great based his strategies and campaigns on his army’s unique capabilities and these were made possible by effec- tive supply chain management.
In the spirit of the saying, “Amateurs talk strategy and professionals talk logistics,” let’s look at the campaigns of Alexander the Great. For those who think that his greatness was only due to his ability to dream up bold moves and cut a dashing figure in the saddle, think again. Alexander was a master of supply chain management and he could not have succeeded otherwise. The authors from Greek and Roman times who recorded his deeds had little to say about something so apparently unglamorous as how he secured supplies
IN THE REAL WORLD
(Continued)
8 ESSENTIALS of Supply Chain Management
for his army. Yet, from these same sources, many small details can be pieced together to show the overall supply chain picture and how Alexander managed it. A modern historian, Donald Engels, has investigated this topic in his book Alexander the Great and the Logistics of the Macedonian Army (Engles, Donald W., 1978, Alexander the Great and the Logistics of the Macedonian Army, Los Angeles, CA: University of California Press).
He begins by pointing out that given the conditions and the technol- ogy that existed in Alexander’s time, his strategy and tactics had to be very closely tied to his ability to get supplies and to run a lean, efficient organization. The only way to transport large amounts of material over long distances was by oceangoing ships or by barges on rivers and canals. Once away from rivers and seacoasts, an army had to be able to live off the land over which it traveled. Diminishing returns set in quickly when using pack animals and carts to haul supplies, because the animals themselves had to eat and would soon consume all the food and water they were hauling unless they could graze along the way.
Alexander’s army was able to achieve its brilliant successes because it managed its supply chain so well. The army had a logis- tics structure that was fundamentally different from other armies of the time. In other armies the number of support people and camp followers was often as large as the number of actual fight- ing soldiers, because armies traveled with huge numbers of carts and pack animals to carry their equipment and provisions, as well as the people needed to tend them. In the Macedonian army the use of carts was severely restricted. Soldiers were trained to carry their own equipment and provisions. Other contemporary armies did not require their soldiers to carry such heavy burdens but they paid for this because the resulting baggage trains reduced their speed and mobility. The result of the Macedonian army’s logistics structure was that it became the fastest, lightest, and most mobile army of its time. It was capable of making lightning strikes against an opponent, often before they were even aware of what was
IN THE REAL WORLD (CONTINUED)
Key Concepts of Supply Chain Management 9
happening. Because the army was able to move quickly and sud- denly, Alexander could use this capability to devise strategies and employ tactics that allowed him to surprise and overwhelm enemies that were numerically much larger.
The picture that emerges of how Alexander managed his supply chain is an interesting one. For instance, time and again the historical sourc- es mention that before he entered a new territory, he would receive the surrender of its ruler and arrange in advance with local officials for the supplies his army would need. If a region did not surrender to him in advance, Alexander would not commit his entire army to a campaign in that land. He would not risk putting his army in a situation where it could be crippled or destroyed by a lack of provisions. Instead, he would gather intelligence about the routes, the resources, and the cli- mate of the region and then set off with a small, light force to surprise his opponent. The main army would remain behind at a well-stocked base until Alexander secured adequate supplies for it to follow.
Whenever the army set up a new base it looked for an area that provided easy access to a navigable river or a seaport. Then ships would arrive from other parts of Alexander’s empire, bringing in large amounts of supplies. The army always stayed in its winter camp until the first spring harvest of the new year so that food supplies would be available. When it marched, it avoided dry or uninhabited areas and moved through river valleys and populated regions whenever possible so the horses could graze and the army could requisition supplies along the route.
Alexander had a deep understanding of the capabilities and limita- tions of his supply chain. He learned well how to formulate strate- gies and use tactics that built upon the unique strengths that his logistics and supply chain capabilities gave him, and he wisely took measures to compensate for the limitations of his supply chain. His opponents often outnumbered him and were usually fighting on their own home territory. Yet their advantages were undermined by clumsy and inefficient supply chains that restricted their ability to act and limited their options for opposing Alexander’s moves.
IN THE REAL WORLD (CONTINUED)
10 ESSENTIALS of Supply Chain Management
The goal or mission of supply chain management can be defi ned
using Eli Goldratt’s words as “Increase throughput while simultaneous-
ly reducing both inventory and operating expense.” In this defi nition,
throughput refers to the rate at which sales to the end customer occur.
Depending on the market being served, sales or throughput occur for
different reasons. In some markets, customers value and will pay for high
levels of service. In other markets customers seek simply the lowest price
for an item.
As we saw in the previous section, there are fi ve areas where com-
panies can make decisions that will defi ne their supply chain capa-
bilities: production; inventory; location; transportation; and infor-
mation. Chopra and Meindl defi ne the fi rst four and I add the fi fth as
performance drivers that can be managed to produce the capabilities
needed for a given supply chain.
Effective supply chain management calls fi rst for an understanding
of each driver and how it operates. Each driver has the ability to directly
affect the supply chain and enable certain capabilities. The next step is
to develop an appreciation for the results that can be obtained by mix-
ing different combinations of these drivers. Let’s start by looking at the
drivers individually.
Production
Production refers to the capacity of a supply chain to make and store
products. The facilities of production are factories and warehouses. The
fundamental decision that managers face when making production
decisions is how to resolve the trade-off between responsiveness and
effi ciency. If factories and warehouses are built with a lot of excess ca-
pacity, they can be very fl exible and respond quickly to wide swings in
product demand. Facilities where all or almost all capacity is being used
are not capable of responding easily to fl uctuations in demand. On the
other hand, capacity costs money and excess capacity is idle capacity not
Key Concepts of Supply Chain Management 11
in use and not generating revenue. So the more excess capacity that ex-
ists, the less effi cient the operation becomes.
Factories can be built to accommodate one of two approaches to
manufacturing:
1. Product Focus—A factory that takes a product focus performs the
range of different operations required to make a given product
line from fabrication of different product parts to assembly of
these parts.
2. Functional Focus—A functional approach concentrates on
performing just a few operations such as only making a
select group of parts or only doing assembly. These functions
can be applied to making many different kinds of products.
A product approach tends to result in developing expertise about
a given set of products at the expense of expertise about any particu-
lar function. A functional approach results in expertise about particular
functions instead of expertise in a given product. Companies need to
decide which approach or what mix of these two approaches will give
them the capability and expertise they need to best respond to customer
demands.
As with factories, warehouses too can be built to accommodate
different approaches. There are three main approaches to use in ware-
housing:
1. Stock Keeping Unit (SKU) Storage—In this traditional approach,
all of a given type of product is stored together. This is an ef-
fi cient and easy to understand way to store products.
2. Job Lot Storage—In this approach, all the different products re-
lated to the needs of a certain type of customer or related to
the needs of a particular job are stored together. This allows for
12 ESSENTIALS of Supply Chain Management
an effi cient picking and packing operation but usually requires
more storage space than the traditional SKU storage approach.
3. Crossdocking—An approach that was pioneered by Wal-Mart
in its drive to increase effi ciencies in its supply chain. In this
approach, product is not actually warehoused in the facility.
Instead the facility is used to house a process where trucks
from suppliers arrive and unload large quantities of differ-
ent products. These large lots are then broken down into
smaller lots. Smaller lots of different products are recom-
bined according to the needs of the day and quickly loaded
onto outbound trucks that deliver the products to their fi nal
destinations.
Inventory
Inventory is spread throughout the supply chain and includes every-
thing from raw material to work in process to fi nished goods that are
held by the manufacturers, distributors, and retailers in a supply chain.
Again, managers must decide where they want to position themselves
in the trade-off between responsiveness and effi ciency. Holding large
amounts of inventory allows a company or an entire supply chain to
be very responsive to fl uctuations in customer demand. However, the
creation and storage of inventory is a cost and to achieve high levels of
effi ciency, the cost of inventory should be kept as low as possible.
There are three basic decisions to make regarding the creation and
holding of inventory:
1. Cycle Inventory—This is the amount of inventory needed to
satisfy demand for the product in the period between purchases
of the product. Companies tend to produce and to purchase
in large lots in order to gain the advantages that economies of
Key Concepts of Supply Chain Management 13
scale can bring. However, with large lots also come increased
carrying costs. Carrying costs come from the cost to store,
handle, and insure the inventory. Managers face the tradeoff
between the reduced cost of ordering and better prices offered
by purchasing product in large lots and the increased carry-
ing cost of the cycle inventory that comes with purchasing in
large lots.
2. Safety Inventory—Inventory that is held as a buffer against un-
certainty. If demand forecasting could be done with perfect
accuracy, then the only inventory that would be needed would
be cycle inventory. But since every forecast has some degree of
uncertainty in it, we cover that uncertainty to a greater or lesser
degree by holding additional inventory in case demand is sud-
denly greater than anticipated. The tradeoff here is to weigh the
costs of carrying extra inventory against the costs of losing sales
due to insuffi cient inventory.
3. Seasonal Inventory—This is inventory that is built up in
anticipation of predictable increases in demand that occur
at certain times of the year. For example, it is predictable
that demand for antifreeze will increase in the winter. If a
company that makes antifreeze has a fi xed production rate
that is expensive to change, then it will try to manufacture
product at a steady rate all year long and build up inventory
during periods of low demand to cover for periods of high
demand that will exceed its production rate. The alternative
to building up seasonal inventory is to invest in fl exible
manufacturing facilities that can quickly change their rates
of production of different products to respond to increases in
demand. In this case, the tradeoff is between the cost of car-
rying seasonal inventory and the cost of having more fl exible
production capabilities.
14 ESSENTIALS of Supply Chain Management
Location
Location refers to the geographical site of supply chain facilities. It also
includes the decisions related to which activities should be performed
in each facility. The responsiveness versus effi ciency tradeoff here is the
decision whether to centralize activities in fewer locations to gain econ-
omies of scale and effi ciency, or to decentralize activities in many lo-
cations close to customers and suppliers in order for operations to be
more responsive.
When making location decisions, managers need to consider a range
of factors that relate to a given location including the cost of facilities,
the cost of labor, skills available in the workforce, infrastructure condi-
tions, taxes and tariffs, and proximity to suppliers and customers. Loca-
tion decisions tend to be very strategic decisions because they commit
large amounts of money to long-term plans.
Location decisions have strong impacts on the cost and performance
characteristics of a supply chain. Once the size, number, and location of
facilities are determined, that also defi nes the number of possible paths
through which products can fl ow on the way to the fi nal customer.
Location decisions refl ect a company’s basic strategy for building and
delivering its products to market.
Transportation
This refers to the movement of everything from raw material to
fi nished goods between different facilities in a supply chain. In trans-
portation the tradeoff between responsiveness and effi ciency is mani-
fested in the choice of transport mode. Fast modes of transport such
as airplanes are very responsive but also more costly. Slower modes
such as ship and rail are very cost effi cient but not as responsive. Since
transportation costs can be as much as a third of the operating cost of
a supply chain, decisions made here are very important.
Key Concepts of Supply Chain Management 15
There are six basic modes of transport that a company can choose
from:
1. Ship—which is very cost effi cient but also the slowest mode of
transport. It is limited to use between locations that are situated
next to navigable waterways and facilities such as harbors and
canals.
2. Rail—which is also very cost effi cient but can be slow. This
mode is also restricted to use between locations that are served
by rail lines.
3. Pipelines—which can be very effi cient but are restricted to
commodities that are liquids or gases such as water, oil, and
natural gas.
4. Trucks—which are a relatively quick and very fl exible mode
of transport. Trucks can go almost anywhere. The cost of this
mode is prone to fl uctuations though, as the cost of fuel fl uc-
tuates and the condition of roads varies.
5. Airplanes—which are a very fast mode of transport and are very
responsive. This is also the most expensive mode, and it is some-
what limited by the availability of appropriate airport facilities.
6. Electronic Transport—which is the fastest mode of transport
and is very fl exible and cost effi cient. However, it can only
be used for movement of certain types of products such as
electric energy, data, and products composed of data such as
music, pictures, and text. Someday technology that allows us
to convert matter to energy and back to matter again may
completely rewrite the theory and practice of supply chain
management (“beam me up, Scotty...”).
Given these different modes of transportation and the location of
the facilities in a supply chain, managers need to design routes and
16 ESSENTIALS of Supply Chain Management
networks for moving products. A route is the path through which
products move, and networks are composed of the collection of
the paths and facilities connected by those paths. As a general rule,
the higher the value of a product (such as electronic components or
pharmaceuticals), the more its transport network should emphasize
responsiveness, and the lower the value of a product (such as bulk
commodities like grain or lumber), the more its network should
emphasize effi ciency.
Information
Information is the basis upon which to make decisions regarding the
other four supply chain drivers. It is the connection between all of
the activities and operations in a supply chain. To the extent that this
connection is a strong one (i.e., the data is accurate, timely, and com-
plete), the companies in a supply chain will each be able to make good
decisions for their own operations. This will also tend to maximize the
profi tability of the supply chain as a whole. That is the way that stock
markets or other free markets work and supply chains have many of the
same dynamics as markets.
Information is used for two purposes in any supply chain:
1. Coordinating daily activities related to the functioning of the
other four supply chain drivers: production; inventory; location;
and transportation. The companies in a supply chain use avail-
able data on product supply and demand to decide on weekly
production schedules, inventory levels, transportation routes,
and stocking locations.
2. Forecasting and planning to anticipate and meet future de-
mands. Available information is used to make tactical
forecasts to guide the setting of monthly and quarterly pro-
duction schedules and timetables. Information is also used
Key Concepts of Supply Chain Management 17
The Five Major Supply Chain Drivers
Each market or group of customers has a specific set of needs. The supply chains that serve different markets need to respond effec- tively to these needs. Some markets demand and will pay for high levels of responsiveness. Other markets require their supply chains to focus more on efficiency. The overall effect of the decisions made concerning each driver will determine how well the supply chain serves its market and how profitable it is for the participants in that supply chain.
TIPS & TECHNIQUES
for strategic forecasts to guide decisions about whether to
build new facilities, enter a new market, or exit an existing
market.
18 ESSENTIALS of Supply Chain Management
Wal-Mart is a company shaped by its supply chain and the efficiency of its supply chain has made it a leader in the markets it serves.
Sam Walton decided to build a company that would serve a mass market and compete on the basis of price. He did this by creating one of the world’s most efficient supply chains. The structure and operations of this company have been defined by the need to lower its costs and increase its productivity so that it could pass these sav- ings on to its customers in the form of lower prices. The techniques that Wal-Mart pioneered are now being widely adopted by its com- petitors and by other companies serving entirely different markets.
Wal-Mart introduced concepts that are now industry standards. Many of these concepts come directly from the way the company
EXECUTIVE INSIGHT
Within an individual company the tradeoff between responsiveness
and effi ciency involves weighing the benefi ts that good information can
provide against the cost of acquiring that information. Abundant, accu-
rate information can enable very effi cient operating decisions and better
forecasts but the cost of building and installing systems to deliver this
information can be very high.
Within the supply chain as a whole, the responsiveness versus ef-
fi ciency tradeoff that companies make is one of deciding how much
information to share with the other companies and how much
information to keep private. The more information about product sup-
ply, customer demand, market forecasts, and production schedules that
companies share with each other, the more responsive everyone can be.
Balancing this openness however, are the concerns that each company
has about revealing information that could be used against it by a com-
petitor. The potential costs associated with increased competition can
hurt the profi tability of a company.
Key Concepts of Supply Chain Management 19
builds and operates its supply chain. Let’s look at four such concepts:
1 The strategy of expanding around distribution centers (DCs)
2 Using electronic data interchange (EDI) with suppliers
3 The “big box” store format
4 “Everyday low prices”
The strategy of expanding around DCs is central to the way Wal- Mart enters a new geographical market. The company looks for areas that can support a group of new stores, not just a single new store. It then builds a new DC at a central location in the area and opens its first store at the same time. The DC is the supply chain bridgehead into the new territory. It supports the opening of more new stores in the area at a very low additional cost. Those savings are passed along to the customers.
The use of EDI with suppliers provides the company two substantial benefits. First of all this cuts the transaction costs associated with the ordering of products and the paying of invoices. Ordering prod- ucts and paying invoices are, for the most part, well-defined and routine processes that can be made very productive and efficient through EDI. The second benefit is that these electronic links with suppliers allow Wal-Mart a high degree of control and coordination in the scheduling and receiving of product deliveries. This helps to ensure a steady flow of the right products at the right time, deliv- ered to the right DCs, by all Wal-Mart suppliers.
The “big box” store format allows Wal-Mart to, in effect, combine a store and a warehouse in a single facility and get great operating effi- ciencies from doing so. The big box is big enough to hold large amounts of inventory like a warehouse. And since this inventory is being held at the same location where the customer buys it, there is no delay or cost that would otherwise be associated with moving products from ware- house to store. Again, these savings are passed along to the customer.
EXECUTIVE INSIGHT (CONTINUED)
(Continued)
20 ESSENTIALS of Supply Chain Management
“Everyday low prices” are a way of doing two things. The first thing is to tell its price-conscious customers that they will always get the best price. They need not look elsewhere or wait for special sales. The effect of this message to customers helps Wal-Mart do the second thing, which is to accurately forecast product sales. By eliminating special sales and assuring customers of low prices, it smoothes out demand swings, making demand more steady and predictable. This way stores are more likely to have what customers want when they want it.
Taken individually, these four concepts are each useful but their real power comes from being used in connection with each other. They combine to form a supply chain that drives a self-reinforcing business process. Each concept builds on the strengths of the oth- ers to create a powerful business model for a company that has grown to become a dominant player in its markets.
There seem to be some similarities between Wal-Mart and Alexander the Great. Both developed very effective supply chains that were central to their success.
EXECUTIVE INSIGHT (CONTINUED)
The Evolving Structure of Supply Chains The participants in a supply chain are continuously making decisions
that affect how they manage the fi ve supply chain drivers. Each organi-
zation tries to maximize its performance in dealing with these drivers
through a combination of outsourcing, partnering, and in-house exper-
tise. In the fast-moving markets of our present economy, a company
usually will focus on what it considers to be its core competencies in
supply chain management and outsource the rest.
This was not always the case though. In the slower-moving mass
markets of the industrial age it was common for successful companies to
attempt to own much of their supply chain. That was known as vertical
integration. The aim of vertical integration was to gain maximum ef-
fi ciency through economies of scale (see Exhibit 1.1).
Key Concepts of Supply Chain Management 21
Old Supply Chains Versus New Vertically integrated companies serving slow-moving mass markets once attempted to own much of their supply chains. Today’s fast- moving markets require more flexible and responsive supply chains.
EXHIBIT 1.1
Raw Materials Company
Vertical integration has given way to “ virtual integration.”
Companies now focus on their core competencies, and partner with other companies to create supply chains for fast-moving markets.
Transportation Company
Manufacturing Company
Independent Distributor
Independent Retailer
Fragmented Fast-Moving
Markets
22 ESSENTIALS of Supply Chain Management
In the fi rst half of the 1900s, Ford Motor Company owned much
of what it needed to feed its car factories. It owned and operated iron
mines that extracted iron ore, steel mills that turned the ore into steel
products, plants that made component car parts, and assembly plants that
turned out fi nished cars. In addition, they owned farms where they grew
fl ax to make into linen car tops and forests that they logged and sawmills
where they cut the timber into lumber for making wooden car parts.
Ford’s famous River Rouge Plant was a monument to vertical integra-
tion—iron ore went in at one end and cars came out at the other end.
Henry Ford in his 1926 autobiography, Today and Tomorrow, boasted that
his company could take in iron ore from the mine and put out a car 81
hours later (Ford, Henry, 1926, Today and Tomorrow, Portland, Oregon:
Productivity Press, Inc.).
This was a profi table way of doing business in the more predictable,
one-size-fi ts-all industrial economy that existed in the early 1900s. Ford
and other businesses churned out mass amounts of basic products. But
as the markets grew and customers became more particular about the
kind of products they wanted, this model began to break down. It could
not be responsive enough or produce the variety of products that were
being demanded. For instance, when Henry Ford was asked about the
number of different colors a customer could request, he said, “They can
have any color they want as long as it’s black.” In the 1920s Ford’s market
share was more than 50 percent, but by the 1940s it had fallen to below
20 percent. Focusing on effi ciency at the expense of being responsive to
customer desires was no longer a successful business model.
Globalization, highly competitive markets, and the rapid pace of
technological change are now driving the development of supply chains
where multiple companies work together, each company focusing on
the activities that it does best. Mining companies focus on mining,
timber companies focus on logging and making lumber, and manu-
facturing companies focus on different types of manufacturing from
making component parts to doing fi nal assembly. This way people in
Key Concepts of Supply Chain Management 23
each company can keep up with rapid rates of change and keep learning
the new skills needed to compete in their particular businesses.
Where companies once routinely ran their own warehouses or op-
erated their own fl eets of trucks, they now have to consider whether
those operations are really a core competency or whether it is more cost
effective to outsource those operations to other companies that make
logistics the center of their business. To achieve high levels of operating
effi ciency and to keep up with continuing changes in technology, com-
panies need to focus on their core competencies. It requires this kind of
focus to stay competitive.
Instead of vertical integration, companies now practice “virtual
integration.” Companies fi nd other companies whom they can work
with to perform the activities called for in their supply chains. How
a company defi nes its core competencies and how it positions itself
in the supply chains it serves is one of the most important decisions it
can make.
Participants in the Supply Chain In its simplest form, a supply chain is composed of a company and the
suppliers and customers of that company. This is the basic group of
participants who create a simple supply chain. Extended supply chains
contain three additional types of participants. First there is the sup-
plier’s supplier or the ultimate supplier at the beginning of an extended
supply chain. Then there is the customer’s customer or ultimate cus-
tomer at the end of an extended supply chain. Finally there is a whole
category of companies who are service providers to other companies
in the supply chain. These are companies who supply services in logis-
tics, fi nance, marketing, and information technology.
In any given supply chain there is some combination of companies
who perform different functions. There are companies who are pro-
ducers, distributors or wholesalers, retailers, and companies or individuals
24 ESSENTIALS of Supply Chain Management
who are the customers, the fi nal consumers of a product. Supporting
these companies there will be other companies that are service providers
that provide a range of needed services.
Producers
Producers or manufacturers are organizations that make a product. This
includes companies that are producers of raw materials and companies
that are producers of fi nished goods. Producers of raw materials are or-
ganizations that mine for minerals, drill for oil and gas, and cut timber.
It also includes organizations that farm the land, raise animals, or catch
seafood. Producers of fi nished goods use the raw materials and sub-
assemblies made by other producers to create their products.
Producers can create products that are intangible items such as mu-
sic, entertainment, software, or designs. A product can also be a service
such as mowing a lawn, cleaning an offi ce, performing surgery, or teach-
ing a skill. In many instances the producers of tangible, industrial prod-
ucts are moving to areas of the world where labor is less costly. Producers
in the developed world of North America, Europe, and parts of Asia are
increasingly producers of intangible items and services.
Distributors
Distributors are companies that take inventory in bulk from producers
and deliver a bundle of related product lines to customers. Distributors
are also known as wholesalers. They typically sell to other businesses
and they sell products in larger quantities than an individual consumer
would usually buy. Distributors buffer the producers from fl uctuations
in product demand by stocking inventory and doing much of the sales
work to fi nd and service customers. For the customer, distributors fulfi ll
the “Time and Place” function—they deliver products when and where
the customer wants them.
Key Concepts of Supply Chain Management 25
A distributor is typically an organization that takes ownership of
signifi cant inventories of products that they buy from producers and sell
to consumers. In addition to product promotion and sales, other func-
tions the distributor performs are inventory management, warehouse
operations, and product transportation, as well as customer support and
post-sales service. A distributor can also be an organization that only
brokers a product between the producer and the customer, and never
takes ownership of that product. This kind of distributor performs main-
ly the functions of product promotion and sales. In both of these cases,
as the needs of customers evolve and the range of available products
changes, the distributor is the agent that continually tracks customer
needs and matches them with products available.
Retailers
Retailers stock inventory and sell in smaller quantities to the general
public. This organization also closely tracks the preferences and demands
of the customers that it sells to. It advertises to its customers and often
uses some combination of price, product selection, service, and con-
venience as the primary draw to attract customers for the products it
sells. Discount department stores attract customers using price and wide
product selection. Upscale specialty stores offer a unique line of products
and high levels of service. Fast food restaurants use convenience and low
prices as their draw.
Customers
Customers or consumers are any organization that purchases and uses
a product. A customer organization may purchase a product in order to
incorporate it into another product that they in turn sell to other cus-
tomers. Or a customer may be the fi nal end user of a product who buys
the product in order to consume it.
26 ESSENTIALS of Supply Chain Management
Service Providers
These are organizations that provide services to producers, distributors,
retailers, and customers. Service providers have developed special exper-
tise and skills that focus on a particular activity needed by a supply chain.
Because of this, they are able to perform these services more effectively
and at a better price than producers, distributors, retailers, or consumers
could do on their own.
Some common service providers in any supply chain are pro-
viders of transportation services and warehousing services. These are
trucking companies and public warehouse companies and they are
known as logistics providers. Financial service providers deliver ser-
vices such as making loans, doing credit analysis, and collecting on
past due invoices. These are banks, credit rating companies, and col-
lection agencies. Some service providers deliver market research and
advertising, while others provide product design, engineering services,
legal services, and management advice. Still other service providers
offer information technology and data collection services. All of these
service providers are integrated to a greater or lesser degree into the
ongoing operations of the producers, distributors, retailers, and con-
sumers in the supply chain.
Supply chains are composed of repeating sets of participants that
fall into one or more of these categories. Over time the needs of the
supply chain as a whole remain fairly stable. What changes is the mix
of participants in the supply chain and the roles that each participant
plays. In some supply chains, there are few service providers because the
other participants perform these services on their own. In other supply
chains very effi cient providers of specialized services have evolved and
the other participants outsource work to these service providers instead
of doing it themselves. Examples of supply chain structure are shown in
Exhibit 1.2.
Key Concepts of Supply Chain Management 27
Supply Chain Structure
EXHIBIT 1.2
Supplier
Ultimate Supplier
Ultimate CustomerSupplier Company
Service Provider
Product Designer
Raw Material Producer
Manufacturer Distributor Retailer Retail
Customer
Logistics Provider
Finance Provider
Business Customer
Market Research
Customer
CustomerCompany
Aligning the Supply Chain with Business Strategy A company’s supply chain is an integral part of its approach to the markets
it serves. The supply chain needs to respond to market requirements
28 ESSENTIALS of Supply Chain Management
and do so in a way that supports the company’s business strategy. The
business strategy a company employs starts with the needs of the cus-
tomers that the company serves or will serve. Depending on the needs of
its customers, a company’s supply chain must deliver the appropriate mix
of responsiveness and effi ciency. A company whose supply chain allows
it to more effi ciently meet the needs of its customers will gain market
share at the expense of other companies in that market and also will be
more profi table.
For example, let’s consider two companies and the needs that their
supply chains must respond to. The two companies are 7-Eleven and
Sam’s Club, which is a part of Wal-Mart. The customers who shop at
convenience stores like 7-Eleven have a different set of needs and pref-
erences from those who shop at a discount warehouse like Sam’s Club.
The 7-Eleven customer is looking for convenience and not the lowest
price. That customer is often in a hurry, and prefers that the store be
nearby and have enough variety of products so that they can pick up
small amounts of common household or food items that they need
immediately. Sam’s Club customers are looking for the lowest price.
They are not in a hurry and are willing to drive some distance and buy
large quantities of limited numbers of items in order to get the lowest
price possible.
Clearly the supply chain for 7-Eleven needs to emphasize re-
sponsiveness. That group of customers expects convenience and will
pay for it. On the other hand, the Sam’s Club supply chain needs to
focus tightly on effi ciency. The Sam’s Club customer is very price
conscious and the supply chain needs to fi nd every opportunity to
reduce costs so that these savings can be passed on to the customers.
Both of these companies’ supply chains are well aligned with their
business strategies and because of this they are each successful in their
markets.
There are three steps to use in aligning your supply chain with
your business strategy. The fi rst step is to understand the markets that
Key Concepts of Supply Chain Management 29
your company serves. The second step is to defi ne the strengths or
core competencies of your company and the role the company can
or could play in serving its markets. The last step is to develop the
needed supply chain capabilities to support the roles your company
has chosen.
Understand the Markets Your Company Serves
Begin by asking questions about your customers. What kind of customer
does your company serve? What kind of customer does your customer
sell to? What kind of supply chain is your company a part of ? The an-
swers to these questions will tell you what supply chains your company
serves and whether your supply chain needs to emphasize responsiveness
or effi ciency. Chopra and Meindl have defi ned the following attributes
that help to clarify requirements for the customers you serve. These
attributes are:
• The quantity of the product needed in each lot—Do your customers want small amounts of products or will they buy large quan-
tities? A customer at a convenience store or a drug store buys in
small quantities. A customer of a discount warehouse club, such
as Sam’s Club, buys in large quantities.
• The response time that customers are willing to tolerate—Do your customers buy on short notice and expect quick service or is a
longer lead time acceptable? Customers of a fast food restaurant
certainly buy on short notice and expect quick service. Cus-
tomers buying custom machinery would plan the purchase in
advance and expect some lead time before the product could be
delivered.
• The variety of products needed—Are customers looking for a nar- row and well-defi ned bundle of products or are they looking for
30 ESSENTIALS of Supply Chain Management
a wide selection of different kinds of products? Customers of a
fashion boutique expect a narrowly defi ned group of products.
Customers of a “big box” discount store like Wal-Mart expect a
wide variety of products to be available.
• The service level required—Do customers expect all products to be available for immediate delivery or will they accept partial deliv-
eries of products and longer lead times? Customers of a music
store expect to get the CD they are looking for immediately or
they will go elsewhere. Customers who order a custom-built new
machine tool expect to wait a while before delivery.
• The price of the product—How much are customers willing to pay? Some customers will pay more for convenience or high
levels of service and other customers look to buy based on the
lowest price they can get.
• The desired rate of innovation in the product—How fast are new products introduced and how long before existing products be-
come obsolete? In products such as electronics and computers,
customers expect a high rate of innovation. In other products,
such as house paint, customers do not desire such a high rate of
innovation.
Defi ne Core Competencies of Your Company
The next step is to defi ne the role that your company plays or wants
to play in these supply chains. What kind of supply chain participant is
your company? Is your company a producer, a distributor, a retailer, or
a service provider? What does your company do to enable the supply
chains that it is part of? What are the core competencies of your com-
pany? How does your company make money? The answers to these
questions tell you what roles in a supply chain will be the best fi t for
your company.
Key Concepts of Supply Chain Management 31
Be aware that your company can serve multiple markets and partici-
pate in multiple supply chains. A company like W.W. Grainger serves sev-
eral different markets. It sells maintenance, repair, and operating (MRO)
supplies to large national account customers such as Ford and Boeing
and it also sells these supplies to small businesses and building contrac-
tors. These two different markets have different requirements as meas-
ured by the above customer attributes.
When you are serving multiple market segments, your company will
need to look for ways to leverage its core competencies. Parts of these
supply chains may be unique to the market segment they serve, while
other parts can be combined to achieve economies of scale. For example,
if manufacturing is a core competency for a company, it can build a
range of different products in common production facilities. Then dif-
ferent inventory and transportation options can be used to deliver the
products to customers in different market segments.
Develop Needed Supply Chain Capabilities
Once you know what kind of markets your company serves and the role
your company does or will play in the supply chains of these markets,
then you can take this last step, which is to develop the supply chain
capabilities needed to support the roles your company plays. This devel-
opment is guided by the decisions made about the fi ve supply chain
drivers. Each of these drivers can be developed and managed to em-
phasize responsiveness or effi ciency depending on the business require-
ments.
1. Production—This driver can be made very responsive by build-
ing factories that have a lot of excess capacity and that use
fl exible manufacturing techniques to produce a wide range
of items. To be even more responsive, a company could do
their production in many smaller plants that are close to major
32 ESSENTIALS of Supply Chain Management
groups of customers so that delivery times would be shorter. If
effi ciency is desirable, then a company can build factories with
very little excess capacity and have the factories optimized for
producing a limited range of items. Further effi ciency could be
gained by centralizing production in large central plants to get
better economies of scale.
2. Inventory—Responsiveness here can be had by stocking high
levels of inventory for a wide range of products. Additional
responsiveness can be gained by stocking products at many
locations so as to have the inventory close to customers and
available to them immediately. Effi ciency in inventory manage-
ment would call for reducing inventory levels of all items and
especially of items that do not sell as frequently. Also, economies
of scale and cost savings could be obtained by stocking inven-
tory in only a few central locations.
3. Location—A location approach that emphasizes responsiveness
would be one where a company opens up many locations to
be physically close to its customer base. For example, McDon-
ald’s has used location to be very responsive to its customers by
opening up lots of stores in its high-volume markets. Effi ciency
can be achieved by operating from only a few locations and
centralizing activities in common locations. An example of this
is the way Dell Computers serves large geographical markets
from only a few central locations that perform a wide range of
activities.
4. Transportation—Responsiveness can be achieved by a trans-
portation mode that is fast and fl exible. Many companies that
sell products through catalogs or over the Internet are able to
provide high levels of responsiveness by using transportation
to deliver their products, often within 24 hours. FedEx and
UPS are two companies that can provide very responsive
Key Concepts of Supply Chain Management 33
transportation services. Effi ciency can be emphasized by trans-
porting products in larger batches and doing it less often. The
use of transportation modes such as ship, rail, and pipelines can
be very effi cient. Transportation can be made more effi cient if it
is originated out of a central hub facility instead of from many
branch locations.
5. Information—The power of this driver grows stronger each
year as the technology for collecting and sharing information
becomes more widespread, easier to use, and less expensive.
Information, much like money, is a very useful commodity
because it can be applied directly to enhance the perfor-
mance of the other four supply chain drivers. High levels of
responsiveness can be achieved when companies collect and
share accurate and timely data generated by the operations of
the other four drivers. The supply chains that serve the elec-
tronics markets are some of the most responsive in the world.
Companies in these supply chains, from manufacturers to
distributors to the big retail stores collect and share data
about customer demand, production schedules, and inven-
tory levels.
Where effi ciency is more the focus, less information about fewer
activities can be collected. Companies may also elect to share less infor-
mation among themselves so as not to risk having that information used
against them. Please note, however, that these information effi ciencies
are only effi ciencies in the short term and they become less effi cient
over time because the cost of information continues to drop and the cost
of the other four drivers usually continues to rise. Over the longer term,
those companies and supply chains that learn how to maximize the use
of information to get optimal performance from the other drivers will
gain the most market share and be the most profi table.
34 ESSENTIALS of Supply Chain Management
Three Steps to Align Supply Chain and Business Strategy
TIPS & TECHNIQUES
Key Concepts of Supply Chain Management 35
Professor Sunil Chopra is a keen observer of the ways that sup- ply chains respond over time to changes in their economic and regulatory environments and to shifts in technology and cus- tomer demands. In an interview, Professor Chopra shared some of his observations.
“Look at a company’s products and how they’re being changed by advances in technology,” he said. “For instance, Dell’s build-to- order business model and its practice of selling directly to custom- ers are not so valuable anymore because people don’t customize their computer purchases very much anymore.”
People used to buy mostly desktop PCs, but now sales of laptops surpass PCs, and people don’t feel the need to customize their laptops the way they did with their PCs. “So Dell now is saying they will ship from stock instead of their traditional model, which was to build-to-order-and-ship customized PCs.”
And Professor Chopra points out that Dell is also restructuring its retail channels. Dell not only sells direct, but also sells through retailers such as Wal-Mart for standard low-end PCs. On a $500 machine the shipping expense is a significant part of the total cost, so it’s better to sell low-end PCs through a local retailer like Wal-Mart
Apple, on the other hand, has a different strategy, according to Professor Chopra. “They make the user interface the customized part of their product while their hardware is a commodity. Their hardware is standard and it’s the apps that run on the hardware that customize the product.”
Unlike Dell, Apple has only about 15 basic product models, and this enables them to have a simple hardware supply chain. Apple adds value to the hardware it sells by designing a user interface (UI) that customers find very attractive. So they are willing to pay premium prices for what would otherwise be commodity hardware because they want the UI that Apple puts on its hardware.
EXECUTIVE INSIGHT
(Continued)
36 ESSENTIALS of Supply Chain Management
However, one of the challenges that this business model creates for Apple is that they need to have a big hit product every few years in order to keep ahead of their competitors who come out with close copies of the Apple products and offer them for sale at lower prices. For instance, just as Google’s Android is starting to cut into sales of Apple’s iPhone, Apple comes out with a compelling new product in the iPad. “iPad is doing well now,” said Chopra, “but they have to come up with another big hit product in another couple of years as competitors learn to copy the iPad.”
He also pointed out how regulations such as the current tax struc- ture on Internet sales channels like the one Dell uses can influ- ence and even distort supply chain structures. Dell is not taxed on out-of-state sales. So that causes them to remain centralized and keep using an Internet direct-sales channel when, if they had to pay out-of-state sales taxes, they would otherwise move to a decentral- ized model. If the regulations and tax structures related to Internet sales change, then Dell’s supply chain structure will also change.
Supply chains are becoming so efficient and customer preferences change so quickly that profit margins are relentlessly squeezed. Companies need to find ways to cut their fixed costs of producing products. And they cannot risk getting too invested in a business model that emphasizes either low-cost efficiency or high-cost responsiveness. Efficiency and responsiveness are two ends of a continuum, and companies need to be flexible enough to reposition themselves on that continuum quickly when markets shift.
Professor Chopra observes that the question of efficiency versus responsiveness can be addressed like an investment portfolio question. If you are concentrated at either end of the spectrum you are in a risky position because the world will probably change sud- denly and your company might not be able to adjust fast enough to keep pace.
How do you position your company or your portfolio of business to best fit the markets you serve? Some portion of your business
EXECUTIVE INSIGHT (CONTINUED)
Key Concepts of Supply Chain Management 37
must be responsive, so you move that part near to your custom- ers, and another part of your business must be efficient so you position it offshore in low-cost-labor countries. In Dell’s case the server market is still a market that values a lot of customization so that is the part they make responsive and Dell does server assembly onshore near its customers. But customers no longer value customization in PCs and laptops so they have outsourced that part of their business to emphasize efficiency and that work is now done offshore.
And this leads to another issue that Professor Chopra pointed out. As markets and the supply chains that serve them get more and more efficient and fluid, the middle class in developed countries tends to get hollowed out. “If you are a highly skilled worker in a developed nation, then your services are sought after and you can leverage the low-cost labor of workers in developing nations to build products you design,” said Chopra. But this also displaces large numbers of low- and medium-skilled workers in developed coun- tries, as jobs once performed by them are sent offshore to be done by low-cost workers in developing nations.
From the 1990s through the first decade of this century, wages in developed countries have polarized. There are some who have seen their incomes increase dramatically as they leveraged the low-cost labor available in developing nations. And a lot of middle class work- ers in developed nations have seen their wages drop significantly because their work is now being done elsewhere. “This produces greater value for the world as a whole, but now the question is how are we going to distribute that value in order to maintain a broad middle class in the developed countries?”
Professor Sunil Chopra is the IBM Distinguished Professor of Operations Management at Northwestern University’s Kellogg School of Management. He has co-authored the books Managing Business Process Flows and Supply Chain Management: Strategy, Planning, and Operation, 4th Edition.
EXECUTIVE INSIGHT (CONTINUED)
38 ESSENTIALS of Supply Chain Management
Chapter Summary A supply chain is composed of all the companies involved in the design,
production, and delivery of a product to market. Supply chain manage-
ment is the coordination of production, inventory, location, and trans-
portation among the participants in a supply chain to achieve the best
mix of responsiveness and effi ciency for the market being served. The
goal of supply chain management is to increase sales of goods and ser-
vices to the fi nal, end-use customer while at the same time reducing
both inventory and operating expenses.
The business model of vertical integration that came out of the in-
dustrial economy has given way to “virtual integration” of companies in
a supply chain. Each company now focuses on its core competencies and
partners with other companies that have complementary capabilities for
the design and delivery of products to market. Companies must focus on
improvements in their core competencies in order to keep up with the
fast pace of market and technological change in today’s economy.
To succeed in the competitive markets that make up today’s economy,
companies must learn to align their supply chains with the demands
of the markets they serve. Supply chain performance is now a distinct
competitive advantage for companies who excel in this area. One of the
largest companies in North America is a testament to the power of effec-
tive supply chain management. Wal-Mart has grown steadily over the last
several decades and much, if not most, of its success is directly related to
its evolving capabilities to continually improve its supply chain.
39
CHAPTER 2
Supply Chain Operations Planning and Sourcing
After reading this chapter you will be able to
● Gain a conceptual appreciation of the business operations in any supply chain
● Exercise an executive-level understanding of operations involved in supply chain planning and sourcing
● Start to assess how well these operations are working within your own company
A s the saying goes, “It’s not what you know, but what you can
remember when you need it.” Since there is an infi nite amount of
detail in any situation, the trick is to fi nd useful models that capture
the salient facts and provide a framework to organize the rest of the
relevant details. The purpose of this chapter is to provide some useful
models of the business operations that make up the supply chain.
A Useful Model of Supply Chain Operations In the fi rst chapter we saw that there are fi ve drivers of supply chain
performance. These drivers can be thought of as the design parameters
or policy decisions that defi ne the shape and capabilities of any supply
Essentials of Supply Chain Management, Third Edition by Michael Hugos
Copyright © 2011 John Wiley & Sons
40 ESSENTIALS of Supply Chain Management
chain. Within the context created by these policy decisions, a supply
chain goes about doing its job by performing regular, ongoing opera-
tions. These are the “nuts and bolts” operations at the core of every
supply chain.
As a way to get a high-level understanding of these operations and
how they relate to each other, we use a simplifi ed version of the supply
chain operations reference (SCOR) model developed by the Supply
Chain Council (Supply Chain Council Inc., 12320 Barker Cypress Rd,
Suite 600, PMB 321, Cypress, TX 77429, www.supply-chain.org). Read-
ers can get information on the full model at their web site. Our simpli-
fi ed model identifi es four categories of operations:
1. Plan
2. Source
3. Make
4. Deliver
Plan
This refers to all the operations needed to plan and organize the opera-
tions in the other three categories. We will investigate three operations
in this category in some detail: demand forecasting, product pricing, and
inventory management.
Source
Operations in this category include the activities necessary to acquire the
inputs to create products or services. We look at two operations here. The
fi rst, procurement, is the acquisition of materials and services. The second
operation, credit and collections, is not traditionally seen as a sourcing
activity but it can be thought of as, literally, the acquisition of cash. Both
these operations have a big impact on the effi ciency of a supply chain.
Supply Chain Operations 41
Make
This category includes the operations required to develop and build
the products and services that a supply chain provides. Operations that
we discuss in this category are product design, production management,
and facility and management. The SCOR model does not specifi cally
include the product design and development process, but it is included
here because it is integral to the production process.
Four Categories of Supply Chain Operations
TIPS & TECHNIQUES
Within the constraints set by decisions about the four supply chain drivers, these business operations do the work that makes the supply chain a reality.
42 ESSENTIALS of Supply Chain Management
Deliver
These operations encompass the activities that are part of receiving cus-
tomer orders and delivering products to customers. The three operations
we review are management, product delivery, and return processing.
These are the operations that constitute the core connections between
companies in a supply chain.
The rest of this chapter presents further detail in the categories of
Plan and Source. There is an executive-level overview of the three main
operations that constitute the planning process and two operations that
comprise the sourcing process. Chapter 3 presents an executive over-
view of the key operations in making and delivering.
Demand Forecasting and Planning (Plan) Supply chain management decisions are based on forecasts that defi ne
which products will be required, what amount of these products will be
called for, and when they will be needed. The demand forecast becomes
the basis for companies to plan their internal operations and to cooper-
ate among each other to meet market demand. All forecasts deal with four major variables that combine to deter-
mine what market conditions will be like. Those variables are:
1. Supply
2. Demand
3. Product Characteristics
4. Competitive Environment
Supply is determined by the number of producers of a product and
by the lead times that are associated with a product. The more producers
there are of a product and the shorter the lead times, the more predict-
able this variable is. When there are only a few suppliers or when lead
Supply Chain Operations 43
times are longer, then there is more potential uncertainty in a mar-
ket. Like variability in demand, uncertainty in supply makes forecasting
more diffi cult. Also, longer lead times associated with a product require
a longer time horizon over which forecasts must be made. Supply chain
forecasts must cover a time period that encompasses the combined lead
times of all the components that go into the creation of a fi nal product.
Demand refers to the overall market demand for a group of related
products or services. Is the market growing or declining? If so, what is
the yearly or quarterly rate of growth or decline? Or maybe the market
is relatively mature and demand is steady at a level that has been pre-
dictable for some period of years. Also, many products have a seasonal
demand pattern. For example, snow skis and heating oil are more in
demand in the winter, and tennis rackets and sun screen are more in
demand in the summer. Perhaps the market is a developing market—the
products or services are new and there is not much historical data on
demand or the demand varies widely because new customers are just
being introduced to the products. Markets where there is little histori-
cal data and lots of variability are the most diffi cult when it comes to
demand forecasting.
Product characteristics include the features of a product that infl u-
ence customer demand for the product. Is the product new and develop-
ing quickly like many electronic products or is the product mature and
changing slowly or not at all, as is the case with many commodity prod-
ucts? Forecasts for mature products can cover longer timeframes than
forecasts for products that are developing quickly. It is also important to
know whether a product will steal demand away from another product.
Can it be substituted for another product? Or will the use of one product
drive the complementary use of a related product? Products that either
compete with or complement each other should be forecasted together.
Competitive environment refers to the actions of a company and
its competitors. What is the market share of a company? Regardless of
whether the total size of a market is growing or shrinking, what is the
44 ESSENTIALS of Supply Chain Management
trend in an individual company’s market share? Is it growing or declin-
ing? What is the market share trend of competitors? Market share trends
can be infl uenced by product promotions and price wars, so forecasts
should take into account such events that are planned for the upcoming
period. Forecasts should also account for anticipated promotions and
price wars that will be initiated by competitors.
Forecasting Methods
There are four basic methods to use when doing forecasts. Most forecasts
are done using various combinations of these four methods. Chopra and
Meindl defi ne these methods as:
1. Qualitative
2. Causal
3. Time Series
4. Simulation
Qualitative methods rely upon a person’s intuition or subjective
opinions about a market. These methods are most appropriate when
there is little historical data to work with. When a new line of products is
introduced, people can make forecasts based on comparisons with oth-
er products or situations that they consider similar. People can forecast
using production adoption curves that they feel refl ect what will happen
in the market.
Causal methods of forecasting assume that demand is strongly re-
lated to particular environmental or market factors. For instance, de-
mand for commercial loans is often closely correlated to interest rates.
So if interest rate cuts are expected in the next period of time, then loan
forecasts can be derived using a causal relationship with interest rates.
Another strong causal relationship exists between price and demand. If
prices are lowered, demand can be expected to increase and if prices are
raised, demand can be expected to fall.
Supply Chain Operations 45
Time series methods are the most common form of forecasting.
They are based on the assumption that historical patterns of demand
are a good indicator of future demand. These methods are best when
there is a reliable body of historical data and the markets being forecast
are stable and have demand patterns that do not vary much from one
year to the next. Mathematical techniques such as moving averages and
exponential smoothing are used to create forecasts based on time se-
ries data. These techniques are employed by most forecasting software
packages.
Simulation methods use combinations of causal and time series meth-
ods to imitate the behavior of consumers under different circumstances.
This method can be used to answer questions such as what will happen
to revenue if prices on a line of products are lowered or what will hap-
pen to market share if a competitor introduces a competing product or
opens a store nearby.
Few companies use only one of these methods to produce forecasts.
Most companies do several forecasts using several methods and then
combine the results of these different forecasts into the actual forecast
that they use to plan their businesses. Studies have shown that this proc-
ess of creating forecasts using different methods and then combining
the results into a fi nal forecast usually produces better accuracy than the
output of any one method alone.
Regardless of the forecasting methods used, when doing forecasts
and evaluating their results it is important to keep several things in mind.
First of all, short-term forecasts are inherently more accurate than long-
term forecasts. The effect of business trends and conditions can be much
more accurately calculated over short periods than over longer peri-
ods. When Wal-Mart began restocking its stores twice a week instead of
twice a month, the store managers were able to signifi cantly increase the
accuracy of their forecasts because the time periods involved dropped
from two or three weeks to three or four days. Most long range, multi-
year forecasts are highly speculative.
46 ESSENTIALS of Supply Chain Management
Aggregate forecasts are more accurate than forecasts for individual
products or for small market segments. For example, annual forecasts for
soft drink sales in a given metropolitan area are fairly accurate but when
these forecasts are broken down to sales by districts within the metropoli-
tan area, they become less accurate. Aggregate forecasts are made using a
broad base of data that provides good forecasting accuracy. As a rule, the
more narrowly focused or specifi c a forecast is, the less data is available
and the more variability there is in the data, so the accuracy is diminished.
Finally, forecasts are always wrong to a greater or lesser degree. There
are no perfect forecasts and businesses need to assign some expected de-
gree of error to every forecast. An accurate forecast may have a degree
of error that is plus or minus 5 percent. A more speculative forecast may
have a plus or minus 20 percent degree of error. It is important to know
the degree of error because a business must have contingency plans to
cover those outcomes. What would a company do if raw material prices
were 5 percent higher than expected? What would it do if demand was
20 percent higher than expected?
Aggregate Planning
Once demand forecasts have been created, the next step is to create a
plan for the company to meet the expected demand. This is called ag-
gregate planning, and its purpose is to satisfy demand in a way that maxi-
mizes profi t for the company. The planning is done at the aggregate level
and not at the level of individual stock keeping units (SKUs). It sets the
optimum levels of production and inventory that will be followed over
the next 3 to 18 months.
The aggregate plan becomes the framework within which
short-term decisions are made about production, inventory, and
distribution. Production decisions involve setting parameters such as the
rate of production and the amount of production capacity to use, the size
of the workforce, and how much overtime and subcontracting to use.
Supply Chain Operations 47
Inventory decisions include how much demand will be met immedi-
ately by inventory on hand and how much demand can be satisfi ed later
and turned into backlogged orders. Distribution decisions defi ne how
and when product will be moved from the place of production to the
place where it will be used or purchased by customers.
There are three basic approaches to take in creating the aggregate
plan. They involve trade-offs among three variables. Those variables are:
(1) amount of production capacity; (2) the level of utilization of the
production capacity; and (3) the amount of inventory to carry. We look
The Four Forecasting Variables and the Four Forecasting Methods
TIPS & TECHNIQUES
48 ESSENTIALS of Supply Chain Management
briefl y at each of these three approaches. In actual practice, most com-
panies create aggregate plans that are a combination of these three ap-
proaches.
1. Use Production Capacity to Match Demand. In this approach the
total amount of production capacity is matched to the level of
demand. The objective here is to use 100 percent of capacity at
all times. This is achieved by adding or eliminating plant capac-
ity as needed and hiring and laying off employees as needed.
This approach results in low levels of inventory but it can be
very expensive to implement if the cost of adding or reducing
plant capacity is high. It is also often disruptive and demoral-
izing to the workforce if people are constantly being hired or
fi red as demand rises and falls. This approach works best when
the cost of carrying inventory is high and the cost of changing
capacity plant and workforce—is low.
2. Utilize Varying Levels of Total Capacity to Match Demand. This ap-
proach can be used if there is excess production capacity avail-
able. If existing plants are not used 24 hours a day and 7 days a
week then there is an opportunity to meet changing demand
by increasing or decreasing utilization of production capacity.
The size of the workforce can be maintained at a steady rate
and overtime and fl exible work scheduling used to match pro-
duction rates. The result is low levels of inventory and also
lower average levels of capacity utilization. The approach makes
sense when the cost of carrying inventory is high and the cost
of excess capacity is relatively low.
3. Use Inventory and Backlogs to Match Demand. Using this ap-
proach provides for stability in the plant capacity and work-
force and enables a constant rate of output. Production is not
matched with demand. Instead inventory is either built up
Supply Chain Operations 49
during periods of low demand in anticipation of future de-
mand or inventory is allowed to run low and backlogs are
built up in one period to be fi lled in a following period. This
approach results in higher capacity utilization and lower costs
of changing capacity but it does generate large inventories and
backlogs over time as demand fl uctuates. It should be used
when the cost of capacity and changing capacity is high and
the cost of carrying inventory and backlogs is relatively low.
Product Pricing (Plan) Companies and entire supply chains can infl uence demand over time
by using price. Depending how price is used, it will tend to maximize
either revenue or gross profi t. Typically marketing and salespeople want
to make pricing decisions that will stimulate demand during peak sea-
sons. The aim here is to maximize total revenue. Often fi nancial or
production people want to make pricing decisions that stimulate de-
mand during low periods. Their aim is to maximize gross profi t in
peak demand periods and generate revenue to cover costs during low
demand periods.
Relationship of Cost Structure to Pricing
The question for each company to ask is, “Is it better to do price pro-
motion during peak periods to increase revenue or during low periods
to cover costs?” The answer depends on the company’s cost structure. If
a company has fl exibility to vary the size of its workforce and produc-
tive capacity and the cost of carrying inventory is high, then it is best
to create more demand in peak seasons. If there is less fl exibility to vary
workforce and capacity and if cost to carry inventory is low, it is best to
create demand in low periods.
50 ESSENTIALS of Supply Chain Management
An example of a company that can quickly ramp up production
would be an electronics component manufacturer. Such companies have
invested in plant and equipment that can be quickly reconfi gured to
produce different fi nal products from an inventory of standard compo-
nent parts. The fi nished goods inventory is expensive to carry because it
soon becomes obsolete and must be written off.
These companies are generally motivated to run promotions in peak
periods to stimulate demand even further. Since they can quickly in-
crease production levels, a reduction in the profi t margin can be made
up for by an increase in total sales if they are able to sell all the product
that they manufacture.
A company that cannot quickly ramp up production levels is a paper
mill. The plant and equipment involved in making paper is very expensive
and requires a long lead time to build. Once in place, a paper mill operates
most effi ciently if it is able to run at a steady rate all year long. The cost
of carrying an inventory of paper products is less expensive than carrying
an inventory of electronic components because paper products are com-
modity items that will not become obsolete. These products also can be
stored in less expensive warehouse facilities and are less likely to be stolen.
A paper mill is motivated to do price promotions in periods of low
demand. In periods of high demand the focus is on maintaining a good
profi t margin. Since production levels cannot be increased anyway, there
is no way to respond to or profi t from an increase in demand. In peri-
ods where demand is below the available production level, then there is
value in increased demand. The fi xed cost of the plant and equipment is
constant so it is best to try to balance demand with available production
capacity. This way the plant can be run steadily at full capacity.
Inventory Management (Plan) Inventory management is a set of techniques that are used to manage the
inventory levels within different companies in a supply chain. The aim
Supply Chain Operations 51
is to reduce the cost of inventory as much as possible while still main-
taining the service levels that customers require. Inventory management
takes its major inputs from the demand forecasts for products and the
prices of products. With these two inputs, inventory management is an
ongoing process of balancing product inventory levels to meet demand
and exploiting economies of scale to get the best product prices.
Product Promotion and Company Cost Structure
TIPS & TECHNIQUES
52 ESSENTIALS of Supply Chain Management
As we discussed in Chapter 1, there are three kinds of inventory: (1)
cycle inventory; (2) seasonal inventory; and (3) safety inventory. Cycle
inventory and seasonal inventory are both infl uenced by economy of
scale considerations. The cost structure of the companies in any supply
chain will suggest certain levels of inventory based on production costs
and inventory carrying cost. Safety inventory is infl uenced by the pre-
dictability of product demand. The less predictable product demand is,
the higher the level of safety inventory is required to cover unexpected
swings in demand.
The inventory management operation in a company or an entire
supply chain is composed of a blend of activities related to managing
the three different types of inventory. Each type of inventory has its own
specifi c challenges and the mix of these challenges will vary from one
company to another and from one supply chain to another.
Cycle Inventory
Cycle inventory is the inventory required to meet product demand over
the time period between placing orders for the product. Cycle inventory
exists because economies of scale make it desirable to make fewer orders
of large quantities of a product rather than continuous orders of small
product quantity. The end-use customer of a product may actually use
a product in continuous small amounts throughout the year. But the
distributor and the manufacturer of that product may fi nd it more cost
effi cient to produce and stock the product in large batches that do not
match the usage pattern.
Cycle inventory is the buildup of inventory in the supply chain
due to the fact that production and stocking of inventory is done in
lot sizes that are larger than the ongoing demand for the product. For
example, a distributor may experience an ongoing demand for Item A
that is 100 units per week. The distributor fi nds, however, that it is most
cost effective to order in batches of 650 units. Every six weeks or so the
Supply Chain Operations 53
distributor places an order causing cycle inventory to build up in the
distributor’s warehouse at the beginning of the ordering period. The
manufacturer of Item A that all the distributors order from may fi nd
that it is most effi cient for them to manufacture in batches of 14,000
units at a time. This also results in the buildup of cycle inventory at the
manufacturer’s location.
Economic Order Quantity
Given the cost structure of a company, there is an order quantity that is
the most cost-effective amount to purchase at a time. This is called the
economic order quantity (EOQ) and it is calculated as:
EOQ = 2UO hC
where:
U = annual usage rate O = ordering cost C = cost per unit h = holding cost per year as a percentage of unit cost For instance, let’s say that Item Z has an annual usage rate (U) of
240, a fi xed cost per order (O) of $5.00, a unit cost (C) of $7.00, and
an annual holding cost (h) of 30 percent per unit. If we do the math, it
works out as:
EOQ 2 240 5.00
.30 7.00 = × ×
×
EOQ 2400= 2 1.
EOQ = 1142 86.
EOQ = 33.81 and rounded to the nearest whole unit, it is 34
54 ESSENTIALS of Supply Chain Management
If the annual usage rate for Item Z is 240, then the monthly usage
rate is 20. An EOQ of 34 represents about seven weeks’ supply. This may
not be a convenient order size. Small changes in the EOQ do not have a
big impact on total ordering and holding costs so it is best to round off
the EOQ quantity to the nearest standard ordering size. In the case of
Item Z, there may be 30 units in a case. So it would make sense to adjust
the EOQ for Item Z to 30.
The EOQ formula works to calculate an order quantity that results
in the most effi cient investment of money in inventory. Effi ciency here
is defi ned as the lowest total unit cost for each inventory item. If a cer-
tain inventory item has a high usage rate and is expensive, the EOQ
formula recommends a low order quantity which results in more orders
per year but less money invested in each order. If another inventory item
has a low usage rate and is inexpensive, the EOQ formula recommends
a high order quantity. This means fewer orders per year but since the
unit cost is low, it still results in the most effi cient amount of money to
invest in that item.
Seasonal Inventory
Seasonal inventory happens when a company or a supply chain with a
fi xed amount of productive capacity decides to produce and stockpile
products in anticipation of future demand. If future demand is going to
exceed productive capacity, then the answer is to produce product in
times of low demand that can be put into inventory to meet the high
demand in the future.
Decisions about seasonal inventory are driven by a desire to get the
best economies of scale given the capacity and cost structure of each
company in the supply chain. If it is expensive for a manufacturer to
increase productive capacity, then capacity can be considered as fi xed.
Once the annual demand for the manufacturer’s products is determined,
the most effi cient schedule to utilize that fi xed capacity can be calculated.
Supply Chain Operations 55
Understanding the Economic Ordering Quantity (EOQ)
Good inventory management requires a company to know the EOQ for all the products it buys. The EOQ for different products changes over time so a company needs an ongoing measurement process to keep the numbers accurate and up to date.
TIPS & TECHNIQUES
This schedule will call for seasonal inventory. Managing seasonal
inventory calls for demand forecasts to be accurate since large amounts
of inventory can be built up this way and it can become obsolete, or
holding costs can mount if the inventory is not sold off as anticipated.
Managing seasonal inventory also calls for manufacturers to offer price
incentives to persuade distributors to purchase the product and put it in
their warehouses well before demand for it occurs.
56 ESSENTIALS of Supply Chain Management
Safety Inventory
Safety inventory is necessary to compensate for the uncertainty that ex-
ists in a supply chain. Retailers and distributors do not want to run out
of inventory in the face of unexpected customer demand or unexpected
delay in receiving replenishment orders, so they keep safety stock on
hand. As a rule, the higher the level of uncertainty, the higher the level
of safety stock that is required.
Safety inventory for an item can be defi ned as the amount of in-
ventory on hand for an item when the next replenishment EOQ lot
arrives. This means that the safety stock is inventory that does not turn
over. In effect, it becomes a fi xed asset and it drives up the cost of car-
rying inventory. Companies need to fi nd a balance between their desire
to carry a wide range of products and offer high availability on all of
them, and their confl icting desire to keep the cost of inventory as low as
possible. That balance is refl ected quite literally in the amount of safety
stock that a company carries.
Procurement (Source)
Traditionally, the main activities of a purchasing manager were to beat
up potential suppliers on price and then buy products from the lowest-
cost supplier that could be found. That is still an important activity, but
there are other activities that are becoming equally important. Because
of this, the purchasing activity is now seen as part of a broader function
called procurement. The procurement function can be broken into fi ve
main activity categories:
1. Purchasing
2. Consumption Management
3. Vendor Selection
4. Contract Negotiation
5. Contract Management
Supply Chain Operations 57
Key Points to Remember about Inventory Management
TIPS & TECHNIQUES
58 ESSENTIALS of Supply Chain Management
With the spread of our global, interconnected economy, there also comes the need to understand cultural and behavioral drivers that influence the procurement process. Huseyin Eskici is the head of the Procurement Department of the Istanbul Stock Exchange and he negotiates contracts with suppliers from all over the world. In an interview I posed three questions and asked him to share his insights on this topic.
1 In your experience negotiating purchasing contracts with sup- pliers from different countries, what differences do you see in the negotiating process? For instance what are the negotiating differences you see between a British company or a Turkish company or a Chinese or an American company?
In my experience, negotiating purchasing contracts with sup- pliers from different countries has to do with their cultures. When negotiating purchasing contracts with suppliers from different countries, world-class purchasing specialists should know that they have different cultural backgrounds. What I mean by culture is “the system of values and norms that are shared among a group of people and taken togather constitute a design for living and negotiating”.
When I compare and contrast the Western or English nego- tiation culture with Turkish negotiation culture it is possible to list several differences. To begin with, Turkish suppliers generally give more importance and allocate more time to personal relations before and during the process of contract negotiation, whereas English suppliers prefer to start contract negotiations after completing generally accepted business protocols, such as meeting, exchanging business cards, and drinking traditional Turkish black tea or Turkish coffee. For example, when you are negotiating a contract with a Turkish supplier you may find yourself chatting about economic and political problems of the country or complaining about your
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Supply Chain Operations 59
organizational problems. You may even be talking about which soccer team is going to be champion this year. Almost 80 per- cent of the time is allocated to establishing trust and a good personal relationship and 20 percent is allocated to contract negotiation.
Turkish negotiation culture is based on verbal communication rather than on numbers, financial information, and analysis relat- ing to the contract and the companies involved, whereas Western or English negotiation culture is mainly based on numerical com- munication such as facts, figures, numbers, and process analy- sis relating to the supply contract and the supplier firm.
Turkish culture is collectivist in nature, that is, individuals rare- ly prefer to take personal initiative or responsibility in making a final decision unless his or her authority is clearly defined. They prefer collective decision making when faced with critical and risky cases, whereas Western culture is individualistic in nature, that is, individuals are prone to make final decisions within their jurisdiction since they regard the success or fail- ure as their personal responsibility. In critical cases, Turkish suppliers and negotiators like the boss or general manager to make final decisions because of our risk- averse culture.
English or U.S. suppliers do not hesitate to make decisions and conclude contracts because their limits of authority are usually clearly defined by their organizations. This relates to their individualistic cultural background. But, I have to admit, there are now many younger well-educated and trained busi- ness professionals in Turkey, and they know how to start, manage, and close a contract-negotiation process based on the Western model.
2 You observe that negotiating behaviors are based on the cul- ture and social structure of the country where a company is based. Can you describe some common patterns that you see when negotiating with companies from different countries.
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60 ESSENTIALS of Supply Chain Management
I have observed that the socio-economic structure and economic and political power of countries where companies are based shape both organizational and personal negotiation styles. If we keep aside global and multi-national companies, I can describe some common patterns regarding negotiating behaviors that I have seen when negotiating a purchasing contract with compa- nies from the United States:
Negotiators of the U.S. companies are self confident in general because their country is almost as large as a continent and they believe that their country is the most powerful one in the world. Their body language reflects that they are free and self- confident. They ideologically believe strongly in individual rights and freedoms and the superiority of private business. They are prone to use personal initiative and take risk, if necessary, to conclude a purchasing contract because their common national ideology is based on the virtues of individualism and capitalism. They generally act aggressively in the process of negotiations, since capitalist ideology supports and reproduces the belief that “Competition is good and the best one will be the win- ner.” If a Turkish negotiator is not aware of fundamentals of American culture, she or he may interpret their negotiating style as rude, arrogant, opportunistic, and unethical.
Americans, when they like and respect the people they meet, call them by first names. This represents their sincerity and real friendship. In contrast, a real Londoner usually prefers to call people by their surnames. In Turkish business etiquette, when you call someone by first name immediately after you meet, if she or he does not know much about American cul- ture, may interpret this behavior as impolite and disrespectful. In the Turkish business culture during negotiations, it is better and safer for foreigners to use formal surnames. My name is Huseyin Eskici so it is best to start by addressing me as “Mr. Eskici”. Later on, if things go well then one could shift and call me “Mr. Huseyin”. If a Turk has academic or professional
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Supply Chain Operations 61
titles such as “Doctor” or “Professor” it is usually best to say “Mr. Doctor” or “Mr. Professor” instead of using their first names or surnames.
Americans value time and like to start negotiation as soon as possible. They express themselves frankly and use a straight- forward get-to-the-point business style. This manner may be interpreted as arrogant or disrespectful in Asiatic cultures or collectivist cultures like the Chinese and the Turks. Americans prefer to know and follow laws, rules, and regulations when they are negotiating purchasing contracts, because they are liv- ing in a strictly regulated society and they are well aware of the cost of breaching laws and regulations. Whereas tax evasion is a big crime for American citizens, in developing countries like Turkey, it may be tolerated and regarded as normal or ordinary.
3 Describe an experience in your career that has taught you an important lesson in purchasing and describe the lesson you learned and how you have used that lesson since then.
In 2007, I negotiated a supplier contract with a marketing manager who represents one of the prominent computer system companies in the world. I had to purchase additional servers and software for the system used by the Istanbul Stock Exchange to run its stock-trading operations. We had to purchase the servers from this particular company because we already were using their hardware and software to run our trading operations. They quoted us an initial purchase price of almost a million U.S. dollars.
Before the negotiation, I read all their technical documents about the system and asked our IT specialists about technical matters that I could not understand. I also asked why we had to buy the system and what were the components (hardware, software, UPS, etc.). Moreover, I learned that the marketing manager from England would personally come and negotiate the contract. After that, I did research about negotiating culture
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62 ESSENTIALS of Supply Chain Management
and business etiquette in England. Also, I read all the purchas- ing and other contracts that were signed between that com- pany and the Istanbul Stock Exchange in order to estimate my desired target price and estimate his desired target price. From this I discovered that the discount rate from initially quoted pric- es with this company was typically 45 percent and the ratio of maintenance costs to purchase price was around 20 percent.
When the English marketing manager and the Turkish partner came to my office, I was ready to negotiate based on my research. After a short initial meeting, as we were drinking Turkish coffee, I told the marketing manager that I knew exactly what we needed to buy, and that I never engaged in “horse- trading” but instead worked from principles based on signed contracts already in place with his company. I told him they had to give us a larger discount on the purchase price than they had before because we would be working with them for at least 10 years, and his firm would be making more profit from the maintenance service than on the one-time sale of the system.
He told me that in order to receive a higher discount than before, his company wanted prepayment of 80 percent of the contract. I told him that we had to follow strict rules and regulations, so if they could give us a guarantee letter from an English bank, our financial department would allow us to make that prepayment. He told me that his firm could get the guarantee letter and on this basis we could negotiate the price. He told me there was no need for him to refer this issue to headquarters, because he was sure about the guarantee letter and had the authority to make a final price offer for the contract. At the end of the day we concluded the contract at a discount of slightly more than 60 percent off their initially quoted price and the ratio of mainte- nance service costs to the purchase price was about 24 percent.
The contract was officially ratified by the supplier and the Stock Exchange and we sent the purchase order to their sales office in England and awaited the delivery of a bank guarantee letter
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Supply Chain Operations 63
in order to make our prepayment. Two weeks later the market- ing manager wrote me a letter stating their finance department could not get a guarantee letter from their bank and even though they could not collect 80 percent of the total contracted price before delivery of the hardware and software, they would still keep their promises about the price, discount rates, and deliv- ery terms. They said they did not want to lose a prominent cus- tomer in Turkey and in the Mediterranean and Eurasian Zones.
What I have learned from this experience is that, if you study and prepare your negotiation strategy by taking into account a sup- plier’s business etiquette and negotiating culture, you can make effective and efficient purchasing contracts even if the supplier has a monopoly in the business and is the exclusive seller of the product. Since then, I have continued to learn more about inter- cultural negotiation strategies. I am now writing a book in English for executive MBA students in my country. I would like to name the book Negotiation Strategies for Purchasing Specialists.
Huseyin Eskici is the Director of Administrative Affairs at the Istanbul Stock Exchange (ISE). He had served as Inspector and later as Chief Inspector in the Auditing and Inspection Board of the ISE from 1991 to 1998. He has been actively working as the Head of the Procurement Department in the ISE since 1998. He is a CPA and has an MBA degree in Contemporary Management Studies.
Purchasing
These activities are the routine activities related to issuing purchase
orders for needed products. There are two types of products that a
company buys: (1) direct or strategic materials that are needed to pro-
duce the products that the company sells to its customers; and (2) indirect
or maintenance, repair, and operations (MRO) products that a company
consumes as part of daily operations.
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64 ESSENTIALS of Supply Chain Management
The mechanics of purchasing both types of products are largely the
same. Purchasing decisions are made, purchase orders are issued, ven-
dors are contacted, and orders are placed. There is a lot of data com-
municated in this process between the buyer and the supplier—items
and quantities ordered, prices, delivery dates, delivery addresses, billing
addresses, and payment terms. One of the greatest challenges of the
purchasing activity is to see to it that this data communication happens
in a timely manner and without error. Much of this activity is very
predictable and follows well-defi ned routines.
Consumption Management
Effective procurement begins with an understanding of how much of what
categories of products are being bought across the entire company as well
as by each operating unit. There must be an understanding of how much of
what kinds of products are bought from whom and at what prices.
Expected levels of consumption for different products at the vari-
ous locations of a company should be set and then compared against
actual consumption on a regular basis. When consumption is signifi -
cantly above or below expectations, this should be brought to the atten-
tion of the appropriate parties so possible causes can be investigated and
appropriate actions taken. Consumption above expectations is either a
problem to be corrected or it refl ects inaccurate expectations that need
to be reset. Consumption below expectations may point to an oppor-
tunity that should be exploited or it also may simply refl ect inaccurate
expectations to begin with.
Vendor Selection
There must be an ongoing process to defi ne the procurement capa-
bilities needed to support the company’s business plan and its operating
model. This defi nition will provide insight into the relative importance
Supply Chain Operations 65
of vendor capabilities. The value of these capabilities has to be consid-
ered in addition to simply the price of a vendor’s product. The value of
product quality, service levels, just-in-time delivery, and technical sup-
port can only be estimated in light of what is called for by the business
plan and the company’s operating model.
Once there is an understanding of the current purchasing situation
and an appreciation of what a company needs to support its business
plan and operating model, a search can be made for suppliers who have
both the products and the service capabilities needed. As a general rule, a
company seeks to narrow down the number of suppliers it does business
with. This way it can leverage its purchasing power with a few suppliers
and get better prices in return for purchasing higher volumes of product.
Contract Negotiation
As particular business needs arise, contracts must be negotiated with in-
dividual vendors on the preferred vendor list. This is where the specifi c
items, prices, and service levels are worked out. The simplest negotiations
are for contracts to purchase indirect products where suppliers are selected
on the basis of lowest price. The most complex negotiations are for con-
tracts to purchase direct materials that must meet exacting quality require-
ments and where high service levels and technical support are needed.
Increasingly, though, even negotiations for the purchase of indirect
items such as offi ce supplies and janitorial products are becoming more
complicated because they fall within a company’s overall business plan
to gain greater effi ciencies in purchasing and inventory management.
Suppliers of both direct and indirect products need a common set of ca-
pabilities. Gaining greater purchasing effi ciencies requires that suppliers
of these products have the capabilities to set up electronic connections
for purposes of receiving orders, sending delivery notifi cations, sending
invoices, and receiving payments. Better inventory management requires
that inventory levels be reduced, which often means suppliers need to
66 ESSENTIALS of Supply Chain Management
make more frequent and smaller deliveries and orders must be fi lled ac-
curately and completely.
All these requirements need to be negotiated in addition to the basic
issues of products and prices. The negotiations must make trade-offs be-
tween the unit price of a product and all the other value-added services
that are required. These other services can either be paid for by a higher
margin in the unit price, by separate payments, or by some combina-
tion of the two. Performance targets must be specifi ed and penalties and
other fees defi ned when performance targets are not met.
Contract Management
Once contracts are in place, vendor performance against these contracts
must be measured and managed. Because companies are narrowing their
base of suppliers, the performance of each supplier that is chosen be-
comes more important. A particular supplier may be the only source
of a whole category of products that a company needs, and if it is not
meeting its contractual obligations, the activities that depend on those
products will suffer.
A company needs the ability to track the performance of its sup-
pliers and hold them accountable to meet the service levels they agreed
to in their contracts. Just as with consumption management, people in a
company need to routinely collect data about the performance of sup-
pliers. Any supplier that consistently falls below requirements should be
made aware of its shortcomings and asked to correct them.
Often the suppliers themselves should be given responsibility for
tracking their own performance. They should be able to proactively take
action to keep their performance up to contracted levels. An example
of this is the concept of vendor-managed inventory (VMI). VMI calls
for the vendor to monitor the inventory levels of its product within a
customer’s business. The vendor is responsible for watching usage rates
and calculating EOQs. The vendor proactively ships products to the
Supply Chain Operations 67
customer locations that need them and invoices the customer for those
shipments under terms defi ned in the contract.
Credit and Collections (Source) Procurement is the sourcing process a company uses to get the goods
and services it needs. Credit and collections is the sourcing process that
a company uses to get its money. The credit operation screens potential
customers to make sure the company only does business with custom-
ers who will be able to pay their bills. The collections operation is what
actually brings in the money that the company has earned.
Approving a sale is like making a loan for the sale amount for a
length of time defi ned by the payment terms. Good credit manage-
ment tries to fulfi ll customer demand for products and also minimize
the amount of money tied up in receivables. This is analogous to the way
good inventory management strives to meet customer demand and also
minimize the amount of money tied up in inventory.
The supply chains that a company participates in are often selected on
the basis of credit decisions. Much of the trust and cooperation that is pos-
sible between companies who do business together is based upon good
credit ratings and timely payments of invoices. Credit decisions affect who
a company will sell to and also the terms of the sale. The credit and collec-
tions function can be broken into three main categories of activity:
1. Set Credit Policy
2. Implement Credit and Collections Practices
3. Manage Credit Risk
Set Credit Policy
Credit policy is set by senior managers in a company such as the con-
troller, chief fi nancial offi cer, treasurer, and chief executive offi cer. The
68 ESSENTIALS of Supply Chain Management
fi rst step in this process is to review the performance of the company’s
receivables. Every company has defi ned a set of measurements that they
use to analyze their receivables, such as: days sales outstanding (DSO);
percent of receivables past customer payment terms; and bad debt write-
off amount as percent of sales. What are the trends? Where are there
problems?
Once management has an understanding of the company’s receiva-
bles situation and the trends affecting that situation, they can take the
next step which is to set or change risk-acceptance criteria to respond to
the state of the company’s receivables. These criteria should change over
time as economic and market conditions evolve. These criteria defi ne the
kinds of credit risks that the company will take with different kinds of
customers and the payment terms that will be offered.
Implement Credit and Collections Practices
These activities involve putting in place and operating the procedures
that will carry out and enforce the credit policies of the company. The
fi rst major activity in this category is to work with the company salespeo-
ple to approve sales to specifi c customers. As noted earlier, making a sale is
like making a loan for the amount of the sale. Customers often buy from
a company because that company extends them larger lines of credit and
longer payment terms than its competitors. Credit analysis goes a long
way to assure that this loan is only made to customers who will pay it off
promptly as called for by the terms of the sale.
After a sale is made, people in the credit area work with customers
to provide various kinds of service. They work with customers to proc-
ess product returns and issue credit memos for returned products. They
work with customers to resolve disputes and clear up questions by pro-
viding copies of contracts, purchase orders, and invoices.
The third major activity that is performed is collections. This is a
process that starts with the ongoing maintenance of each customer’s
Supply Chain Operations 69
accounts payable status. Customers that have past-due accounts are con-
tacted and payments are requested. Sometimes new payment terms and
schedules are negotiated.
The collections activity also includes the work necessary to re-
ceive and process customer payments that can come in a variety of
different forms. Some customers will wish to pay by electronic funds
transfer (EFT). Others will use bank drafts and revolving lines of cred-
it or purchasing cards. If customers are in other countries there are
still other ways that payment can be made, such as international letters
of credit.
Manage Credit Risk
The credit function works to help the company take intelligent risks
that support its business plan. What may be a bad credit decision from
one perspective may be a good business decision from another perspec-
tive. If a company wants to gain market share in a certain area it may
make credit decisions that help it to do so. Credit people work with
other people in the business to fi nd innovative ways to lower the risk of
selling to new kinds of customers.
Managing risk can be accomplished by creating credit programs that
are tailored to the needs of customers in certain market segments such as
high technology companies, start-up companies, construction contrac-
tors, or customers in foreign countries. Payment terms that are attractive
to customers in these market segments can be devised. Credit risks can
be lowered by the use of credit insurance, liens on customer assets, and
government loan guarantees for exports.
For important customers and particularly large individual sales, peo-
ple in the credit area work with others in the company to structure
special deals just for a single customer. This increases the value that the
company can provide to such a customer and can be a signifi cant part of
securing important new business.
70 ESSENTIALS of Supply Chain Management
Increasing emphasis on total cost of ownership (TCO) is bring- ing higher cost suppliers back to the request-for-proposal (RFP) table once again. Suppliers in the United States and other developed nations have lost business over the last two decades to lower-cost suppliers in the developing world, but now factors other than price alone are important, as companies reconsider what support they need from their supply chains. Sean Correll, a director at the strategic sourcing firm Emptoris (www.Emptoris. com), explores the trend in this executive insight.
It’s no secret that the desire to acquire goods and services cheaply has led U.S. companies to begin sourcing products from countries that are considered “low cost.” Traditionally, such deci- sions have been made based on the monetary cost of an item or service. Not surprisingly, this left suppliers in North America, Western Europe, and other developed nations at a disadvantage, as labor costs of domestically produced goods and services could be undercut by those coming from low-cost markets.
However, during the past decade companies have begun to take advantage of the ability to make much more sophisticated deci- sions when it comes to sourcing the items and services they require. Strategic sourcing technology now makes it possible to analyze numerous factors simultaneously (this analysis is dif- ficult to perform using traditional sourcing technology). This has led to a fundamental shift in the “analyzed cost” of contracting suppliers, from that of monetary cost to total cost of ownership (TCO).
TCO takes into account numerous factors beyond pure price in analyzing the cost associated with engaging a given supplier. Often these factors are qualitative as well as quantitative, and they measure factors that are critical to the bottom-line cost of doing business.
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Supply Chain Operations 71
For example, in addition to price, companies may be concerned with lead or delivery times. Additionally, companies are concerned with quality, which can be measured in units such as defects per million. In fact, a recent survey sponsored by Emptoris and CFO Research Services (“Supplier Side Economics: Making Vendor Relationships an Enduring Source of Competitive Advantage,” CFO Research Services, September 2010 http://www.cfo.com/white- papers/) found that companies are now more concerned with timeliness and quality than pure price. According to the survey, senior financial executives at Fortune 1000 companies rated the two top factors with the greatest impact on their companies’ busi- ness performance as the ability of suppliers to meet commitments (58 percent) and the quality of products from suppliers (54 per- cent). Price of products was the third factor (51 percent).
Additionally, companies tend to value the ease of doing business with a given suppler, which can be measured in factors such as the num- ber of rejected purchase orders. All of this represents a shift in supply chain thinking with special significance for companies in the devel- oped world that can now compete using these additional criteria.
The following example illustrates how qualitative factors are now weighed along with price in supply chain decision making:
In this sourcing event, in addition to using the monetary cost (prod- uct cost plus all logistics cost) in the analysis, we used scores based on answers to qualitative questions. One such question on a sourcing analysis performed for a Global 1000 Pharmaceutical cus- tomer was, “What percent of your warehouse facilities have been validated as being monitored for proper temperature and humidity?”
The answer could be given as any whole number from 0 to 100 (i.e., 0 percent garnered a score of 0, 1 percent garnered a score of 1, etc.)
The following formula was used to convert the score to a quantita- tive dollar amount:
Total Unit Cost = Price Weight × Unit Bid Cost + RFP Question Scores Weight × Unit Bid Cost × (100-RFP Question Scores Rating)/100
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72 ESSENTIALS of Supply Chain Management
For our example, assume the following for a U.S. supplier:
• Total Dollar Cost of the Item = $10
• Score for question = 50
• For the analysis, 75 percent of the “analyzed cost” is obtained using the Total Dollar Cost and 25 percent is obtained using the score converted to a quantitative dollar amount using the formula above (this can be modified to any 100 percent mix, for example 80/20 or 90/10 depending on how much importance is to be placed on the Total Dollar Cost and how much impor- tance is placed on the question score). For this item:
Total Cost = 75% × $10 + 25% × $10 × (100–50) /100 = $8.75
In theory, because of process controls (temperature and humidity) on 50 percent of the warehouse facilities, you are saving $1.25 per item ($10-8.75).
While U.S. manufacturers may not be able to compete on “unit bid cost,” oftentimes they can provide other qualitative advantages that make them more competitive.
By contrast, let’s assume that a supplier from a low-cost country was able to deliver a unit price of $9, yet a Question score of 10 (i.e., 10 percent of the supplier’s warehouse facilities have the required temperature and humidity controls). Using the same for- mula for comparison:
Total Cost = 75% x $9 + 25% x $9 x (100-10)/100 = $8.78
As you can see, in this case, the U.S. supplier is able to provide a lower cost by offering a superior “qualitative” score, despite a unit bid cost that is 10 percent higher.
Because the “Price Weight/RFP Question Scores Weight” ratio will be determined at the discretion of the commodity purchas- ing expert or other decision-maker based on the importance they place on it, the impact of a qualitative criterion can be diminished or expanded depending on the needs of individual purchasing companies. In this example, a 70/30 split would have yielded an
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Supply Chain Operations 73
even more favorable total cost for the U.S. supplier—likewise, an 80/20 split would have tipped the scales in favor of the low-cost country supplier.
Similarly, just as temperature and humidity controls were a factor in this example, companies may take into account factors such as percentage of on-time deliveries, number of defects per million, and number of rejected purchase orders.
The answer to the question of whether or not to use a higher- cost supplier or a supplier in a low-cost country will vary from case to case—there is no standard answer to such a ques- tion. However, manufacturers in developed countries can, in many cases, offer such advantages as a more optimized sup- ply chain (which means shorter transit time and smaller ware- house space), low political and operational risk, and the ability to quickly innovate. This means that in instances where the decision maker is using advanced strategic sourcing technol- ogy, manufacturers in first-world developed nations are being considered for bids where they might not otherwise have been considered.
Sean Correll, Director of Consulting Services for Emptoris (www. emptoris.com), has worked directly with hundreds of clients to deliver solutions to their supply management organizations. He provides guidance during all phases of the sourcing lifecycle, and manages the strategic direction of projects.
Chapter Summary The business operations that drive the supply chain can be grouped into
four major categories: (1) plan; (2) source; (3) make; and (4) deliver. The
business operations that comprise these categories are the day-to-day
operations that determine how well the supply chain works. Companies
must continually make improvements in these areas.
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74 ESSENTIALS of Supply Chain Management
Planning refers to all the operations needed to plan and organize the
operations in the other three categories. This includes operations such
as demand forecasting, product pricing, and inventory management.
Increasingly, it is these planning operations that determine the potential
effi ciency of the supply chain.
Sourcing includes the activities necessary to acquire the inputs to
create products or services. This includes operations such as procure-
ment and credit and collections. Both these operations have a big impact
on the effi ciency of a supply chain.
75
CHAPTER 3
Supply Chain Operations Making and Delivering
After reading this chapter you will be able to
● Exercise an executive level understanding of operations involved in the categories of making products and delivering products
● Assess supply operations in your company that may be candidates for outsourcing
M any companies and the supply chains they participate in serve
customers who are growing more sophisticated every year and
demanding higher levels of service. Continuous improvements
to the operations described in this chapter are needed to deliver the ef-
fi ciency and responsiveness that evolving supply chains require.
Product Design (Make) Product designs and selections of the components needed to build these
products are based on the technology available and product performance
requirements. Until recently, little thought was given to how the design
of a product and the selection of its components affect the supply chain
required to make the product. Yet these costs can become 50 percent or
more of the product’s cost.
Essentials of Supply Chain Management, Third Edition by Michael Hugos
Copyright © 2011 John Wiley & Sons
76 ESSENTIALS of Supply Chain Management
When considering product design from a supply chain perspec-
tive the aim is to design products with fewer parts, simple designs, and
modular construction from generic sub-assemblies. This way the parts
can be obtained from a small group of preferred suppliers. Inventory can
be kept in the form of generic sub-assemblies at appropriate locations
in the supply chain. There will not be the need to hold large fi nished-
goods inventories because customer demand can be met quickly by as-
sembling fi nal products from generic sub-assemblies as customer orders
arrive.
The supply chain required to support a product is molded by the
product’s design. The more fl exible, responsive, and cost effi cient the
supply chain is, the more likely the product will succeed in its market.
To illustrate this point, consider the following scenario.
Fantastic Company designs a fantastic new home entertainment
system with wide screen TV and surround sound. It performs to de-
manding specifi cations and delivers impressive results. But the elec-
tronics that power the entertainment center are built with components
from 12 different suppliers.
Demand takes off and the company ramps up production. Manag-
ing quality control and delivery schedules for 12 suppliers is a challenge.
More procurement managers and staff are hired. Assembly of the com-
ponents is complex and delays in the delivery of components from any
of the suppliers can slow down production rates. So buffer stocks of
fi nished goods are kept to compensate for this.
Several new suppliers were required to provide the specifi ed prod-
uct components. One of them has quality control problems and has to be
replaced and another supplier decides after several months to cease produc-
tion of the component it supplies to Fantastic Company. They bring out a
new component with similar features but not an exact replacement.
Fantastic Company has to suspend production of the home enter-
tainment system while a team of engineers redesigns the part of the
system that used the discontinued component so that it can use the new
Supply Chain Operations 77
component. During this time, buffer stocks run out in some locations
and sales are lost when customers go elsewhere.
A competitor called Nimble Company is attracted by the success of
Fantastic Company and comes out with a competing product. Nimble
Company designed a product with fewer parts and uses components
from only four suppliers. The cost of procurement is much lower since
they only have to coordinate four suppliers instead of 12. There are no
production delays due to lack of component parts and product assembly
is easier.
While Fantastic Company, who pioneered the market, struggles
with a balky supply chain, Nimble Company provides the market with
lower cost and a more reliable supply of the product. Nimble Company
with its responsive and less-costly supply chain takes market share away
from Fantastic Company.
What can be learned here? Product design defi nes the shape of
the supply chain and this has a great impact on the cost and avail-
ability of the product. If product design, procurement, and manufac-
turing people can work together in the design of a product, there is a
tremendous opportunity to create products that will be successful and
profi table.
There is a natural tendency for design, procurement, and manu-
facturing people to have different agendas unless their actions are co-
ordinated. Design people are concerned with meeting the customer
requirements. Procurement people are interested in getting the best
prices from a group of pre-screened preferred suppliers. Folks in manu-
facturing are looking for simple fabrication and assembly methods and
long production runs.
Cross-functional product design teams with representatives from
these three groups have the opportunity to blend the best insights
from each group. Cross-functional teams can review the new product
design and discuss the relevant issues. Can existing preferred suppli-
ers provide the components needed? How many new suppliers are
78 ESSENTIALS of Supply Chain Management
needed? What opportunities are there to simplify the design and re-
duce the number of suppliers? What happens if a supplier stops pro-
ducing a certain component? How can the assembly of the product
be made easier?
At the same time they are reviewing product designs, a cross-
functional team can evaluate existing preferred suppliers and manu-
facturing facilities. What components can existing suppliers provide?
What are their service levels and technical support capabilities? How
large a workforce and what kind of skills are needed to make the
product? How much capacity is needed and which facilities should be
used?
A product design that does a good job of coordinating the three
perspectives—design, procurement, and manufacturing—will result in a
product that can be supported by an effi cient supply chain. This will give
the product a fast time to market and a competitive cost.
Production Scheduling (Make) Production scheduling allocates available capacity (equipment, labor, and
facilities) to the work that needs to be done. The goal is to use available
capacity in the most effi cient and profi table manner. The production
scheduling operation is a process of fi nding the right balance between
several competing objectives:
• High Utilization Rates—This often means long production runs and centralized manufacturing and distribution centers. The
idea is to generate and benefi t from economies of scale.
• Low Inventory Levels—This usually means short production runs and just-in-time delivery of raw materials. The idea is to mini-
mize the assets and cash tied up in inventory.
• High Levels of Customer Service—Often requires high levels of inventory or many short production runs. The aim is to provide
Supply Chain Operations 79
the customer with quick delivery of products and not to run out
of stock in any product.
When a single product is to be made in a dedicated facility, schedul-
ing means organizing operations as effi ciently as possible and running
the facility at the level required to meet demand for the product. When
several different products are to be made in a single facility or on a single
assembly line, this is more complex. Each product will need to be pro-
duced for some period of time and then time will be needed to switch
over to production of the next product.
The fi rst step in scheduling a multi-product production facility is
to determine the economic lot size for the production runs of each
product. This is a calculation much like the economic order quantity
(EOQ) calculation used in the inventory control process. The calcu-
lation of economic lot size involves balancing the production set-up
costs for a product with the cost of carrying that product in inventory.
If set ups are done frequently and production runs are done in small
batches, the result will be low levels of inventory but the production
costs will be higher due to increased set-up activity. If production costs
are minimized by doing long production runs, then inventory levels
will be higher and product inventory carrying costs will be higher.
Once production quantities have been determined, the second step
is to set the right sequence of production runs for each product. The
basic rule is that if inventory for a certain product is low relative to its
expected demand, then production of this product should be scheduled
ahead of other products that have higher levels of inventory relative to
their expected demand. A common technique is to schedule production
runs based on the concept of a product’s “run-out time.” The run-out
time is the number of days or weeks it would take to deplete the product
inventory on hand given its expected demand. The run-out time calcu-
lation for a product is expressed as
R = P / D
80 ESSENTIALS of Supply Chain Management
where:
R = run-out time
P = number of units of product on hand
D = product demand in units for a day or week
The scheduling process is a repetitive process that begins with a
calculation of the run-out times for all products—their R-values. The
fi rst production run is then scheduled for the product with the lowest
Production Scheduling Production scheduling is a constant balancing act between utilization rates, inventory levels, and customer service levels.
TIPS & TECHNIQUES
Supply Chain Operations 81
R-value. Assume that the economic lot size for that product has been
produced, and then recalculate all product R-values. Again, select the
product with the lowest R-value, and schedule its production run next.
Assume the economic lot size is produced for this product and again
recalculate all product R-values. This scheduling process can be repeated
as often as necessary to create a production schedule going as far into
the future as needed.
After scheduling is done, the resulting inventory should be continu-
ously checked against actual demand. Is inventory building up too fast?
Should the demand number be changed in the calculation of run-out
time? Reality rarely happens as planned, so production schedules need
to be constantly adjusted.
Facility Management (Make) All facility-management decisions happen within the constraints set by
decisions about facility locations. Location is one of the fi ve supply chain
drivers discussed in Chapter 1. It is usually quite expensive to shut down
a facility or to build a new one, so companies live with the consequences
of decisions they make about where to locate their facilities. Ongoing
facility management takes location as a given and focuses on how best to
use the capacity available. This involves making decisions in three areas:
1. The Role Each Facility Will Play
2. How Capacity Is Allocated in Each Facility
3. The Allocation of Suppliers and Markets to Each Facility
The role each facility will play involves decisions that determine
what activities will be performed in which facilities. These decisions
have a big impact on the fl exibility of the supply chain. They largely
defi ne the ways that the supply chain can change its operations to meet
changing market demand. If a facility is designated to perform only a
82 ESSENTIALS of Supply Chain Management
single function or serve only a single market, it usually cannot easily be
shifted to perform a different function or serve a different market if sup-
ply chain needs change.
How capacity is allocated in each facility is dictated by the role that
the facility plays. Capacity allocation decisions result in the equipment
and labor that is employed at the facility. It is easier to change capacity
allocation decisions than to change location decisions, but still it is not
cost effective to make frequent changes in allocation. So, once decided,
capacity allocation strongly infl uences supply chain performance and
profi tability. Allocating too little capacity to a facility creates inability to
meet demand and loss of sales. Too much capacity in a facility results in
low utilization rates and higher supply chain costs.
The allocation of suppliers and markets to each facility is infl uenced
by the fi rst two decisions. Depending on the role that a facility plays
and the capacity allocated to it, the facility will require certain kinds of
suppliers and the products and volumes that it can handle mean that it
can support certain types of markets. Decisions about the suppliers and
markets to allocate to a facility will affect the costs for transporting sup-
plies to the facility and transporting fi nished products from the facility
to customers. These decisions also affect the overall supply chain’s ability
to meet market demands.
Order Management (Deliver) Order management is the process of passing order information from
customers back through the supply chain from retailers to distributors
to service providers and producers. This process also includes passing
information about order delivery dates, product substitutions, and back
orders forward through the supply chain to customers. This process has
long relied on the use of the telephone and paper documents such as
purchase orders, sales orders, change orders, pick tickets, packing lists,
and invoices.
Supply Chain Operations 83
A company generates a purchase order and calls a supplier to fi ll
the order. The supplier who gets the call either fi lls the order from its
own inventory or sources required products from other suppliers. If the
supplier fi lls the order from its inventory, it turns the customer purchase
order into a pick ticket, a packing list, and an invoice. If products are
sourced from other suppliers, the original customer purchase order is
turned into a purchase order from the fi rst supplier to the next sup-
plier. That supplier in turn will either fi ll the order from its inventory
or source products from other suppliers. The purchase order it receives
is again turned into documents such as pick tickets, packing lists, and
invoices. This process is repeated through the length of the supply chain.
OfficeMax (www.OfficeMax.com) sells office supplies, office furniture, and office technology through a network of more than 800 stores. In the face of a tough economy and the need to improve supply chain operations, OfficeMax found that increased collaboration between different internal groups delivered sig- nificant benefits. Reuben Slone, Executive Vice President of Supply Chain, and Nikhil Sagar, Vice President of Inventory Management, describe how these improvements were achieved.
While OfficeMax was in the midst of executing a major turnaround plan, the onset of the “Great Recession” set a much greater hurdle, calling for it to overcome the effects of rapidly shrinking sales and volatile fuel costs. More than ever, OfficeMax had to deliver greatly improved working capital productivity and cost productivity levels while maintaining the customer experience through strong product availability. The case for internal collaboration was never stronger.
This was also the time that an economic value added (EVA) mind- set was being developed within the company. EVA training was widely rolled out with the help of the University of Notre Dame,
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84 ESSENTIALS of Supply Chain Management
and caused a much greater focus on asset and working capital management.
Reuben Slone, Executive Vice President of Supply Chain, called his team together and communicated his vision for the transfor- mation needed to overcome the new economic challenge. The Supply Chain team had already established a powerful track record of delivering strong results against the turnaround plan, but the challenge at hand now called for the team to reach new and higher levels of performance, and develop and implement strate- gies that made conscious trade offs between supply chain opera- tional costs and working capital productivity. The Supply Chain Operations and Inventory Management groups were asked to chal- lenge each other’s assumptions. This was not going to be easy— there was a lot of high performing talent in both groups. These were people that now had to work together on the same team.
Guidelines for the internal collaboration were established. All par- ties on the project were declared equal, no existing practices were considered sacred, and all parties were encouraged to question everything. The project group would make fact-based decisions, not emotional reactions, and the EVA model would be used as an empirical framework for decision making. The team was given a clear set of priorities—product availability, working capital pro- ductivity, and cost productivity. And finally, business goals were revised to reflect a broad set of shared supply chain outcomes.
Interpersonal relationships were focused on open discussions between the Supply Chain Operations and Inventory Management teams to discuss past problems (perceived or real) and close collaboration was strongly encouraged between the two teams. For example, a territorial mindset would no longer be tolerated, and a good idea would be a good idea, regardless of which team it came from. A low-cost team-building event was held to help lay the foundation for this new collaborative working model.
These guidelines and the resulting collaboration delivered a highly effective solution to the challenge. The team improved the use of
IN THE REAL WORLD (CONTINUED)
Supply Chain Operations 85
delivery truck storage volume (known as cube utilization) through modification of limitations on stops per truck. They established the optimal number of deliveries for all stores based on the EVA model. By comparing delivery costs with working capital, the EVA model offers a very relevant framework for making supply chain trade-offs between operating cost and working capital.
The model’s strength lies in its ability to compare the impact of decisions on post-tax net operating profit with the opportunity cost of working capital invested to implement that decision. In the delivery example, the team estimated the working capital impact of progressively increasing delivery frequencies to a store. This was done across clusters of stores grouped together based on similar sales-velocity levels. The EVA model was then used to iden- tify the inflection point for each store velocity group—essentially the point at which the trade off was EVA positive—and this was used as the ideal delivery investment for that store group.
Clearly, higher-velocity stores deserved higher delivery frequen- cies, because they had the potential to sell more inventory. This model, however, allowed people to make the intuitive decision more of an exact science, allowing them to save valuable delivery- cost dollars without hurting service levels and minimizing the working capital impact. The functional teams worked together to allocate delivery frequencies down to the individual store level. In addition to looking at quarterly store rankings based on sales, they also incorporated unique location level constraints (such as isolated, single-store deliveries with higher cost per delivery) through collaborative review with the Transportation team.
The team modified delivery spacing to maximize productivity of deliveries through more even balancing of the point of sale (POS) capture between multiple deliveries. This ensured that for a two- delivery-per-week store, each replenishment run should target three or four days of sales. For a three-delivery-per-week store, each replenishment run should have two or three days of sales.
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86 ESSENTIALS of Supply Chain Management
They next moved the creation of replenishment delivery schedules from evening to morning. When the deliveries were being created in the evenings, the POS capture for the current day were not complet- ed yet, so the delivery plan was based on the POS movement up to the previous day only. By moving the delivery-creation process to the following morning, an additional day’s worth of POS movement was captured, reducing the latency of the plan, without increasing the overall lead time, since the execution against the delivery plan was still allowed to commence at its normal time every morning.
The team also created Opportunistic Delivery Skipping—by intro- ducing a check into the delivery schedule-creation process to eliminate extremely low cube loads. The inventory management group developed and executed the criteria for this check. They used criteria such as store-in-stocks measured as a percent of SKUs within a store that had one or more units on hand, ensuring at least one delivery a week and avoiding two consecutive skips.
The team then implemented palletization of loads—enabling easi- er loading and offloading, and allowing for reduced handling costs at distribution center (DC) and store level. The quicker receipt process at store level also enabled greater store flexibility around receipt planning; weekend deliveries and a broader receipt window being a couple of the favorable outcomes.
Next the group worked with OfficeMax’s third-party transportation carrier, Werner, to migrate from a graduated stop charge to a flat stop charge. And finally, they shifted the delivery-truck trailer- storage capacity target from 1800 cubic feet to 2500 cubic feet.
All of this work resulted in breakthrough results. The total number of miles driven to retail stores was reduced by 24 percent, or 6.9 million miles, from 2007 to 2009. Store inventory shrunk by 16 percent year-over-year, while maintaining a record low number of stock outs per store. OfficeMax proved that internal collabora- tion enabled unprecedented supply chain improvements despite the extraordinary challenges of the Great Recession.
IN THE REAL WORLD (CONTINUED)
Supply Chain Operations 87
Reuben Slone is Executive Vice President, Supply Chain for OfficeMax. Harvard Business Review published two of his articles: “Leading a Supply Chain Turnaround” October 2004; and “Are You the Weakest Link in your Supply Chain?” September 2007. In May 2010, Harvard Business Press published his book, The New Supply Chain Agenda: The 5 Steps that Drive Real Value.
Nikhil Sagar is Vice President, Inventory Management for OfficeMax. He is the author of the article “CPFR At Whirlpool Corporation: Two Heads and An Exception Engine” Journal of Business Forecasting, Winter 2003–2004 and one of the authors of the article “Forecasting and Risk Analysis in Supply Chain Management – GARCH Proof of Concept” published in the book Managing Supply Chain Risk and Vulnerability.
In the last 20 years or so, supply chains have become noticeably more
complex than they previously were. Companies now deal with multiple
tiers of suppliers, outsourced service providers, and distribution-channel
partners. This complexity has evolved in response to changes in the way
products are sold, increased customer service expectations, and the need
to respond quickly to new market demands.
The traditional order-management process has longer lead and lag
times built into it due to the slow movement of data back and forth in the
supply chain. This slow movement of data works well enough in some
simple supply chains, but in complex supply chains faster and more accu-
rate movement of data is necessary to achieve the responsiveness and effi -
ciency that is needed. Modern order management focuses on techniques
to enable faster and more accurate movement of order-related data.
In addition, the order-management process needs to do excep-
tion handling and provide people with ways to quickly spot problems
and give them the information they need to take corrective action.
This means the processing of routine orders should be automated and
IN THE REAL WORLD (CONTINUED)
88 ESSENTIALS of Supply Chain Management
orders that require special handling because of issues such as insuf-
fi cient inventory, missed delivery dates, or customer change requests
need to be brought to the attention of people who can handle these
issues. Because of these requirements, order management is beginning
to overlap and merge with a function called customer relationship
management (CRM) that is often thought of as a marketing and sales
function.
Because of supply chain complexity and changing market demands,
order management is a process that is evolving rapidly. However, a handful
of basic principles can be listed that guide this operation:
• Enter the Order Data Once and Only Once—Capture the data elec- tronically as close to its original source as possible and do not
manually reenter the data as it moves through the supply chain.
It is usually best if the customers themselves enter their orders
into an order-entry system. This system should then transfer the
relevant order data to other systems and supply chain partici-
pants as needed for creation of purchase orders, pick tickets, in-
voices, and so on.
• Automate the Order Handling—Manual intervention should be minimized for the routing and fi lling of routine orders. Com-
puter systems should send needed data to the appropriate lo-
cations to fulfi ll routine orders. Exception handling should
identify orders with problems that require people to get in-
volved to fi x them.
• Make Order Status Visible to Customers and Service Agents—Let cus- tomers track their orders through all the stages, from entry of the
order to delivery of the products. Customers should be able to
see order status on demand without having to enlist the assistance
of other people. When an order runs into problems, bring the order
to the attention of service agents who can resolve the problems.
Supply Chain Operations 89
• Integrate Order Management Systems with Other Related Systems to Maintain Data Integrity—Order-entry systems need product de-
scriptive data and product prices to guide the customer in making
their choices. The systems that maintain this product data should
communicate with order-management systems. Order data is
needed by other systems to update inventory status, calculate de-
livery schedules, and generate invoices. Order data should auto-
matically fl ow into these systems in an accurate and timely manner.
Four Rules for Efficient Order Management
TIPS & TECHNIQUES
90 ESSENTIALS of Supply Chain Management
Delivery Scheduling (Deliver) The delivery scheduling operation is of course strongly affected by
the decisions made concerning the modes of transportation that will
be used. The delivery-scheduling process works within the constraints
set by transportation decisions. For most modes of transportation
there are two types of delivery methods: direct deliveries and milk run
deliveries.
Direct Deliveries
Direct deliveries are deliveries made from one originating location to
one receiving location. With this method of delivery the routing is sim-
ply a matter of selecting the shortest path between the two locations.
Scheduling this type of delivery involves decisions about the quantity
to deliver and the frequency of deliveries to each location. The advan-
tages of this delivery method are found in the simplicity of operations
and delivery coordination. Since this method moves products directly
from the location where they are made or stored in inventory to a lo-
cation where the products will be used, it eliminates any intermediate
operations that combine different smaller shipments into a single, com-
bined larger shipment.
Direct deliveries are effi cient if the receiving location generates
economic order quantities (EOQs) that are the same size as the ship-
ment quantities needed to make best use of the transportation mode be-
ing used. For instance, if a receiving location gets deliveries by truck and
its EOQ is the same size as a truck load (TL), then the direct-delivery
method makes sense. If the EOQ does not equal TL quantities, then this
delivery method becomes less effi cient. Receiving expenses incurred at
the receiving location are high because this location must handle sepa-
rate deliveries from the different suppliers of all the products it needs.
Supply Chain Operations 91
Milk Run Deliveries
Milk run deliveries are deliveries that are routed to either bring prod-
ucts from a single originating location to multiple receiving locations or
deliveries that bring products from multiple originating locations to a
single receiving location. Scheduling milk run deliveries is a much more
complex task than scheduling direct deliveries. Decisions must be made
about delivery quantities of different products, about the frequency of
deliveries, and most importantly about the routing and sequencing of
pickups and deliveries.
The advantages of this method of delivery are in the fact that more
effi cient use can be made of the mode of transportation used and the
cost of receiving deliveries is lower because receiving locations get
fewer and larger deliveries. If the EOQs of different products needed
by a receiving location are less than truck load (LTL) amounts, milk
run deliveries allow orders for different products to be combined until
the resulting quantity equals a TL amount. If there are many receiving
locations that each need smaller amounts of products, they can all be
served by a single truck that starts its delivery route with a TL amount
of products.
There are two main techniques for routing milk run deliveries.
Each routing technique has its strengths and weaknesses, and each
technique is more or less effective depending on the situation in
which it is used and the accuracy of the data that is available. Both of
these techniques are supported by software packages. The two tech-
niques are:
1. The Savings Matrix Technique
2. The Generalized Assignment Technique
The savings matrix technique is the simpler of the two techniques
and can be used to assign customers to vehicles and to design routes
92 ESSENTIALS of Supply Chain Management
where there are delivery-time windows at receiving locations and other
constraints. The technique is robust and can be modifi ed to take into ac-
count many different constraints. It provides a reasonably good routing
solution that can be put to practical use. Its weakness lies in the fact that
it is often possible to fi nd more cost-effective solutions using the gen-
eralized assignment technique. This technique is best used when there
are many different constraints that need to be satisfi ed by the delivery
schedule.
The generalized assignment technique is more sophisticated and
usually gives a better solution than the savings matrix technique
when there are no constraints on the delivery schedule other than
the carrying capacity of the delivery vehicle. The disadvantage of this
technique is that it has a harder time generating good delivery sched-
ules as more and more constraints are included. This technique is best
used when the delivery constraints are limited to vehicle capacity or
to total travel time.
Delivery Sources
Deliveries can be made to customers from two sources:
1. Single-Product Locations
2. Distribution Centers
Single-product locations are facilities such as factories or warehouses
where a single product or a narrow range of related items are available
for shipment. These facilities are appropriate when there is a predictable
and high level of demand for the products they offer and where ship-
ments will be made only to customer locations that can receive the
products in large, bulk amounts. They offer great economies of scale
when used effectively.
Supply Chain Operations 93
Distribution centers are facilities where bulk shipments of prod-
ucts arrive from single-product locations. When suppliers are located
a long distance away from customers, the use of a distribution cent-
er provides for economies of scale in long-distance transportation
to bring large amounts of products to a location close to the fi nal
customers.
The distribution center may warehouse inventory for future ship-
ment or it may be used primarily for crossdocking. Crossdocking is a
technique pioneered by Wal-Mart where truckload shipments of single
products arrive and are unloaded. At the same time these trucks are be-
ing unloaded, their bulk shipments are being broken down into smaller
lots and combined with small lots of other products and loaded right
back onto other trucks. These trucks then deliver the products to their
fi nal locations.
Distribution centers that use crossdocking provide several benefi ts.
The fi rst is that product fl ows faster in the supply chain since little inven-
tory is held in storage. The second is that there is less handling expense
since product does not have to be put away and then retrieved later
from storage. The benefi ts of crossdocking can be realized when there
are large predictable product volumes and when economies of scale can
be had on both the inbound and outbound transportation. However,
crossdocking is a demanding technique and it requires a considerable
degree of coordination between inbound and outbound shipments.
Transporting and delivering goods is expensive so capabilities in this
area are closely aligned with the actual needs of the market that the
supply chain serves. Highly responsive supply chains usually have high
transport and delivery costs because their customers expect quick de-
livery. This results in many small shipments of product. Less-responsive
supply chains can aggregate orders over a period of time and make fewer
and larger shipments. This results in more economies of scale and lower
transport costs.
94 ESSENTIALS of Supply Chain Management
Return Processing (Deliver) This process is also known as “reverse logistics.” All supply chains have to
deal with returns. This is often a diffi cult and ineffi cient process and in
the Supply-Chain Council’s supply chain operations reference (SCOR)
model a whole category of activities has been devoted to this pro-
cess. End customers, retailers, distributors, and manufacturers all return
products under certain circumstances. The most common circumstances
are: the wrong products were delivered; the products that were delivered
were damaged in transit or were defective from the factory; and more
product was delivered than was needed by the customer. All of these cir-
cumstances arise from supply chain ineffi ciencies that created the need
to return products.
Companies and supply chains as a whole need to keep track of the
kinds of returns that happen, their frequency, and if the return rates
are rising or falling. Return processing should be effi cient, yet at the
same time remember that if other supply chain activities are managed
effectively there will not be the need for a lot of return processing. Op-
timizing the return process can become an exercise in improving the
effi ciency of a process that should not be happening in the fi rst place.
If return rates are increasing it is far more effective to fi nd and fi x the
sources of the problems that make returns necessary.
One area where returns are a value-added activity for the entire sup-
ply chain is where product recycling comes into play. In this area returns
happen at the end of the product life cycle as the end user sends the
product back to the manufacturer or some other organization that will
either reuse or safely dispose of the product. As environmental aware-
ness spreads and companies and governments adopt green policies and
regulations, there will be a steadily growing volume of recycling activ-
ity. And recycling companies will emerge to handle this activity not as
return processing but instead as a sourcing activity. This will be the way
they acquire their raw materials.
Supply Chain Operations 95
Transforming public health supply chains in developing countries calls for collaboration between all parties in the supply chain, and Partnership for Supply Chain Management is a leader in this effort. Jay Heavner, director of communications, and David Jamieson, deputy director for project planning describe the work their organization is doing in this area.
The Partnership for Supply Chain Management (PFSCM) is a nonprofit organization established to manage the Supply Chain Management System (SCMS), a project of the United States’ President’s Emergency Plan for AIDS Relief (PEPFAR).
When PEPFAR began, HIV/AIDS was devastating many countries in sub-Saharan Africa and elsewhere. The disease was destroying communities and leaving an entire generation of orphans. Those living with HIV/AIDS had little or no hope of receiving treatment. In 2005, PEPFAR established SCMS to provide a reliable, cost- effective, and secure supply of products for HIV/AIDS programs focused on 15 countries. According to Richard Owens, SCMS Project Director, “PEPFAR and other international prevention, care, and treatment efforts could not begin to meet the need without national and regional supply chains that could operate at a scale and level of reliability never before seen in the developing world.”
At the time, many doubted that HIV/AIDS commodities could be reliably delivered to the hardest-to-reach areas of the developing world. “But we knew they could,” said Owens.
PFSCM partnered with some of the best-known companies in inter- national public health and supply chain management, leveraging the expertise of each. As the project has developed, JSI Research and Training Institute (U.S.), Management Sciences for Health (U.S.), and Crown Agents (U.S., UK) operate field offices in 16 countries to manage technical assistance, client relations, and procurement. I+solutions (Netherlands) procures pharmaceuti- cals, and Crown Agents procures laboratory supplies and test kits.
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96 ESSENTIALS of Supply Chain Management
Booz & Company monitors supply chain performance to identify areas for improvement. UPS (U.S.) manages international freight and logistics. 3i Infotech and Northrop Grumman provide world- class supply chain, Information Technology (IT), and enterprise management software and services. Additional team members provide specialty supply chain services.
When the project began, SCMS gathered staff from these compa- nies at their offices to map out process flow on a wall measuring 8 feet high by 50 feet long. Using sticky notes and fueled by cof- fee and commitment, people clarified roles and responsibilities for each supply chain function and identified how they would measure supply chain performance. The scale of the health emergency meant that failure was not an option for PEPFAR or SCMS.
A key mandate of the project was to contribute to bringing down the cost of antiretroviral drugs (ARVs), which at the time was prohibi- tively expensive—about $1,500 per patient per year. Leveraging their purchasing power and international expertise, SCMS negoti- ated contracts with suppliers that over time lowered the average cost of ARVs to an affordable $100 to $200 per year. More than 90 percent of ARVs procured by SCMS are from generic suppliers approved by the U.S. Food and Drug Administration. Once SCMS was confident of the quantities required, they further reduced costs by shipping about 65 percent of commodities by sea and land ver- sus costly airfreight, saving the U.S. government up to 80 percent on shipping costs—more than $36 million by September of 2010.
SCMS quickly built a global supply chain that began delivering large volumes of ARVs to regional distribution centers (RDCs) located in Ghana, Kenya, and South Africa, close to points of intended use. These RDCs were established by PHD (South Africa), one of their partners, and operate on a commercial basis, providing services to SCMS and other clients. This strategy meant that SCMS could reliably deliver the required amounts of ARVs to the hardest-hit countries even though the drugs were arriving in areas character- ized by weak supply chain infrastructures.
IN THE REAL WORLD (CONTINUED)
Supply Chain Operations 97
The next step was to provide technical assistance to strengthen local supply chain operations. Lack of demand forecasting and supply planning was a key challenge: SCMS rejected one of the first orders they received for ARVs because they knew the recipi- ent country already had an over-supply of stock that was likely to expire. The country had no visibility into what they had in stock or what they would need in the future.
In many countries, warehouses lacked basic equipment. Boxes were stacked on the ground, and inventory was tracked manually, if at all. Loss of stock through expiry and damage was common. And cold chain capabilities where pharmaceuticals and other per- ishable goods were kept at cool or frozen temperatures was rarely an option. Through a range of short- and long-term technical assis- tance—warehousing and distribution, logistics management infor- mation systems, and more—SCMS is helping transform the public health supply chains in many of the countries where it operates.
The project was designed to procure ARVs and test kits, and a relatively limited number of other products. But it soon became apparent that laboratory equipment, reagents, and other supplies were equally essential. Lists of these commodities can include thousands of items, many of which are practically identical. This represented a very different procurement and supply challenge. Even agreeing on product specifications was a major hurdle. The SCMS team has supported regional and national harmonization efforts to reduce the range of products being procured, and published a catalog of products available through the project to help clients with product specification.
Developing countries face a major challenge from poor-quality and counterfeit products. So the U.S. Government rightly demanded that SCMS establish a world-class quality assurance program. Partnering with North-West University in South Africa to sample and test ARVs and other pharmaceuticals, “SCMS has prevented any sub-standard medicines from reaching patients through our supply chain,” said Owens.
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98 ESSENTIALS of Supply Chain Management
When asked how these activities might be different in a not-for- profit world as opposed to a for-profit business, Owens observed that the technical approach is the same. SCMS brings industry best practices to their supply chain operations and to the develop- ing countries where they work. Their supply chain includes many private sector companies, and their regional distribution centers now serve a number of public and private sector clients. “What’s different,” said Owens, “is the U.S. Government funds the prod- ucts while local government entities like ministries of health define their needs. Interestingly, our performance is as good as, or usually better than, the private sector in Africa and elsewhere. The only real difference is that we’re not motivated by profit. Our mission is to help save lives.”
Jay Heavner is Communications Director for SCMS. He is the author of various publications for the project, including “From Emergency Relief to Sustained Response: long-term success of HIV/AIDS programs depends on integrated national and global supply chains”, and “Three years of saving lives through stron- ger HIV/AIDS supply chains: A report on the global impact of SCMS.”
David Jamieson is Deputy Director for Project Planning and Global Partnerships for SCMS. He is a co-author of “Improving the Economic Efficiency of PEPFAR Treatment Programs Through Increased Use of Generic Antiretroviral Drugs,” Journal of the American Medical Association published in June 2010. He also contributed to procurement guides for condoms published by World Health Organization (WHO), and for essential drugs for WHO and the World Bank.
IN THE REAL WORLD (CONTINUED)
Supply Chain Operations Can Be Outsourced After reading about the 11 basic supply chain operations in this chapter
and the previous one, which of these operations are done by in-house
Supply Chain Operations 99
staff in your company? How many of these operations are core compe-
tencies? How many of these operations bring money into your company
and how many of them consume money?
The relentless pressure on profi t margins that free markets create is
a driving force behind the growth of outsourcing. What may be con-
sidered as overhead for Company A may be a service that Company B
can offer and make a profi t doing so. Company B may be able to offer
this service for a price lower than it costs Company A to do it in house.
Company A is going to consider outsourcing.
The traditional participants in supply chains are producers, logistics
providers, distributors, and retailers. How many of the 10 supply chain
operations can be called core competencies of any of these organiza-
tions? There are some operations such as credit and collections, product
design, and order management that may not be a core competency of
any of the traditional participants. This creates opportunities for new
service providers to take on these operations and offer them to the other
supply chain participants. All 10 of these operations need to be done for
the supply chain as a whole, but they do not all need to be done by any
single company and indeed they cannot all be done well by any single
company.
The other force that drives outsourcing is the growing sophistication
of the markets that supply chains serve. Gone are the days when Ford
Motor Company could run a vertically integrated company that did
everything from mine iron ore to produce steel to design and build au-
tomobiles. That structure was only possible because the markets it served
were content to buy mass quantities of standard products. As Henry Ford
said when asked about what colors his customers could choose from,
“They can have any color they want as long as it’s black.” Markets today
demand and pay for all sorts of innovations, customized features, and ser-
vices. This creates complexity in the supply chain, and participants who
specialize in certain areas bring the expertise and effi ciencies that are
required to manage this complexity.
100 ESSENTIALS of Supply Chain Management
A collaborative supply chain can enable a group of smaller companies to better compete with their larger industry rivals. There are tangible benefits generated by collaboration and also obstacles to overcome before the benefits can be achieved. Joel Sutherland, managing director at the Center for Value Chain Research at Leigh University (http://www.lehigh.edu/ cvcr), describes a supply chain collaboration project called “The Confection Connection” and the results they achieved.
Candy maker Just Born Inc. may not be a household name but their products are known around the world. Located in Bethlehem, Pennsylvania, USA, Just Born was founded in 1923 and is now the eighth-largest confectioner in the United States. The company’s most famous brands include marshmallow Peeps, Mike and Ike, Hot Tamales, and Peanut Chews.
The candy is manufactured in Bethlehem, and then is shipped from there to a nearby distribution center (DC) run by OHL, a global 3PL services provider. From the DC, product ships out to customers nationwide, in either less-than-truckload (LTL) or truck- load (TL) shipments. Just Born serves LTL customers via distribu- tion centers known as “pool points.” There, third-party logistics (3PL) providers break down truckloads into smaller shipments for delivery. Full truckloads, meanwhile, move directly from the DC to customers’ facilities.
In 2007, Just Born began a major re-engineering of its supply chain network. To design the optimal network Just Born decided to seek help from outside the company, and they opted to work with researchers at the Center for Value Chain Research (CVCR) at Lehigh University, also located in Bethlehem. The researchers at CVCR built a mathematical model for optimizing the company’s distribution network.
EXECUTIVE INSIGHT
Supply Chain Operations 101
PROJECT RESULTS
The model’s objective is to minimize the manufacturer’s average transportation cost. This includes line-haul costs for truckloads to pool points and direct customers as well as the per-pound cost to ship to LTL customers. The model is capable of deciding, for a representative period of time, which of the 28 available pool points should be used and how much volume each pool point should handle. The model also indicates which custom- ers should be served by direct truckload and which by LTL, and how truckload shipments should be scheduled throughout the network. The researchers aggregated Just Born’s customers to the three-digit ZIP (postal code) level, and excluded customers that typically receive small or infrequent shipments. The result- ing data set modeled roughly 85 percent of the manufacturer’s average weekly volume.
The model revealed that Just Born’s existing network was too costly and not as efficient as it could be. For example, there were too many pool points—the optimal number turned out to be 22, rather than 28, locations. But the researchers found that the ship- per had some leeway in that regard; it could still achieve near-opti- mal results with anywhere from 20 to 24 pool points (Exhibit 3.1).
EXHIBIT 3.1
Cost vs. Number of Pool Points Used
C o
st s
($ /w
ee k)
12 14 16 18 20
Number of Pool Points 22 24 26 28 30
EXECUTIVE INSIGHT (CONTINUED)
(Continued)
102 ESSENTIALS of Supply Chain Management
NEXT STEP—COLLABORATION
Just Born is now increasing the amount of freight shipped out of this DC by including other confectionery shippers to form a collaboration of like shippers delivering product to like custom- ers. This collaborative arrangement is known as the “Confection Connection”. It is estimated that this new solution will save the collaborating companies approximately 25 percent of their total transportation costs per year,as shown in Exhibit 3.2.
EXHIBIT 3.2
Estimated Combined Freight Spend Savings Is 25 Percent
Separate Models
Combined Model
$- $10
Transportation costs ($ millions)
$20
Company A
Company B
Company C
Company D
All Co’s Combined
The concept of freight consolidation is not new, but it is tricky for companies to grasp when they are being asked to partner with competitors in a collaborative way. Yet for smaller confectioneries like Just Born, who are competing with giants like Mars, Nestle, and Hershey, collaborating is a way to achieve the critical mass to compete more effectively with these larger companies. Working with competitors makes sense, especially when their deliveries are going to the same retailers who prefer to have fewer trucks pulling in and out of their own distribution centers.
And partnering helps candy makers create ideal truckloads. For instance, Just Born makes huge shipments of marshmallow Peeps around holiday periods, but they are so light it is better to package
EXECUTIVE INSIGHT (CONTINUED)
Supply Chain Operations 103
them in trucks with heavier freight, achieving an optimal weight- to-cube ratio.
COLLABORATION VALUE ADD
Collaborative transportation management (CTM) demonstrates that opportunities to add value increase as multiple shipper net- works are integrated, connecting a broader sphere of shippers, receivers, and carriers and enabling enhanced opportunities for communication and improved execution. Central to the effort to connect a network of collaborating parties is the development of a common information hub. In general, the level of information shar- ing increases with the level of collaboration. Exhibit 3.3 portrays the extension of value contribution as the collaborative network expands and information sharing increases.
EXHIBIT 3.3
Value Contribution as the Collaborative Network Expands
Level of Collaboration
Traditional Vendor • Transactional • No visibility
Partnership Collaboration • Shipper, Receiver, and Carrier • Shared forecast • Committed capacity • Visibility and security
Consortium Collaboration
• Multiple Shippers, Carriers • Third-party facilitation • Information Hub • Relationship management
Value
Opportunity to add value through CTM increases as multiple shipper networks are integrated, carriers are connected, and communication and execution capabilities are enhanced
(Continued)
EXECUTIVE INSIGHT (CONTINUED)
104 ESSENTIALS of Supply Chain Management
KEY ENABLERS AND ROADBLOCKS TO COLLABORATION
In order for collaborative initiatives to succeed, key enablers must be in place. These enablers support best practices in critical activity areas and help overcome the roadblocks to success that inevitably surround collaboration.
There are a number of key enablers that are equally important. Successful collaboration is a function of how well people work together both internally and with collaboration partners. The follow- ing enablers are related to the human side of CTM:
1 Common Interest — All parties need to have a stake in the collaboration’s outcome to ensure their ongoing commitment.
2 Openness — For a relationship to work, the partners must openly discuss their practices and processes. Sometimes this means sharing information traditionally considered proprietary (though adherence to anti-trust guidelines remains prerequisite).
3 Recognizing who and what is important — Not all prospective collaborators and supply chain activities are created equal. Choose those that will deliver the greatest benefits.
4 Clear expectations — All parties need to understand what is expected of them and others in the relationship.
5 Leadership — Without a champion to move collaboration for- ward, nothing significant will ever be accomplished.
6 Cooperation, not punishment — When things go wrong in a relationship, punitive actions seldom make them better. The right approach is to solve the problem jointly.
7 Trust — This basic human quality must be evident through- out the organization—at every management level and func- tional area.
8 Benefit Sharing — In a true relationship, the partners need to share both the pain and the gain—-use of a shared modu- lar supply chain scorecard can help.
EXECUTIVE INSIGHT (CONTINUED)
Supply Chain Operations 105
9 Advanced IT—IT is essential to enabling collaborative rela- tions across the supply chain. Communication and process automation achieved through IT enables CTM by facilitating real-time, accurate data transfer.
In addition to enablers, firms seeking to implement CTM should recognize and avoid roadblocks to CTM success. Many of these roadblocks stem from behaviors, attitudes, and practices asso- ciated with traditional business operations. The following list summarizes primary potential roadblocks to successful collabora- tion, as identified at Lehigh University’s Center for Value Chain Research.
1 Control and Trust—How is knowledge shared in such rela- tionships? Who owns and controls the intellectual property gained in such relationships and how is this shared?
2 Sharing of proprietary information—How is information protected from getting into the hands of competitors?
3 Ethical issues—The very nature of collaborative relation- ships has not yet been clearly ironed out.
4 Integration of systems and technology—When sharing information and integrating systems, each company within the relationship must have accurate data to share.
5 Going global—Due to the size and scope of many business- es today, the complexity of global collaboration is something that has not yet been demonstrated.
6 Measuring and documenting benefits—While there are a number of different metrics in use today, there is no easy way to document total CTM benefits.
7 Structure—Establishing effective and implementable “stan- dards” will be needed before such relationships can be suc- cessful and sustainable.
EXECUTIVE INSIGHT (CONTINUED)
(Continued)
106 ESSENTIALS of Supply Chain Management
SUMMARY
Collaboration is not meant for every situation. That is, collabora- tive efforts must result in gains for everyone involved. If outcomes involve only one party gaining, and the winner’s gains are not shared to offset the losses of others, the collaboration should not be pur- sued. Therefore, no single party can only consider what it stands to gain from the effort. The initiative must represent a collective win.
The final requirement is ability. Having good opportunities and good intentions will only get you so far. The partners must individu- ally and collectively have the skills and information capabilities to seize the opportunities. Management and analytical skills are nec- essary for finding the value and selling the prospects with internal and external parties.
While outside parties such as 3PL providers are not required of CTM, they can serve as facilitators of communication or execution. This is particularly true when potential for gains are found among trading partners but capabilities are lacking. The presence of an unbiased, capable intermediary can sometimes make collabora- tion possible when it might not exist otherwise.
Joel Sutherland is Managing Director, Center for Value Chain Research, and Adjunct Professor at Lehigh University. He is also president at Envoy Inc, a supply chain consulting company he founded in 1994. He has more than 30 years experience as a supply chain professional working for manufacturers, wholesale distributors, and third party service providers and is a frequent speaker at supply chain conferences.
Chapter Summary The Make category includes the operations required to develop and build
the products and services that a supply chain provides. Operations that are
in this category are: product design; production management; and facility
EXECUTIVE INSIGHT (CONTINUED)
Supply Chain Operations 107
and management. The Deliver category of operations encompasses the
activities that are part of receiving customer orders and delivering prod-
ucts to customers. The two main operations are order entry/fulfi llment
and product delivery. These two operations constitute the core connec-
tions between companies in a supply chain. The third operation in this
category is return processing. This activity happens when customers need
to return a product for any reason.
The relentless pressure on profi t margins that free markets create is a
driving force behind the growth of outsourcing. What may be considered
as overhead for Company A may be a service that Company B can offer
and make a profi t doing so. Company B may be able to offer this service
for a price lower than it costs Company A to do it in house. In that case
Company A is going to consider outsourcing.
109
CHAPTER 4
Using Information Technology
After reading this chapter you will be able to
● Assess the technology that is available to support and en- able effective supply chain operations
● Appreciate new technology trends and the business capabilities that they will enable
● Better understand how to apply this technology to your own supply chain operations
Information Systems that Support the Supply Chain Information technology supports internal operations and also collabora-
tion between companies in a supply chain. Using high-speed data net-
works and databases, companies can share data to better manage the
supply chain as a whole and their own individual positions within the
supply chain. The effective use of this technology is a key aspect of a
company’s success.
Although many readers of this book do not need to understand all
the aspects and nuances of information technology (IT), every reader
does need to understand the basic concepts that apply to using this tech-
nology effectively. Let’s start with a simple reference model to describe
IT. Then we’ll use this model to classify and gain perspective on available
technology and how it can be used.
Essentials of Supply Chain Management, Third Edition by Michael Hugos
Copyright © 2011 John Wiley & Sons
110 ESSENTIALS of Supply Chain Management
All information systems are composed of technology that performs
three main functions: data capture and communication; data storage and
retrieval; and data manipulation and reporting. Different information
systems have different combinations of capabilities in these three func-
tional areas. The specifi c combination of capabilities is dependent on
the demands of the job that a system is designed to perform. Infor-
mation systems that are employed to support various aspects of supply
chain management are created from technologies that perform some
combination of these three functions.
Data Capture and Data Communications The fi rst functional area is composed of systems and technology that cre-
ate high speed data capture and communications networks. We look at:
• The Internet
• Broadband
• Electronic Data Interchange (EDI)
• eXtensible Markup Language (XML)
The Internet
The Internet is the global data communications network that uses what
is known as Internet Protocol (IP) standards to move data from one
point to another. The Internet is the universal communication network
that can connect with all computers and communication devices. Once
a device is hooked into the Internet it can communicate with any other
device that is also connected to the Internet, regardless of the different
internal data formats that they may use.
Before the Internet, companies had to put in expensive dedicated
networks to connect themselves to other companies and move data be-
tween their different computer systems. Now, with the Internet already
Using Information Technology 111
in place, different companies have a way to quickly and inexpensively
connect their computer systems. If needed, extra data protection and
privacy can be provided by using technology to create virtual private
networks (VPN), which utilize the Internet to create very secure com-
munication networks.
Broadband
Basically, this means any communication technology that offers high-
speed (faster than a 56Kb dial-up modem) access to the Internet with
a connection that is always on. This includes technologies such as co-
axial cable, digital subscriber line (DSL), metro Ethernet, fi xed wireless,
and satellite. Broadband technology is spreading and, as it does, it be-
comes possible for companies in a supply chain to easily and inexpen-
sively hook up with each other and exchange large volumes of data in
real time.
Most companies have connected themselves internally using local
area network (LAN) technology such as Ethernet that gives them plen-
ty of internal communication capability. Many companies have con-
nected some or all of their different geographical locations using wide
area network (WAN) technology such as T1, T3, or frame relay. What
now needs to happen is high speed, relatively low-cost connections be-
tween separate companies, and that is the role that wireless broadband
and cloud computing is playing (see pg. 133).
Electronic Data Interchange (EDI)
Electronic data interchange (EDI) is a technology that was devel-
oped to transmit common types of data between companies that do
business with each other. Large companies in the manufacturing,
automobile, and transportation industries deployed it in the 1980s.
It was built to automate back office transactions such as the sending
112 ESSENTIALS of Supply Chain Management
and receiving of purchase orders (known as an “850” transaction),
invoices (an “810”), advance shipment notices (an “856”), and back
order status (an “855”) to name just a few. It originally was built
to run on big, mainframe computers using value-added networks
(VANs) to connect with other trading partners. That technology was
expensive.
Many companies have large existing investments in EDI systems
and fi nd that it is very cost effective to continue to use these systems
to communicate with other businesses. Standard EDI data sets have
been defi ned for a large number of business transactions. Com-
panies can decide which data sets they will use and which parts of
each data set they will use. EDI systems can now run on any type of
computer from mainframe to PC and can use the Internet for data
communication as well as VANs. Costs for EDI technology have come
down considerably.
Extensible Markup Language (XML)
XML (eXtensible Markup Language) is a technology that is being de-
veloped to transmit data in fl exible formats between computers and
between computers and humans. Where EDI uses rigid, predefi ned data
sets to send data back and forth, XML is extensible and, once certain
standards have been agreed upon, XML can also be used to communi-
cate a wide range of different kinds of data and related processing in-
structions between different computer systems. XML can also be used to
communicate between computers and humans because it can drive user
interfaces such as web browsers and respond to human input. Unlike
EDI, the exact data transactions and processing sequences do not have to
be previously defi ned when using XML.
There are many evolving XML standards in different industries
but as yet none of these standards has been widely adopted. The indus-
try that has made the most progress in adopting XML standards is
Using Information Technology 113
the electronics industry. It is beginning to implement the RosettaNet
XML standards.
In the near term, XML and EDI are merging into hybrid systems
that are evolving to meet the needs of companies in different sup-
ply chains. It is not cost effective for companies with existing EDI
systems that are working well enough to replace them with newer
XML systems all at once. So XML extensions are being grafted onto
EDI systems. Software is available to quickly translate EDI data to
XML and then back to EDI. Service providers are now offering In-
ternet-based EDI to smaller suppliers who do business with large
EDI-using customers.
In the longer term, EDI will be wholly consumed by XML as XML
standards are agreed upon and start to spread. As these standards spread
they will enable very fl exible communication between companies in a
supply chain. XML will allow communication that is more spontaneous
and freeform, like any human language. This kind of communication
will drive a network of computers and people interacting with other
computers and other people. The purpose of this network will be to co-
ordinate supply operations on a daily basis.
Data Storage and Retrieval
The second functional area of an information system is composed of
technology that stores and retrieves data. This activity is performed by
database technology. A database is an organized grouping of data that
is stored in an electronic format. The most common type of database
uses what is called “relational database” technology. Relational databases
store related groups of data in individual tables and provide for retrieval
of data with the use of a standard language called structured query lan-
guage (SQL).
A database is a model of the business processes for which it collects
and stores data. The model is defi ned by the level of detail in the data
114 ESSENTIALS of Supply Chain Management
it collects. The design of every database has to strike a balance between
highly aggregate data at one extreme and highly detailed data at the
other extreme. This balance is arrived at by weighing the needs and
budget of a business against the increasing cost associated with more and
more detailed data. The balance is refl ected in what is called the data
model of the database.
As events occur in a business process, there are database transactions.
The data model of the database determines which transactions can be
recorded since the database cannot record transactions that are either
more detailed or more aggregated than provided for in the data model.
These transactions can be recorded as soon as they happen—called “real-
time” updating—or they may be captured and recorded in batches that
happen on a periodic basis—called “batch” updating.
A database also provides for the different data-retrieval needs of
the people who use it. People doing different jobs will want different
combinations of data from the same database. These different combi-
nations are called “views.” Views can be created and made available to
people who need them to do their jobs. For instance, consider a database
that contains sales history for a range of different products to a range
of different customers. A customer view of this data might show a cus-
tomer the different products and quantities they purchased over a period
of time and show detail of the purchases at each customer location.
A manufacturer view might show all the customers who bought their
group of products over a period of time and show detail for the products
that each customer bought.
Data Manipulation and Reporting
Different supply chain systems are created by combining processing logic
to manipulate and display data with the technology required to capture,
communicate, store, and retrieve data. The way that a system manipulates
Using Information Technology 115
and displays the data that fl ows through it is determined by the specifi c
business operations that the system is designed to support. Information
systems contain the processing logic needed by the business operations
they support. Chopra and Meindl defi ne several kinds of systems that
support supply chain operations:
• Enterprise Resource Planning (ERP)
• Procurement Systems
• Advanced Planning and Scheduling (APS)
• Transportation Planning Systems
• Demand Planning
• Customer Relationship Management (CRM) and Sales Force Automation (SFA)
• Supply Chain Management (SCM)
• Inventory Management Systems
• Manufacturing Execution Systems (MES)
• Transportation Scheduling Systems
• Warehouse Management Systems (WMS)
Enterprise Resource Planning
Enterprise Resource Planning (ERP) systems gather data from across
multiple functions in a company. ERP systems monitor orders, pro-
duction schedules, raw material purchases, and fi nished-goods inven-
tory. They support a process-oriented view of business that cuts across
different functional departments. For instance, an ERP system can view
the entire order-fulfi llment process and track an order from the procure-
ment of material to fi ll the order to delivery of the fi nished product to
the customer.
116 ESSENTIALS of Supply Chain Management
ERP systems come in modules that can be installed on their own
or in combination with other modules. There are usually modules for
fi nance, procurement, manufacturing, order fulfi llment, human resources,
and logistics. The focus of these modules is primarily on carrying out
and monitoring daily transactions. ERP systems often lack the analytical
capabilities needed to optimize the effi ciency of these transactions.
Procurement Systems
Procurement systems focus on the procurement activities that take place
between a company and its suppliers. The purpose of these systems is
to streamline the procurement process and make it more effi cient. Such
systems typically replace supplier catalogs with a product database that
contains all of the needed information about products the company
buys. They also keep track of part numbers, prices, purchasing histories,
and supplier performance.
Procurement systems allow people to compare the price and perfor-
mance capabilities of different suppliers. This way the best suppliers are
identifi ed so that relationships can be established with these suppliers
and prices negotiated. The routine transactions that occur in the pur-
chasing process can then be largely automated.
Advanced Planning and Scheduling
Advanced Planning and Scheduling (APS) systems are highly analyti-
cal applications whose purpose is to assess plant capacity, material avail-
ability, and customer demand. These systems then produce schedules for
what to make in which plant and at what time. APS systems base their
calculations on the input of transaction-level data that is extracted from
ERP or legacy transaction-processing systems. They then use linear pro-
gramming techniques and other sophisticated algorithms to create their
recommended schedules.
Using Information Technology 117
Transportation Planning Systems
Transportation Planning Systems are systems that calculate what quan-
tity of materials should be brought to what locations at what times. The
systems enable people to compare different modes of transportation, dif-
ferent routes, and different carriers. Transportation plans are then created
using these systems. The software for these systems is sold by system
vendors. Other providers—known as content vendors—provide the data
that is needed by these systems, such as mileage, fuel costs, and shipping
tariffs.
Demand Planning
Demand-planning systems use special techniques and algorithms to help
a company forecast its demand. These systems take historical sales data
and information about planned promotions and other events that can
affect customer demand, such as seasonality and market trends. They use
this data to create models that help predict future sales.
Another feature that is often associated with demand planning
systems is revenue management. This feature lets a company experi-
ment with different price mixes for its different products in light of
the predicted demand. The idea is to fi nd a mix of products and prices
that maximizes total revenue to the company. Companies in the travel
industry such as airlines, rental car agencies, and hotels are already using
revenue management techniques. These techniques will spread to other
industries.
Customer Relationship Management and Sales Force Automation
Systems of this type automate many of the tasks related to servicing existing
customers and fi nding new customers. Customer Relationship Manage-
ment (CRM) systems track buying patterns and histories of customers.
118 ESSENTIALS of Supply Chain Management
They consolidate a company’s customer-related data in a place where it is
quickly accessible to customer-service representatives and salespeople who
use the data to better respond to customer requests.
Sales Force Automation (SFA) systems allow a company to better co-
ordinate and monitor the activities of its sales force. These systems automate
many of the tasks related to scheduling sales calls and follow-up visits and
preparing quotes and proposals for customers and prospects.
Supply Chain Management
Supply Chain Management (SCM) systems are suites of different supply
chain applications, such as those described here, that are tightly inte-
grated with each other. An SCM system could be an integrated suite that
contains advanced planning and scheduling, transportation planning, de-
mand planning, and inventory planning applications. SCM systems rely
on ERP or relevant legacy systems to provide them with the data to
support the analysis and planning that they do. These systems have the
analytical capabilities to support strategic-level decision making.
Inventory Management Systems
These systems support the activities described in Chapter 2 that are part
of inventory management such as tracking historical demand patterns
for products, monitoring inventory levels for different products, and cal-
culating economic order quantities and the levels of safety inventory that
should be held for each product. These systems are used to fi nd the right
balance for a company between the cost of carrying inventory and the
cost of running out of inventory and losing sales revenue because of that.
Manufacturing Execution Systems
The focus is on carrying out the production activities in a factory. This
kind of system is less analytical than an APS. It produces short-term
Using Information Technology 119
production schedules and allocates raw materials and production re-
sources within a single manufacturing plant. A Manufacturing Execu-
tion System (MES) is similar in its operational focus to an ERP system
and frequently MES software is produced by ERP software vendors.
Transportation Scheduling Systems
Systems in this category are similar to ERP and MES applications in
that they are less analytical and more focused on daily operational issues.
A transportation scheduling system produces short-term transportation
and delivery schedules that are used by a company.
Warehouse Management Systems
Warehouse Management Systems (WMS) support daily warehouse
operations. They provide capabilities to effi ciently run the ongoing
operations of a warehouse. These systems keep track of inventory levels
and stocking locations within a warehouse and they support the actions
needed to pick, pack, and ship product to fi ll customer orders.
New Trends in Supply Chain Technology The demands of our global economy are forcing companies and entire
supply chains to adopt more fl exible and responsive modes of operation.
Both the interdependence of companies and economies, and the rapid
and often unexpected pace of events call for responses from companies
that are faster and also more well thought out than what was required
in the past.
In order to rise to this challenge, companies must fi nd ways to lever-
age the supply chain systems previously described, which they already
have in place or that they are currently installing. They need to fi nd ways
to provide these systems with more timely and more accurate data and
120 ESSENTIALS of Supply Chain Management
better coordinate the use of these systems. Companies need to achieve
overall supply chain improvements and not just improvements in indi-
vidual supply chain activities.
There are four promising technologies that can be used to com-
plement existing supply chain systems. These technologies do not replace
existing systems. In fact they require that there be an existing infrastructure
of systems to provide the foundation upon which they can be installed.
Once installed, these technologies provide ways to better collect data
needed by existing systems. They also provide better ways to share data
among systems and to make that data visible and meaningful to people
who need it. They also provide people with a way to devise well thought
out and more effective responses to challenges and opportunities. These
four technologies are:
1. Radio Frequency Identifi cation (RFID)
2. Business Process Management (BPM)
3. Business Intelligence (BI)
4. Simulation Modeling
Markets and customer needs are evolving constantly and sup- ply chains need to deliver new capabilities to enable companies to thrive. And often there is a pressing need to move quickly. Robert Meshew, a senior director at Microsoft (www.Microsoft. com), describes a project where he and his team delivered a new physical and digital supply chain in 90 days.
In advance of Microsoft’s launch of Office 2010, our largest retail customer wanted to greatly reduce their on-hand inventory, decrease operations costs, and increase their product in-stock percentage. The retailer pushed our sales team to bring them
IN THE REAL WORLD
Using Information Technology 121
solutions or risk not getting their full support around this important launch for Microsoft.
Our sales team urgently engaged our combined supply chain and IT team to determine how best to accomplish this very challenging goal. Our teams had historically been responsible only for delivering physical boxes of software to the retailers at the right times and in the right quantities. When we first looked at this new problem we saw the traditional solutions—such as collaborative forecasting and planning, lower packaging costs, and consigned inventory—but these solutions didn’t deliver the dramatic improvements we wanted.
This problem required a whole new solution that we didn’t have readily available. After evaluating possible alternatives, our team decided on a key card that could be activated at the retailer point of sale terminal as the best solution. These cards could be manu- factured at a very low price, and would not be active until scanned. The customer could then go to a Microsoft web site to download a copy of the software at a later time. We would also work with the PC manufacturers to pre-load Office 2010 onto their machines to allow customers to instantly access the software with the key.
Benefits of the Point-of-Sale-Activated (POSA) card solution are the following:
1 Friendly to retailers on margin and turns—they don’t pay for the cards up front
2 Support a consistent experience for all retailers across all Microsoft consumer products—single invoice and supply chain point of contact
3 Reduce Shrinkage and inventory risk for the retailers
4 Increase product add on sales with PCs sold—impulse buys at the cash register
5 Provide more consumer choice—retailers can afford a broader assortment of software since they aren’t paying for inventory in advance, and the POSA cards don’t take a lot of shelf space.
(Continued)
IN THE REAL WORLD (CONTINUED)
122 ESSENTIALS of Supply Chain Management
There were challenges for our team in building this POSA solu- tion. First, the new version of Microsoft Office was nearing release and we needed to have the solution within 90 days. Secondly, the lead-time for servers in our crowded data center was greater than 90 days. Finally, we only had a limited amount of funding, as it was at the end of our fiscal year and budgets had been spent.
Given the constraints on the project, we decided that we needed to deliver the solution based on some guiding project principles:
1 We needed to deliver quickly and in iterative fashion, and would use the limited funding constraint as a friend to focus us only on the core elements of the solution—the most important system features. We would structure the work into a series of 30-day releases (blitzes) to achieve this.
2 We would co-locate our team. Given our tight timeline we needed to eliminate communication and decision delays. All business and IT people would work together in the same location.
3 We would look to the cloud to host the solution, as we didn’t have the time to get physical hardware installed and config- ured without reprioritizing existing work in the pipeline.
4 We would use our existing billing, back office systems, and processes in manual mode until we had time to do the prop- er systems integration in a release soon after the launch of Microsoft Office.
The combined project team worked hard and narrowed scope to deliver the core solution. The POSA solution launched on time and exceeded the expectations of our business sponsors. In the first four weeks of service the system delivered thousands of keys suc- cessfully to customers, with minimal customer support issues and 100 percent uptime. Our retail partner exceeded their sales goals for the POSA product and it was highlighted as a key success for our sales team and the Office product group.
IN THE REAL WORLD (CONTINUED)
Using Information Technology 123
Since the initial launch we have implemented additional retailers and added more products, including Windows and Xbox games. We have continued to iteratively add more features to the system, and in addition to activation, we now support key delivery to in-store kiosks and we can print keys on receipts generated by store point- of-sale systems. The solution has been a huge success and has earned our supply chain and IT team a seat at the business man- agement table. We have been called out of the “back office” to work closely with our business executives to define and design the future Digital Supply Chain for all of Microsoft’s product groups.
SOLUTION OVERVIEW
Exhibit 4.1 illustrates how the POSA solution works. Tokens are printed on the cards and loaded into a database. The tokens are associated to keys that will unlock the software. When a POSA card is sold we receive a message from the retailer that sets a flag against the respective token and key pair in our database. We use this activation request to send a sales order event to our billing and financial system. These just-in-time retailer activa- tions are then aggregated into a monthly invoice to the retailers.
The consumer at a later time goes to a Microsoft web site to retrieve the key. If a sale hasn’t occurred there won’t be a key associated with the token, and an error message will be returned if someone tries to activate a key they did not purchase. There is also a link to a download location on the web site for the product if it isn’t already pre-loaded on the customer’s PC.
Robert Meshew leads the Architecture and Production Support orga- nization for Microsoft’s Interactive Entertainment Division manufac- turing, supply chain, and information solutions (MSCIS) group. Robert has 18 years of combined supply chain and IT experience and enjoys putting both disciplines into practice to architect and design solutions that help the business achieve sustainable and strategic advantage.
IN THE REAL WORLD (CONTINUED)
(Continued)
124 ESSENTIALS of Supply Chain Management
Radio Frequency Identifi cation
This is a much-talked-about technology for supply chain management.
What is new is the opportunity to start using this technology widely to
track pallets, cases, and even individual items as they move through sup-
ply chains from manufacturers to end-use customers. Radio frequency
identifi cation (RFID) technology itself is not new and has been in use in
specialized applications for more than 20 years. Now the technology is
maturing and the related costs of using it are coming way down. Where
the technology was once used to track movement of items within a facility
EXHIBIT 4.1
Process Flow for POSA Supply Chain Solution
IN THE REAL WORLD (CONTINUED)
Using Information Technology 125
or within a single company, it is now becoming cost effective to start using
RFID to track products moving through supply chains that stretch all the
way around the globe.
When we talk about RFID we need to understand that there are
two parts to this discussion. The fi rst part is about the technology itself,
the electronic devices that make RFID systems a reality. The second part
is about the information or the content this technology enables us to
capture and share. It is important to understand both parts of RFID in
order to appreciate how it can be such a powerful driver of supply chain
effi ciency.
RFID Technology RFID technology is composed of hardware
such as RFID tags and the radio-frequency scanners and antennas that
enable these hardware devices to communicate with each other. Let’s
start with the RFID tags. They come in two varieties—active and pas-
sive. Active tags have their own power source and continuously broadcast
their information. Passive tags are tags where the tag has no energy of its
own. When a passive RFID tag passes by a radio-frequency scanner the
energy from the radio scanner activates passive tags and induces them to
broadcast their data, which is then picked up by the antenna of a data
reader.
The scanners operate at certain radio frequency levels and at certain
power levels. The RFID tags, whether active or passive, broadcast their
information on certain frequencies. There are standards published for
these frequencies and power levels but the technology is still improving
and standards are evolving.
Passive RFID tags are by far the most widely used. This is because
their cost and complexity is much lower than that of active tags. Large
companies, especially in the consumer-goods retail industry such as Wal-
Mart, are mandating that their suppliers start using passive RFID tags
on the products that they ship. Initially these tags are required only at
the pallet and case level. As the technology matures, as people gain more
experience in the use of the technology, and prices continue to come
126 ESSENTIALS of Supply Chain Management
down, RFID tags will start being required on the individual items them-
selves.
RFID Information RFID information is composed of descriptive
data about the product itself and of tracking data that traces the move-
ment of the product through the supply chain. It makes sense for there
to be a single worldwide standard for this information so that people
all over the world in different companies and countries can read the
data easily and not have to translate it from one standard to another. At
present there is one organization that is setting standards for product
information. This organization is called GS1 (www.gs1.org) and it is a
combination of two previous organizations, the Uniform Code Council
and EAN International. The Uniform Code Council was the origina-
tor of the Universal Product Code or UPC number. EAN International
created the European Article Number or EAN.
The two item numbering schemes—UPC and EAN—were com-
bined in 1997, and starting in 2005 all participants in a supply chain
were required to handle product identifi cation data that is in the
combined format. This is referred to as the “14-digit UPC” in North
America or the “13-digit EAN plus check digit” in Europe. The GS1
organization also introduced a new term for these item-numbering
schemes. The term is Global Trade Item Number or GTIN and it re-
fers to the fact that there is now just one unifi ed 14-digit numbering
scheme.
The GTIN is a part of a global item-numbering scheme that GS1
has introduced called the Electronic Product Code or EPC. The EPC
consists of four components or data fi elds. Those components are: (1)
the version code that tells what version of EPC is being used; (2) the
manager code that tells what organization created the EPC number;
(3) the object class that defi nes the type of item or service; and (4) the
serial number that identifi es a specifi c individual instance of the item
or service. The GTIN already contains data for the manager code and
the object class, so you can think of EPC as a GTIN (or a UPC or
Using Information Technology 127
EAN) with a serial number attached. Organizations can register with
GS1. They will be assigned a manager code and can begin using the
EPC standards.
At present most companies use systems based on the EPC infor-
mation standards combined with passive RFID tags. In these systems a
radio scanner activates a passive RFID tag that sends its EPC number to
a data reader. The data reader sends the EPC number to an application
system that uses the Internet to communicate with a system called the
EPC Global Network. The EPC Global Network is a system designed
by GS1 that enables companies to fi nd out what kind of item an EPC
number refers to and get more information about that specifi c item such
as its manufacture date and its movement history through the supply
chain. Exhibit 4.2 shows how this process works.
RFID Benefi ts and Problems The benefi ts of RFID are signifi -
cant. To begin with, it offers a much lower-cost way to capture data
about products and their movements through a supply chain. The data
that is captured is also more accurate and it can go to great levels of
detail. Data can go from the level of shipping containers to pallets to
cases and down to individual items. This enables much more visibility
of inventory and product fl ows in supply chains. The increased visibility
makes it possible to operate supply chains more effi ciently, leading to
lower costs. And fi nally, because data is captured and stored so much
more effi ciently, it is also easier to share this data with other parties in a
supply chain. This makes supply chain collaboration more effective and
increases overall supply chain productivity.
There are problems with RFID as well. The technology itself is still
improving and it can be diffi cult at times to get it to work as expected.
As companies begin using the technology, they fi nd that it takes time to
set up systems of RFID tags and radio scanners so that there is a high
enough read rate on the data readers. If passive RFID tags are blocked
by metal or liquids or other tags then it can be diffi cult for data readers
to accurately read all the RFID tags that fl ow past them. Data-read rates
128 ESSENTIALS of Supply Chain Management
EPC Global Network
Company Application
System
GS1 ONS
System
Manufacturer EPC-IS
Interface
Logistics Provider EPC-DS Interface
Distributor EPC-DS Interface
EPC Nbr.
EPC Nbr.
Product description & manufacture date
Product movement data
SCM
SCM
SCMMESERP
Company application system sends the scanned EPC numbers to the GS1 ONS System. ONS System sends back the Internet address of the manufacturer who issued the EPC numbers.
Company may contact other companies who handled the product to get data about the movement history of the product. It uses the EPC-DS interface to do this.
ONS System uses EPC manager code to identify the company that issued an EPC number. EPC-IS Interface allows different systems to exchange product descriptive data. EPC-DS Interface allows different systems to exchange product movement data.
RFID tags on incoming pallets and cases are scanned.
Application system contacts manufacturer via Internet using EPC-IS interface. Manufacturer queries its internal systems and sends back product description and manufacture date.
EXHIBIT 4.2
can be very low at fi rst and it takes time and trial and error to get read-
rate percentages up into the high 90s.
The EPC Global Network and its various subsystems are also still
works in progress. The goal is for any company anywhere that reads an
Using Information Technology 129
EPC number to be able to instantly access information describing the
specifi c item and its supply chain movement. This is not always a reality.
It will take a lot of work for product manufacturers to register their EPC
numbers with the EPC Global Network and keep them constantly up
to date. It will take work for other supply chain companies such as logis-
tics and distribution companies to register with GS1 and record data
that tracks product movements. In addition the EPC Global Network
and the EPC standards must keep pace with global developments and
evolve to meet changing needs in different regions of the world and in
different industries.
Business Process Management
A process is a sequence of steps that lead to the delivery of a specifi ed
product or service. When you think about it you realize that business
processes themselves are assets of an organization just as much as the
organization’s people, products, and information. The way that an or-
ganization uses its people, products, and information show up in the way
its business processes operate.
Business process management (BPM) is a way for companies to
carry out a continuous, incremental process of improving their oper-
ational performance. A company starts by mapping out its key processes.
The company defi nes the steps in a process and uses BPM software to
collect and display a continuous stream of data that shows the move-
ment of transactions through each step. The BPM software can be used
to automate many of the routine tasks such as moving different kinds of
data from one task to another. It can also be set to detect certain error
conditions and send automatic alerts to people who need to respond to
these conditions quickly.
When used effectively, BPM software makes a business process vis-
ible to the people who are responsible for the effi cient operation of that
process. When people involved in the operation of a business process see
130 ESSENTIALS of Supply Chain Management
what is happening as it is happening, they can take effective action to
respond to problems and to improve productivity. The process-perform-
ance data that BPM software collects also provides a base of information
that people can use to design new processes when existing ones are no
longer able to meet business needs.
Business Intelligence
Because of the fast pace of change in markets and their supply chains,
it is very important for people and organizations to stay current with
events as they happen and understand what these events mean. Business
intelligence (BI) systems help companies to understand what is hap-
pening within their own organizations and within the markets they
serve.
BI systems collect, store, and analyze data. They collect data using
many different sources. Data can be collected from sensors and RFID
scanners. Data can be collected by BPM systems, or data can be ob-
tained from the many transaction-processing systems in a company such
as ERP systems, order entry systems, or CRM systems. Once the data
is collected, it is stored in a database where people access it as needed.
Often the database is updated with new data on a continuous or real-
time basis.
When people access the data they use BI software tools that help
them analyze the data and display the results. BI software tools run the
range from simple spreadsheets and charts to complex multivariable re-
gression analysis and linear programming. The proper mix of BI tools is
determined by the needs of the people in a situation and their skill and
training levels. Scientists doing molecular research have very demanding
needs and they are also a highly skilled and educated group of people.
Running an effi cient supply chain is a very demanding job but people
do not need the type of sophisticated BI tools called for in molecular
research.
Using Information Technology 131
Successful BI systems are tailored to best support the people using
them. In Chapter 5 we discuss the techniques and metrics for meas-
uring supply chain performance. In light of these requirements, we
then examine the structure of a BI system that is designed to meet the
needs of people responsible for running a supply chain. This provides
a good example of how BI is used to support supply chain operations
(see pages 178–181).
Simulation Modeling
Simulation modeling software is a category of software that is grow-
ing rapidly. Because of the fast pace of change in business, companies
are faced with the need to make important decisions more often and
these decisions have signifi cant consequences on company operations
and profi tability. Companies are faced with decisions such as where to
build a new factory or distribution center and what is the best way to lay
out and equip a new facility.
Simulation modeling software allows people to create a model of a
factory or a supply chain or a delivery route and then subject that model
to different inputs and different situations and observe what happens. A
design that may seem good on paper could very well turn out to have
problems that are not apparent until the design is modeled and its perfor-
mance is simulated under a range of different conditions. It is much faster
and cheaper to fi nd this out through simulations than to fi nd out the
hard way through real experience (see Chapter 7 for more on this idea).
Companies that use BPM systems to manage their work processes
can use the BPM process defi nitions to create models of their processes.
Then they can use the data they collect in their BI systems to provide the
input for simulating these processes under different business conditions.
They can experiment with new ways to organize their work as business
conditions evolve. By using simulation models and data from their BI
systems, companies are able to test out new business models before they
132 ESSENTIALS of Supply Chain Management
actually commit to them. And when new models are implemented there
is much less risk because they have been tested. The models that are se-
lected are shown to be the ones that offer the best performance and are
much less likely to have serious problems.
The Impact on Supply Chain Operations
Although each of these new technologies is interesting and useful all
by themselves, their true potential is realized when they are used in
conjunction with each other. Just as Wal-Mart designed its supply chain
based on the combination of four complementary practices (see Chapter
1 Executive Insight on page 18), companies once again have the oppor-
tunity to design extraordinary supply chains based on the use of combi-
nations of these four new technologies (also see Chapter 7).
RFID technology can provide a steady stream of data that tracks
individual items through a supply chain. This data can be monitored
through the use of BPM systems and combined to provide a com-
prehensive end-to-end picture of the products fl owing through a supply
chain. BPM systems can update this picture on a real-time or near real-
time basis and show people where the bottlenecks and disruptions are
that need their attention.
Once people have identifi ed the bottlenecks and disruptions in a
supply chain, they can make use of BI databases and analytical software
to investigate the situations and identify root causes of these problems.
When root causes are identifi ed, people can design ways to address
these problems. Then by using simulation systems they can model po-
tential supply chain process changes and see the probable impact of
each different process change. In this way people quickly select the
most effective changes and implement them with a high level of confi -
dence that they will actually deliver the desired results.
Just as Wal-Mart rose to dominate its markets through the devel-
opment of a highly effi cient supply chain, there are opportunities once
Using Information Technology 133
again for companies and alliances of companies to collaborate and create
a new breed of supply chains that will be a key factor in achieving new
levels of effi ciency and responsiveness. This new level of supply chain
performance will enable the rise of new companies and whole new
industries. The potential of these new supply chains is further explored
in the last chapter of this book.
A Combination of Technologies Creates Cloud Computing
Since the turn of this century, several different but related kinds of infor-
mation technology have been evolving rapidly, and they are now com-
bining to make it possible to deliver computing resources on demand to
companies almost anywhere in the world. The combination of technol-
ogies, such as the Internet, Web browsers, server virtualization, parallel
computing, and open source software, produces a whole new set of poss-
ibilities for delivering computing resources.
The term “cloud computing” is now used to describe the result
of combining these technologies. IT vendors are offering combinations
of these technologies to companies that want to outsource some or
all of their traditional IT operations such as running data centers and
operating traditional application packages, like ERP, CRM, and other
business support applications.
The exact defi nition of cloud computing is still evolving. Cloud
computing is both a model for delivery of business-computing services
and a method for managing and operating computing hardware and
software infrastructure. Different IT vendors put their own spin on their
defi nitions, but they share more commonality in their defi nitions than
differences. Here are two working defi nitions:
• “Consumer and business products, services, and solutions delivered and consumed in real time over the Internet” (Frank Gens,
134 ESSENTIALS of Supply Chain Management
“Defi ning “Cloud Services”—an IDC update,” IDC Exchange,
(September 30th 2009), http://blogs.idc.com/e/?p=422)
• “…a broad array of Web-based services aimed at allowing us- ers to obtain a wide range of functional capabilities on a ‘pay-
as-you-go’ basis that previously required tremendous hardware/
software investments and professional skills to acquire.” (Jeff
Kaplan, “Simplifying the Term ‘Cloud Computing’” Datama-
tion.com Blog, (June 25, 2009), http://itmanagement.earth-
web.com/netsys/article.php/3826921/Simplifying-the-Term-
Cloud-Computing.htm)
There are three characteristics that everyone seems to accept when
it comes to describing cloud computing. Everyone agrees that cloud
computing has the characteristics of:
1. Practically Unlimited Computing Resources—Resources such
as computing power, data storage space, and additional user
sign-on IDs for applications are available on demand as needed,
and this enables a high degree of agility and scalability in meet-
ing evolving business needs.
2. No Long-Term Commitments—Computing resources are
immediately available and they may be used as long as needed
and then retired because they are acquired on a month-to-
month or even a minute-to-minute basis.
3. Pay-as-You-Go Cost Structure—Because there are no long-
term commitments, the cost of cloud computing resources is a
variable cost, not a fi xed cost; cost fl uctuates depending on the
amount of usage.
For a more detailed and far-reaching discussion of cloud comput-
ing and its impact on business operations please see my book Business
Using Information Technology 135
in the Cloud: What Every Business Needs to Know about Cloud Computing
(Hugos and Hulitzky, Business in the Cloud, John Wiley & Sons, Hoboken
NJ, 2010).
Assessing Technology and System Needs
When evaluating different systems that can be used to support your sup-
ply chain it is important to keep in mind your goal—the reason for using
any of these systems. What customers desire is good service and good
prices. That is what guides them when they select companies to do busi-
ness with. Technology is not an end in itself. It is only a means to enable
a company to be of service to its customers. People and organizations
that keep this in mind will do well.
Technology can be impressive, but in business, technology is only
important insofar as it enables a company or an entire supply chain to
profi tably deliver valuable products and services to its customers. Do
not let the complexity or the details of any technology or system be a
distraction from this basic truth. Indeed, any technology that is highly
complex or that is touted as being “state of the art” or “leading edge” is
probably more suited for a research laboratory than it is for a business
operation.
Success in supply chain management comes from delivering the
highest levels of service at the lowest cost. Technology is expensive and
it can quickly add a lot of cost to business operations. Keep in mind that
it is a far better thing to use simple technology well than to use sophisti-
cated technology in a clumsy manner.
E-Business and Supply Chain Integration
The widespread availability and use of the Internet offers compa-
nies opportunities that did not exist before. These opportunities are
136 ESSENTIALS of Supply Chain Management
Supply chain decisions are more vital than ever before and also more complex than ever before. How will companies address these challenges? One way is through the use of software and techniques for supply network design and simulation modeling. Tolga Yanasik and Thibault Quiviger specialize in the use of these tools and they describe some situations and the benefits they were able to deliver.
Consider the task faced by a large steel maker that is creating its five year investment plan. It must decide where to invest, which factories to revamp, and what production capacity to reduce in its 27 plants in Europe. Its product portfolio is made up of 16,000 different products, and many of them are processed on different production lines in different countries. The team in charge of this process is also concerned with the effect of different price policies contemplated for the different products and how this could modify their investment plan.
Or consider a carmaker that is going to re-engineer its global sup- ply chain operations to build a competitive advantage against its competitors. The questions that both of these companies must answer are similar and are questions such as:
• Which product must be built on demand, which must be built on stock?
• Where to locate the different distribution centers?
• How much stock will be necessary to guarantee 95 percent ser- vice level to every customer with a delivery lead time of X days?
• Out of the total supply chain inventory, how much will be safety stock?
In another case, a company or port authority is planning to build a new container terminal. And it must decide about the new layout
EXECUTIVE INSIGHT
Using Information Technology 137
of the terminal, the number of cranes, the size of the parking lot for the waiting trucks, the number and location of weigh bridges and, most important, the number and layout of the customs gates it must negotiate with the country’s government.
Simulation modeling can be used to answer the questions in all three of these situations. We will illustrate some tools and meth- odologies that can be used by companies to make rational deci- sions about their production and distribution strategies. We will address three different levels of planning: strategic, tactical, and operational. The difference between each level is the time horizon that drives different decision processes. For our discussion we will define these time horizons as follows:
• Strategic: One year to five years, depending on the industry dynamics.
• Tactical: One month to one year
• Operational: One day to one month
STRATEGIC SUPPLY CHAIN DESIGN
The purpose of strategic design is to minimize the total cost of the supply chain under capacity constraints. Using network design tools and quantitative methodologies, people can answer the fol- lowing questions:
• Which product must be produced in which unit?
• Where should I build a new distribution center?
• Where to locate the inventories and how much to guarantee a certain service level?
• What is the most carbon efficient network?
• Is it better to build on demand or to build on stock?
• What is the impact of adding a new product in my Supply Chain?
(Continued)
EXECUTIVE INSIGHT (CONTINUED)
138 ESSENTIALS of Supply Chain Management
EXECUTIVE INSIGHT (CONTINUED)
• What if I reduce my product portfolio complexity in terms of total cost, customer service, and inventory level across the supply chain?
• At which stage of the supply chain should I hold safety stock? What about sharing this cost with my suppliers and customers and optimizing the overall inventory level?
Simulation software packages allow people to build a mathemati- cal model representing the current and potential supply chain, with all of its products, production sites, and distribution sites that are relevant for the decision-making process. People can define the constraints on the supply chain (target service levels, maximum capacity of each plant, transport options, etc.) and quantify these constraints. Costs can then be entered into the model and used to help answer design questions. Exhibit 4.3 below shows the inter- relationships between the physical and operating policy variables that must be modeled.
EXHIBIT 4.3
Physical and Behavioral Policies
Using Information Technology 139
In this model, physical facilities and operating policies are put in place to tackle different problems such as:
• Factory production scheduling in the face of shifting product demand
• Managing production lead times that are longer than commit- ted product delivery lead times to end customers
• Coping with supply uncertainty and demand uncertainty
For example, management of inventories to cope with demand uncertainty (also known as safety stocks), is complex because every stage in the supply chain usually builds up its own safety stock to guarantee a given service level. It can be mathematically demon- strated that this approach is not optimum and tends to build up too much inventory in the supply chain. One can show in simulations that it is possible to reduce the overall value of safety stock in the chain while increasing the service level to the supply chain end customers.
The further downstream in a supply chain, the higher is the value of the inventory and safety stock. And the more upstream safety stock is accumulated, the lower the value of these stocks. Yet safety stock held closer to the end customer guarantees a higher service level. The challenge is to find the optimum locations and quantities of different products and components to hold in the supply chain so as to guarantee target service level for the end customer and also minimize value of safety stocks. In many cases, simulations show how to reduce safety stocks by 30 per- cent or more while increasing service levels by 10 to 20 percent. Simulation shows this performance is achieved by reducing the safety stocks in the intermediate stages of the supply chain while increasing them in the final stage of the supply chain so as to increase service levels for the end customer.
USE OF SIMULATION FOR TACTICAL PLANNING
In tactical supply chain planning, uncertainty is mainly driven by demand uncertainty, but there may be other sources of uncertainty:
EXECUTIVE INSIGHT (CONTINUED)
(Continued)
140 ESSENTIALS of Supply Chain Management
process times, availability of equipment, and complex interactions between workflows sharing limited resources (people, equipment, loading docks, etc.) making it hard to precisely know the overall system capacity. In these conditions, simulation can be of great help.
Simulators help managers to measure the consequences of these different sources of uncertainty in the supply chain opera- tion. Let’s consider here the example of a container terminal in Turkey. The container shipping business is booming in Turkey; a company is expanding its container terminal close to Istanbul in order to follow up on the container market demand. This company is already running another car export business, cars from the Renault Plant located close to the port and an import of steel slab for a neighboring plant. Exhibit 4.4 below shows a proposed layout for the facility. The proposed layout is overlaid on a Google Earth picture of the existing facility
EXHIBIT 4.4
Google Earth
Simulation is a powerful tool to study facility operations and work- flows in scenarios of high variability. Logistics is very much sub- ject to this variability because of the interactions between these
EXECUTIVE INSIGHT (CONTINUED)
Using Information Technology 141
workflows which often cannot be controlled. When considering the different product flows, capacity computation is not simple because of factors such as: different product flows share some common resources (roads, custom tolls, weigh bridges); arrival of trucks is not constant during the day, nor during the week; weighing time and custom control times are very variable; and boat arrival times are unstable because of the crossing of the Bosphorus where many boats are queuing.
Using simulation, it was possible to verify:
• The current layout proposed was not optimal and could not absorb peak traffic
• No new investment was required: changing the layout to make it more flexible was enough to absorb the different traffic peaks
• Investment saved versus contemplated countermeasures: $4M
USE OF SIMULATION IN WAREHOUSE OPERATIONS
Very similar to manufacturing plants, simulation offers many benefits to warehouses. With the aid of simulation, logistics engi- neers can calculate how a new picking or replenishment strategy will affect the service levels or the utilization of lift trucks. Since logistics operations are exposed to more variation than factory production operations, it’s crucial to monitor the behavior of these operations during extreme situations.
Simulation is a highly useful tool for calculating the effect of possible variations. It enables engineers to pinpoint zones of congestion and improve the layout of warehouses to respond to this congestion. Three-dimensional simulation is especially important when designing and installing automation systems such as conveyors, sorters, or palletizers in a warehouse (see Exhibit 4.5).
EXECUTIVE INSIGHT (CONTINUED)
(Continued)
142 ESSENTIALS of Supply Chain Management
EXECUTIVE INSIGHT (CONTINUED)
EXHIBIT 4.5
Three-dimensional Simulation
CONCLUSION
We have shown different techniques and uses of simulation to optimize supply chain investments and operations. We looked first at the strategic level because that’s where the big money and big savings are to be found. Often supply chain managers are stuck in day-to-day operations. They tend to start from their daily experiences and try to extrapolate supply chain strategies. The difficulty of this approach lies in managers becoming focused on incremental changes to existing ways of working and failing to see the larger picture or try new ideas. Supply chains must be tailored to fit business strategy, not the other way around. Simulations of supply chain design and operations enable people to break out of preconceived ideas and try new approaches. Continuous simula- tion to find new ways to structure and operate supply chains is
Using Information Technology 143
vital for companies that wish to keep up with the rapid rates of change in the global economy.
Tolga Yanasik is a principle in the supply chain engineering firm of Dijitalis in Istanbul, Turkey. He specializes in the creation of simulation models for analysis of supply chain operations and optimization tools for efficient planning. (www.dijitalis.com)
Thibault Quiviger is principal in the firm of Enetek in France. He specializes in the use of mathematical methods for simulation modeling and analysis. (www.enetek.eu)
made possible because it is now so easy and relatively inexpensive for
companies to connect to the Internet. Once connected, companies
can send data to and receive data from other companies that they do
business with, regardless of the particular computers or software that
individual companies may be using to run their internal operations.
Based on this data sharing, opportunities exist to achieve tremendous
supply chain effi ciencies and signifi cant increases in customer ser-
vice and responsiveness. These are the results of better supply chain
integration.
E-business encompasses the evolving set of principles and practices
that companies are employing to gain the benefi ts inherent in better
supply chain integration. In the words of professors Hau Lee and Se-
ungjin Whang of Stanford University, e-business specifi cally refers to
“the planning and execution of the front-end and back-end operations
in a supply chain using the Internet.”
In a white paper titled “E-Business and Supply Chain Integration”
published by the Stanford Global Supply Chain Management Forum,
professors Lee and Whang lay out four key dimensions of the impact
of e-business on supply chain integration. These four dimensions create
a sequence of greater and greater integration and coordination among
EXECUTIVE INSIGHT (CONTINUED)
144 ESSENTIALS of Supply Chain Management
supply chain participants. This sequence culminates in the creation of
whole new ways to conduct business. The four dimensions are:
1. Information Integration—Is the ability to share relevant infor-
mation among companies in a supply chain. This includes data
such as: sales history and demand forecasts; inventory status;
production schedules; production capacities; sales promotions;
and transportation schedules. This data should be available to
the people who need it in a real-time, on-line format via the
Internet or private network.
2. Planning Synchronization—Refers to the joint participation of
companies in a supply chain in the demand forecasting and
inventory replenishment scheduling. It also includes the col-
laborative design, development, and bringing to market of new
products.
3. Work-Flow Coordination—Is the next step after planning syn-
chronization. It is the streamlining and automation of ongo-
ing business activities across companies in a given supply chain.
This includes activities such as purchasing and product design.
4. New Business Models—Can emerge as a result of supply chain
integration made possible by the Internet. Roles and responsi-
bilities of companies in a supply chain can be redesigned so that
each company can truly concentrate on the activities that are its
core competencies. Noncore activities can be outsourced to other
companies. New capabilities and effi ciencies will become possible.
Companies are looking at how to achieve effi ciencies in a broad range
of supply chain operations such as product design, demand forecasting,
inventory management, and customer service. The key to realizing these
effi ciencies is information sharing between companies in a supply chain.
Many current e-business developments are working on methods and
standards to share information across multiple companies. Information
Using Information Technology 145
sharing is the foundation, and then cross-company coordination is what
will deliver the desired effi ciencies. Once information integration is in
place, the next three dimensions: planning synchronization; workfl ow
coordination; and new business models can evolve much more rapidly.
E-business and supply chain development has only just begun.
Chapter Summary The use of supporting technology is necessary for effective supply chain
operations. All information systems are composed of technology that
performs three main functions. These three functions are: (1) data cap-
ture and communication; (2) data storage and retrieval; and (3) data ma-
nipulation and reporting. Different supply chain information systems
have different combinations of capabilities in these functional areas.
Systems such as ERP, CRM, and MES are all examples of systems that
consist of combinations of these three functions.
New technologies are having a strong impact on supply chain
management. Some technologies that are changing the way businesses
manage their supply chains are RFID, BPM, BI, and simulation mod-
eling. These technologies do not replace older systems, but instead
build upon the foundation of system functionality provided by existing
systems such as ERP, CRM, and MES. The combined effect of these
new technologies gives a company the ability to closely monitor supply
chain operations and make adjustments quickly and cost effectively.
The Internet makes it possible for companies in a supply chain to
make electronic connections with each other for purposes of exchang-
ing information about the products they sell. These connections also
enable close coordination between companies as they carry out the vari-
ous activities that drive the supply chains they participate in. As these
electronic connections become more widespread and commonplace,
they are enabling a whole new level of cooperation that leads to greater
business effi ciency and responsiveness.
147
CHAPTER 5
Metrics for Measuring Supply Chain Performance
After reading this chapter you will be able to
● Employ a useful model for assessing markets and the supply chains that support them
● Define a concise set of metrics for measuring the performance of a company’s supply chain operations
● Discuss ways to collect and display supply chain perfor- mance data
● Use performance data to spotlight problems and opportunities
S upply chains are fl uid and are continuously adjusting to changes
in supply and demand for the products they handle. To get the per-
formance desired from supply chains requires a company to mon-
itor and control its operations on a daily basis. This chapter introduces
four performance categories that each supply chain participant should
measure. It then discusses the performance metrics that can be used in
each of these performance categories. The chapter also explores some
of the technology that can be used to collect, store, and present perfor-
mance data.
Essentials of Supply Chain Management, Third Edition by Michael Hugos
Copyright © 2011 John Wiley & Sons
148 ESSENTIALS of Supply Chain Management
Useful Model of Markets and Their Supply Chains A supply chain exists to support the market that it serves. To identify
the performance that a supply chain should deliver, we need to evaluate
the market being served. In support of this analysis we will employ a
simple model. The model allows us to categorize a market and identify
the requirements and opportunities that each kind of market presents to
its supply chains. Reality is, of course, more subtle and more complex
than any model can represent but this model can point you in the right
direction and guide you through an investigation of the markets your
company serves.
Let us start by defi ning a market using its two most basic
components—supply and demand. A market is characterized by its com-
bination of supply and demand. This model defi nes four basic kinds of
markets, or market quadrants. In the fi rst quadrant is a market where
both supply and demand for its products are low and unpredictable.
Let’s call this a developing market. In the second quadrant is a market
where supply is low and demand is high. This is a growth market. The
third quadrant contains a market where both supply and demand are
high. There is a lot of predictability in this market so call this a steady
market. In the fourth quadrant, this kind of market supply is higher than
demand. This is a mature market.
In a developing market, both supply and demand are low and also
uncertain. These are usually new markets that are just emerging. These
markets are created by new technology becoming available or by social
and economic trends that cause a group of customers to perceive some
new set of needs. Opportunities in a developing market are in the areas
of partnering with other players in the supply chain to gather intelli-
gence about what the market wants. Cost of sales is high in this market
and inventories are low.
Growth markets are markets where demand is higher than supply
and so supply is often uncertain. If a developing market solidifi es and
Metrics for Measuring Supply Chain Per formance 149
builds up momentum, it can suddenly take off and for a time there is
a surge in demand that suppliers cannot keep up with. Opportunities
in a growth market are in providing a high level of customer service
as measured by order fi ll rates and on-time deliveries. Customers in a
market like this value a reliable source of supply and will pay premium
prices for reliability. Cost of sales should be low since customers are
easy to fi nd and inventories can be higher because they are increasing
in value.
In a steady market both supply and demand are high and thus rela-
tively predictable. This is an established market where market forces have
been at work for a while and have pretty well balanced supply and de-
mand. Opportunities here lie in fi ne tuning and optimizing internal
company operations. Companies should focus on minimizing inventory
and cost of sales while maintaining high levels of customer service.
In a mature market, supply has overtaken demand and excess supply
capacity exists. Demand is reasonably stable or slowly falling but because
of the fi erce competition due to oversupply, demand seems uncertain
from the point of view of any one supplier in this market. Opportunities
in this market are in the area of fl exibility as measured by an ability to
respond quickly to changes in product demand while maintaining high
levels of customer service. Customers in a market like this value the con-
venience of “one stop shopping” where they can purchase a wide variety
of related products at low prices. Inventories should be minimized and
the cost of sales are somewhat higher due to the expense of attracting
customers in a crowded market.
Market Performance Categories Markets in each quadrant have their own mix of opportunities for the
supply chains that support them. A different mix of performance charac-
teristics is required of companies in the supply chains of each kind of
market. In order to thrive, the companies in a supply chain must be able to
150 ESSENTIALS of Supply Chain Management
work together to exploit the opportunities available in their markets. The
highest profi ts go to the companies that can successfully respond to the
opportunities their markets offer. Companies that are unable to respond to
opportunities as effectively will fall behind.
Each Market Quadrant Presents Different Opportunities
MATURE Supply exceeds demand
Opportunities lie in coordinating with supply chain partners to pro- vide a wide range of products to the market and accommodate wide fluctuations in product demand while maintaining high levels of customer service.
DEVELOPING New market and new products,
supply and demand are low
Opportunities lie in partnering with other companies in the supply chain to gather intelli- gence about what the market wants and build and deliver products that will be attractive to the market.
STEADY Established market, supply and
demand are balanced
Opportunities lie in each compa- ny fine tuning and optimizing their internal operations to get maximum efficiency and best overall supply chain profitability.
GROWTH Demand exceeds supply
Opportunities lie in building mar- ket share and recognition through working with supply chain partners to provide high levels of customer service as measured by order fill rate and on-time delivery.
D E M A N D
S U
P P
L Y
What are the markets your company serves? What quadrants are they in? How can your company respond to the opportunities in these markets?
TIPS & TECHNIQUES
Metrics for Measuring Supply Chain Per formance 151
In Chapter 1 we introduced two characteristics that describe sup-
ply chain performance—responsiveness and effi ciency. We all intuitively
know what these two characteristics imply, but now we need to defi ne
them in more precise terms so that they can be measured objectively. We
will use four measurement categories:
1. Customer Service
2. Internal Effi ciency
3. Demand Flexibility
4. Product Development
Customer Service
Customer service measures the ability of the supply chain to meet the
expectations of its customers. Depending on the type of market being
served, the customers in that market will have different expectations
for customer service. Customers in some markets both expect and will
pay for high levels of product availability and quick delivery of small
purchase quantities. Customers in other markets will accept longer waits
for products and will purchase in large quantities. Whatever the market
being served, the supply chain must meet the customer service expec-
tations of the people in that market.
Internal Effi ciency
Internal effi ciency refers to the ability of a company or a supply chain
to operate in such a way as to generate an appropriate level of profi t-
ability. As with customer service, market conditions vary and what is an
appropriate level of profi t varies from one market to another. In a risky
developing market, the profi t margins need to be higher in order to jus-
tify the investment of time and money. In a mature market where there
152 ESSENTIALS of Supply Chain Management
is little uncertainty or risk, profi t margins can be somewhat lower. These
markets offer the opportunity to do large volumes of business and to
make up in gross profi t what is given up in gross margin.
Demand Flexibility
This category measures the ability to respond to uncertainty in levels of
product demand. It shows how much of an increase over current levels
of demand can be handled by a company or a supply chain. It also in-
cludes the ability to respond to uncertainty in the range of products that
may be demanded. This ability is often needed in mature markets.
Product Development
This encompasses a company and a supply chain’s ability to continue
to evolve along with the markets they serve. It measures the ability to
develop and deliver new products in a timely manner. This ability is nec-
essary when serving developing markets.
A Framework for Performance Measurement There are other demands that real-world markets place on their sup-
ply chains; however, by using these four performance categories we can
create a useful framework. This framework describes the mix of perfor-
mance required from companies and supply chains that serve the four
different market quadrants. When a company identifi es the markets it
serves it can then defi ne the performance mix required by those markets
in order to best respond to the opportunities they provide.
Markets in the fi rst quadrant, developing markets, require their
supply chains to excel in product development and customer service.
Growth markets require very high levels of customer service, particu-
larly as measured by order fi ll rates and on-time delivery. Steady markets
Metrics for Measuring Supply Chain Per formance 153
require internal effi ciency as well as an even broader scope of customer
service. Mature markets require all the internal effi ciency and customer
service called for by steady markets. They also require the highest levels
of demand fl exibility.
The most profi table companies and supply chains are those that de-
liver the performance called for by their markets. These organizations are
the most profi table because they are the ones most able to respond effec-
tively to the opportunities offered by their markets. Companies should
collect and track a handful of performance measures that cover these
four areas. This will give them valuable information about how well they
are responding to their markets.
The metrics that measure performance in the four areas are appli-
cable to individual companies and also to entire supply chains. It is harder
to gather these metrics for entire supply chains because companies are
reluctant to share data that may be used against them by their competi-
tors or by their customers or suppliers. There are issues of trust and
incentive to work out before these metrics can readily be collected for
an entire supply chain. Nonetheless, when these issues are worked out,
these metrics will help to guide the behavior of the entire supply chain
and should benefi t all the participants in that chain over the long term.
Customer Service Metrics In the words of Warren Hausman, a professor at Stanford University,
“Service relates to the ability to anticipate, capture, and fulfi ll customer
demand with personalized products and on-time delivery” (Hausman,
Warren H., 2000, “Supply Chain Performance Metrics,” Management
Science & Engineering Department, Stanford University). The reason that
any company exists is to be of service to its customers. The reason that any
supply chain exists is to serve the market it is attached to. These measures
indicate how well a company serves its customers and how well a supply
chain supports its market.
154 ESSENTIALS of Supply Chain Management
Market Quadrants Require a Different Mix of Performance
Does your company excel in the performance categories that relate to the markets you serve? Profit opportunities lie in being a leader in the mix of performance categories that your markets call for.
TIPS & TECHNIQUES
MATURE
• Customer Service • Internal Efficiency • Demand Flexibility
DEVELOPING
• Customer Service • Product Development
STEADY
• Customer Service • Internal Efficiency
GROWTH
• Customer Service
D E M A N D
S U
P P
L Y
There are two sets of customer service metrics, depending on
whether the company or supply chain is in a build-to-stock (BTS) or
build-to-order (BTO) situation. Popular metrics for a build to stock
situation are:
• Complete Order Fill Rate and Order Line Item Fill Rate
• On-Time Delivery Rate
• Value of Total Backorders and Number of Backorders
Metrics for Measuring Supply Chain Per formance 155
• Frequency and Duration of Backorders
• Line Item Return Rate
Popular metrics for a build-to-order situation are:
• Quoted Customer Response Time and On-Time Completion Rate
• On-Time Delivery Rate
• Value of Late Orders and Number of Late Orders
• Frequency and Duration of Late Orders
• Number of Warranty Returns and Repairs
Build to Stock
A build-to-stock (BTS) situation is one where common commodity
products are supplied to a large market or customer base. These are prod-
ucts such as offi ce supplies, cleaning supplies, building supplies, and so
on. Customers expect to get these products right away any time they
need them. Supply chains for these products must meet this demand by
stocking them in inventory so they are always available.
In a BTS environment a customer wants their complete order to
be fi lled immediately. This may be expensive to provide if customer
orders contain a wide range and number of items. It is costly for com-
panies to carry all those items in stock so they may have backup plans
to provide expedited delivery of items not in stock or substitution of
upgraded items for those not in stock. The order-fi ll rate measures
the percentage of total orders where all items on the order are fi lled
immediately from stock. The line-item fi ll rate is the percentage of
total line items on all orders that are fi lled immediately from stock.
Used together, these two measures track customer service from two
important perspectives.
156 ESSENTIALS of Supply Chain Management
Build to Order
A build-to-order (BTO) situation is one where a customized product
is ordered by a customer. This is any situation where a product is built
based on a specifi c customer order and is confi gured to meet a unique set
of requirements defi ned by the customer. An example of this is the way
Boeing builds airplanes for specifi c customers and their requirements or
the way Dell Computer assembles PCs to fi t individual customer orders
and specifi cations.
In a BTO environment it is important to track both the quoted cus-
tomer response time and the on-time completion rate. It is easier for a
company to achieve a high on-time completion rate if it quotes longer
customer response times. The question is whether the customer really
wants a short response time or will accept a longer response time. The
quoted response time needs to be aligned with the company’s value
proposition and competitive strategy.
Internal Effi ciency Metrics Internal effi ciency refers to the ability of a company or a supply chain
to use their assets as profi tably as possible. Assets include anything of tan-
gible value such as plant, equipment, inventory, and cash. Some popular
measures of internal effi ciency are:
• Inventory Value
• Inventory Turns
• Return on Sales
• Cash-to-Cash Cycle Time
Inventory Value
This should be measured both at a point in time and also as an average
over time. The major asset involved in a supply chain is the inventory
Metrics for Measuring Supply Chain Per formance 157
contained throughout the length of the chain. Supply chains and the
companies that make them up are always looking for ways to reduce
inventory while still delivering high levels of customer service. This
means trying to match inventory availability (supply) with sales (de-
mand) and not have excess inventory left over. The only time a company
would want to let inventory exceed sales is in a growth market where
the value of the inventory will increase. However, markets change and as
a rule it is best to avoid excess inventory.
Inventory Turns
This is a way to measure the profi tability of inventory by tracking
the speed with which it is sold or turned over during the course of a
year. This measure is often referred to as “turn and earn” (T&E). It is
calculated by the equation:
Turns = Annual Cost of Sales / Annual Average Inventory Value
Generally, the higher the turn rate the better, although some lower-
turning inventory needs to be available in order to meet customer
service and demand fl exibility.
Return on Sales
Return on sales is a broad measure of how well an operation is being
run. It measures how well fi xed and variable costs are managed and also
the gross profi t generated on sales:
Return on Sales = Earnings before Interest and Tax / Sales
Again, as a rule, the higher the return on sales the better. There are times
though when a company may deliberately reduce this number in order
to gain or defend market share or to incur expenses that are necessary to
achieve some other business objective.
158 ESSENTIALS of Supply Chain Management
Cash-to-Cash Cycle Time
This is the time it takes from when a company pays its suppliers for ma-
terials to when it gets paid by its customers. This time can be estimated
with the following formula:
Cash-to-Cash Cycle Time = Inventory Days of Supply + Days
Sales Outstanding – Average Payment Period on Purchases
The shorter this cycle time the better. A company can often make more
improvements in their accounts payable and receivable areas than they
can in their inventory levels. Accounts receivable may be large due
to late payments caused by billing errors or selling to customers who
are bad credit risks. These are things a company can manage as well as
inventory.
Demand Flexibility Metrics Demand fl exibility describes a company’s ability to be responsive to new
demands in the quantity and range of products and to act quickly. A
company or supply chain needs capabilities in this area in order to cope
with uncertainty in the markets they serve. Some measures of fl exibility
are:
• Activity Cycle Time
• Upside Flexibility
• Outside Flexibility
• Activity Cycle Time
The cycle time measures the amount of time it takes to perform a
supply chain activity such as order fulfi llment, product design, product
assembly, or any other activity that supports the supply chain. This cycle
time can be measured within an individual company or across an entire
Metrics for Measuring Supply Chain Per formance 159
supply chain. Order fulfi llment within a single company may be fast but
that company may only be fi lling an order from another company in the
supply chain. What is important is the cycle time for order fulfi llment
to the ultimate end-use customer that the entire supply chain is there
to serve.
Upside Flexibility
It is the ability of a company or supply chain to respond quickly to ad-
ditional order volume for the products they carry. Normal order volume
may be 100 units per week for a product. Can an order be accom-
modated that is 25 percent greater one week or will the extra product
demand wind up as a backorder? Upside fl exibility can be measured as
the percentage increase over the expected demand for a product that can
be accommodated.
Outside Flexibility
This is the ability to quickly provide the customer with additional prod-
ucts outside the bundle of products normally provided. As markets ma-
ture and technologies blend, products that were once considered outside
of the range of a company’s offerings can become a logical extension
of its offerings. There is danger in trying to provide customers with a
new and unrelated set of products that has little in common with the
existing product bundle. However, there is opportunity to acquire new
customers and sell more to existing customers when outside fl exibility
is managed skillfully.
Product Development Metrics Product development measures a company or a supply chain’s ability to
design, build, and deliver new products to serve their markets as those
160 ESSENTIALS of Supply Chain Management
Performance Measures in the Four Categories
Companies need to track some or all of these metrics to get an accu- rate picture of their capabilities in the four performance categories.
TIPS & TECHNIQUES
Build to Stock (BTS)
• Complete order fill rate & order line item fill rate
• On-time delivery rate • Value of total backorders &
number of backorders
• Frequency and duration of backorders
• Line item return rate
Build to Order (BTO)
• Quoted customer response time & on-time completion rate
• On-time delivery rate • Value of late orders & number
of late orders
• Frequency and duration of late orders
• Number of warranty returns and repairs
INTERNAL EFFICIENCY
• Inventory value • Inventory turns • Return on sales • Cash-to-cash cycle time
DEMAND FLEXIBILITY
• Activity cycle times • Upside flexibility • Outside flexibility
PRODUCT DEVELOPMENT
• Percent of total sales from products introduced in last 12 months • Percent of total SKUs that were introduced in last 12 months • Cycle time for new product development and delivery
CUSTOMER SERVICE
Metrics for Measuring Supply Chain Per formance 161
markets evolve over time. Technical innovations, social change, and eco-
nomic developments cause a market to change over time. Measurements
in this performance category are often overlooked, but companies do so at
their own peril. A supply chain must keep pace with the market it serves
or it will be replaced. The ability to keep pace with an evolving market can
be measured by metrics such as:
• Percentage of total products sold that were introduced in the last year
• Percentage of total sales from products introduced in the last year
• Cycle time to develop and deliver a new product
Operations that Enable Supply Chain Performance In order for an organization to meet the performance requirements of
the markets it serves, it must look to measure and improve its capabilities
in the four categories of supply chain operations:
1. Plan
2. Source
3. Make
4. Deliver
Supply chains created in the last several decades often focused on producing and delivering products at the lowest price. That worked best when product life cycles were longer and sales fore- casts were more accurate. But now, due to the rate of technical and economic change in our global economy, product life cycles
EXECUTIVE INSIGHT
(Continued)
162 ESSENTIALS of Supply Chain Management
are measured in months, prices of component parts, fuel, and labor fluctuate constantly, and sales forecasting is much harder. Supply chains need to focus on responding to constant change. Shoshanah Cohen, Director Emeritus of PRTM Management Consulting, explains why supply chains must balance needs for efficiency and low cost with needs for responsiveness and high customer service.
Traditional supply chain metrics focus on efficiency and productiv- ity, whereas financial metrics focus on cost, revenue, and profit- ability. While it’s not uncommon to find supply chain performance management programs that use both operational and financial metrics, many companies don’t do this particularly well.
As an example, a leading manufacturer of personal computer peripherals relied on a business strategy based on ongoing inno- vation and frequent new product introductions. Product managers were measured on their ability to design, develop, and release a constant stream of profitable new products, while growing market share for their particular categories. A make-to-stock supply chain supported this strategy so that customers could order and receive products immediately after they were released. Supply chain metrics tracked on a regular basis included material and product costs, delivery performance, fill rate, and transportation costs.
Because the company expected every product to maximize its potential margin, the supply chain was optimized to manufacture at the lowest possible unit cost. That meant developing low-cost material suppliers and setting up production in low-cost countries, including several relationships with large original design manufac- turers (ODMs) in Asia and a large company-owned plant in China. Standard product costs were established based on anticipated material prices, planned production schedules, and ocean ship- ment for virtually all products. Standard product margins, there- fore, reflected best-case scenarios for procurement, production, and distribution, and variances were due to fluctuations in selling price.
EXECUTIVE INSIGHT (CONTINUED)
Metrics for Measuring Supply Chain Per formance 163
Although most manufacturing sites were in Asia, most of the company’s business was in North America and Europe. Standard ocean shipment meant that products took up to five weeks to reach regional distribution centers, making the strategic objective of fast order fulfillment a major challenge. “We’re very dependent on an accurate forecast,” explains the company’s Vice President of Global Supply Chain, “but the peripherals market is pretty volatile. Plus we have constant product introductions and phase- outs and a lot of slips in the product development schedule, even though product release dates rarely shift to accommodate them.”
Expediting was one of the few levers available to increase flexibil- ity amid the combination of complexity and forecast inaccuracy— and was used frequently. Shipping raw materials and finished goods by air rather than sea nearly tripled transportation costs, but was necessary to maintain targeted customer-service levels. When necessary, the company also reworked products at regional distribution centers to align availability with current demand. “We recognize that this is also a very expensive option,” notes the Supply Chain VP, “especially since our whole cost model is based on producing in locations with low labor rates. But this is the only way we can meet our fill-rate and on-time delivery objectives.”
The resulting costs were charged to the supply chain group, appearing in quarterly financial reports as unplanned/incremental expenses. While this had a significant impact on the perceived performance of the supply chain organization, product manage- ment didn’t see these added costs as an issue. Because they were not added to the product standard cost, they were virtually invisible to product managers.
Of course, the total cost of managing the supply chain increased significantly as the organization struggled to provide the required flexibility. “We got pummeled every time the quarterly financial reports came out,” the Supply Chain VP explains, “it looked like our spending was out of control. We needed to find a way to get the rest of the
EXECUTIVE INSIGHT (CONTINUED)
(Continued)
164 ESSENTIALS of Supply Chain Management
company to understand that it wasn’t just a supply chain issue, even though the way we were measuring performance made it look that way. We needed a better balance of financial and operation metrics.”
To address this problem, the company modified its enterprise resource planning (ERP) cost module so that expedite and rework costs could be allocated to each major product group and their impact analyzed. “We would have liked to have been able to do this on a product-by-product basis,” notes a financial analyst, “but the cost of putting that level of granularity in place was prohibi- tive.” But even at a product-group level, the impact was clear: for many products, the costs of accommodating development delays and forecast inaccuracy through air shipment and local reconfigu- ration was enough to wipe out profitability for some products.
Product managers were not happy with the new means of mea- surement. “We hadn’t changed anything we were doing,” explains one Product Manager, “but suddenly it looked like our margins were degrading.” The executive management team stood firm despite numerous complaints from the product groups, and directed them to focus more attention on forecasting and compli- ance with established product-development schedules. The new metrics became the catalyst needed to move forward with several major initiatives: improving the forecasting process, increasing product modularity and configurability, and updating systems and processes to enable increased parts commonality.
Of course changing the way costs are allocated does nothing in and of itself to reduce costs or optimize a supply chain. But simply increasing visibility can drive changes in behavior that can lower the overall cost of managing a supply chain.
This example is not unusual. As this company found, measuring oper- ational metrics in isolation can be a counterproductive way to use performance-related data. A more effective approach is to start with the company’s strategic goals, identify the supply chain configuration necessary to support the strategy, and then derive operational and financial performance metrics that support those goals.
EXECUTIVE INSIGHT (CONTINUED)
Metrics for Measuring Supply Chain Per formance 165
Shoshanah Cohen is Director of the Stanford Global Supply Chain Management Forum, a research institute in partnership with indus- try and the Graduate School of Business at Stanford University. The Forum’s mission is to advance the theory and practice of excellence in global supply chain management through, research, development, and dissemination of best practices within a dynamic and increasingly global business environment. She is also co-author of Strategic Supply Chain Management: The Five Disciplines for Top Performance (McGraw-Hill, 2005).
The effi ciency with which these activities are carried out will ulti-
mately determine how well a company performs as measured by things
such as order and line-item fi ll rate, on-time delivery, inventory turns,
and cash-to-cash cycle time. Certain activities are directly related to
certain performance categories. For instance, inventory management
will directly affect a company’s order and line-item fi ll rate and its inven-
tory turns. Its procurement activity will directly affect its return on sales
and upside ability. A company needs to collect data about its activities in
these four operational areas and monitor results.
The Supply-Chain Council’s supply chain operations reference
(SCOR) model suggests the kind of operational data that should be
collected. This data is referred to as “Level 2 Performance Metrics.” In
the plan operation, useful measures are the cost of planning activities,
inventory fi nancing costs, inventory days of supply on hand, and forecast
accuracy. In the sourcing operation, it is useful to have data on material
acquisition costs, sourcing cycle times, and raw material days of sup-
ply. Useful measures in the make operation are the number of product
defects/complaints, make cycle times, build-order attainment rates, and
product quality. Suggested delivery operation measures are fi ll rates, or-
der-management costs, order lead times, and item-return rates.
EXECUTIVE INSIGHT (CONTINUED)
166 ESSENTIALS of Supply Chain Management
This data should be collected regularly and trends should be watched.
When performance targets start to be missed, the next step is to inves-
tigate the business operations that support that performance. Again, the
SCOR model suggests more detailed data that can be collected and ana-
lyzed in each of the four supply chain operating areas. This more detailed
data is referred to as “Level 3 Diagnostic Metrics.”
Diagnostic metrics can be used to analyze the complexity and con-
fi guration of the supply chain and also to study specifi c practices. In the
plan operation, complexity measures are the number and percentage
of order changes, number of stock keeping units (SKUs) carried, pro-
duction volumes, and inventory carrying costs. Confi guration measures
track things such as product volume by channel, number of channels, and
number of supply chain locations. Measures of management practices in
the plan operation are such things as planning cycle time, forecast accu-
racy, and obsolete inventory on hand.
In the source operation, measures of complexity and confi guration
are number of suppliers, percentage of purchasing spending by distance,
and purchased material by geography. Some practice measurements are
supplier delivery performance, payment period, and percentage of items
purchased by their associated lead time.
The make operation has measures of complexity and confi guration
such as number of SKUs, upside production fl exibility, manufacturing
process steps by geographical location, and capacity utilization.
Management practice measurements are value-added percentage,
BTO percentage, BTS percentage, percentage of manufacturing order
changes due to internal issues, and work in process inventory.
In the fourth supply chain operation, deliver, there are complexity
measures that include number of orders by channel, number of line items
and shipments by channel, and percentage of line items returned. Con-
fi guration measures are delivery locations by geography and number of
channels. Practice measures cover things like published delivery lead times,
percentage of invoices that contain billing errors, and order entry methods.
Metrics for Measuring Supply Chain Per formance 167
Business Operations Support Company Performance
PERFORMANCE CATEGORIES
BUSINESS OPERATIONS
CUSTOMER
SERVICE
As measured by: Fill Rate; On-Time Delivery;
Product Returns
INTERNAL
EFFICIENCY
As measured by: Inventory Turns; Return on Sales; Cash-to-Cash
DEMAND
FLEXIBILITY
As measured by: Cycle Times; Upside Flex; Outside Flex
PRODUCT
DEVELOPMENT
As measured by: New Prod. Sales;
% Revenue; Cycle Time
Demand Forecasts X
X
Inventory Management
X
Procurement X X
X X
Credit & Collections X
X XProduct Design
Production
Scheduling
Facility Mgmt.
Order Management X
Delivery Scheduling
Return Processing X X
D E
L I
V E
R
M A K E
S O U R C E
P L A N
X
X X
X
X
X X
X
X
X X
XProduct Pricing
Every business operation indirectly affects overall supply chain performance but certain operations have a strong effect on specific categories of performance. This table shows the performance cat- egories that are most strongly affected by each business operation.
TIPS & TECHNIQUES
168 ESSENTIALS of Supply Chain Management
Collecting and Displaying Performance Data Historically, companies based their management decisions on periodic,
standard reports that showed what happened during some period in the
past. In stable and slow-moving business environments this worked well
enough. However, there are not many companies that work in stable
and slow-moving environments any more. Working from traditional,
periodic, accounting-oriented reports in a fast-paced world is somewhat
like trying to drive a car by looking into the rearview mirror.
The business environments we live in are characterized by shorter
product life cycles, mass markets dissolving into smaller niche markets,
and new technology and distribution channels constantly opening up
new opportunities. The pace of change is both exhilarating and relent-
less. A company must keep up. To do this, a company needs to build a
business intelligence (BI) system that presents data at three levels of detail:
• Strategic—to help top management decide what to do
• Tactical—to help middle management decide how to do it
• Operational—to help people actually do it
Three Levels of Detail In a supply chain management context, strategic data consists of cur-
rent actual, as well as plan and historical numbers that show the com-
pany’s standing in the four performance categories: customer service;
internal effi ciency; demand fl exibility; and product development. In
the Supply-Chain Council SCOR model, data of this type is referred
to as “Level 1” data. This data is summarized by major business units
and for the company as a whole. Strategic data also consists of data
from outside the company such as market sizes and growth rates,
demographics, and economic indicators such as GNP, infl ation rates,
and interest rates. There should also be benchmark data from industry
Metrics for Measuring Supply Chain Per formance 169
Supply Chain Performance Metrics and Diagnostic Measures
(Supply-Chain Council SCOR Model)
TIPS & TECHNIQUES
trade associations and studies that show the operating standards and
fi nancial performance levels that are standard for companies in the
markets being served.
Tactical data consists of actual, plan, and historical numbers in the
four performance categories displayed at the branch offi ce level of detail.
170 ESSENTIALS of Supply Chain Management
This data also includes the performance metrics labeled “Level 2” in the
SCOR model. These metrics monitor the plan, source, make, and deliver
operations that every company in a supply chain must perform.
Operational data consists of the measures labeled “Level 3” in the
SCOR model. These measurements help people who are charged with
getting a job done to understand what is happening and to fi nd ways
to make improvements where needed to meet the performance targets
that have been set. The SCOR model refers to these measurements as
diagnostic measures.
We are awash in data. It is important to present it in such a way that
it is useful. If people are overwhelmed with data they cannot use it. By
organizing data into these three levels, people can quickly access what
they need to do their jobs. Upper management uses strategic-level data
to assess market conditions and set business-performance objectives.
They can drill down to the tactical level or even the operational levels
when necessary. Middle managers use tactical data to do planning and
resource allocation to achieve the performance objectives set by upper
management. Line managers and their staffs use operational data to
solve problems and get things done.
The Data Warehouse
To collect this data requires the creation of a data warehouse. This data
warehouse is a central repository of data that is drawn from a variety of
operating systems and accounting systems in a company. It is important
to collect the needed data at its source. Tap into relevant systems within
a company and capture needed data automatically as a by-product of
daily operations. Avoid having people do manual entry to get data into
the data warehouse.
A data warehouse is composed of a database software package and
the automated connections to other systems needed to collect the rel-
evant data on a regular and timely schedule. Working in conjunction
Metrics for Measuring Supply Chain Per formance 171
with the database software is software that allows for the creation of
standard predefi ned reports and graphic displays which people can use
to monitor operations. In addition to predefi ned reports and displays, the
software must also allow people to do ad hoc queries of the data in the
data warehouse, permitting detailed investigations when necessary.
When designing and building a data warehouse it is best to start
quickly with something that is simple and on a smaller scale. This way
people can get experience in using data more actively to do their jobs.
As they gain experience and can clearly describe the additional fea-
tures they would like, larger and more complex data warehouses can
be built. Remember, the most important component in any data ware-
house system is not the technology, or even the data, but the people
who use the system and their ability to use the system effectively to
learn from the data and become more effi cient at their jobs. Chapter 7
goes into further detail about the design and building of these kinds
of systems.
In addition to helping people inside a company become more effi -
cient in performing their supply chain management jobs, a data warehouse
can also be the foundation for collaboration with other companies in the
supply chain. Whatever information is shared between companies in a
supply chain should be made available to those other companies elec-
tronically. This often takes the form of reports that can be retrieved on
demand by other companies, who access a company’s data warehouse
over the Internet using features of the same data-reporting software that
people inside the company use (see Exhibit 5.1).
Spotlighting Problems and Finding Opportunities Depending on the type of markets a company serves, senior manage-
ment needs to defi ne a handful of key performance targets in the areas
of customer service, internal effi ciency, demand fl exibility, and prod-
uct development. The task then becomes one of fi guring out how to
172 ESSENTIALS of Supply Chain Management
Display Different Views of Data to Different Audiences
The data warehouse supports views of data at the strategic, tactical, and operational levels. This makes it easy for management and staff in a company to get quick access to the data they need to do their jobs. The data warehouse also supports the sharing of data with cus- tomers and suppliers needed to coordinate supply chain activities.
EXHIBIT 5.1
Reports to Customers
Reports to Suppliers
Strategic Market View (Market trends and company
performance targets)
Tactical CompanyView (Allocation of resources to achieve
performance targets)
Company Data Warehouse
(Central store of data)
Operations View (Status of operations in each area
of the company)
manage operations to achieve the target numbers. The point of collect-
ing performance data is to help monitor and control daily, weekly, and
monthly operations.
Metrics for Measuring Supply Chain Per formance 173
People in a company need access to a one-page display of the key
operating or fi nancial measures that they are responsible for achieving.
These one page displays are known as “dashboards” because they show
a person at a glance the data that is most important to them. The data
that is displayed on a senior management dashboard is different from
that on an operating manager’s dashboard and the data on the dashboard
of a staff person in one department is different from a staff person’s in
another department.
Senior management sets company performance targets and they
need access to a dashboard report that shows them the company’s
current performance against these targets. If things are going well and
performance is meeting expectations, then no further attention is called
for, but if performance is falling short against one or more of the perfor-
mance targets, then the senior manager knows right away where more
attention is needed.
Middle managers are responsible for managing their operations
to achieve one or more of the company’s performance targets. Their
dashboards need to show them the plan and actual data on company
performance targets they are responsible for. They need to see quickly
if operations are on target or not and direct their attention accordingly.
Once alerted by their dashboard that there is a problem in a particular
area, the manager can then drill down into further detail in that area.
Staff people in various departments need dashboards that track and
illuminate the specifi c business operations that they are responsible for
such as purchasing, credit, inventory management, and so on. These dis-
plays should highlight issues needing their attention.
For the most part, people run their businesses or do their jobs by
keeping track of a handful of key indicators. These indicators tell them
where to direct their attention and help them steer through a complex
and changing world. When a data warehouse and software reporting
tools are in place in a company, people need to experiment with the
design of their dashboard displays or reports. As they get better at using
174 ESSENTIALS of Supply Chain Management
their dashboards to guide their actions, the overall effect will be for the
company as a whole to become more effi cient and more responsive to
its markets.
Since very few companies work in stable and slow-moving markets
anymore, there is a great need to learn to use data effectively to make
decisions and act. Speed is a major competitive advantage. The faster
a company can spot problems and fi x them or see opportunities and
respond to them, the more profi table the company will be. It will also
have a much better chance of survival over the long term. Companies
that can see their markets change and adjust and follow those markets
most effi ciently are the ones that will stay in business. Companies that
do not notice problems soon enough or that do not see how their
markets change are the ones that will get into trouble (see Exhibit 5.2).
Markets Migrate from One Quadrant to Another Markets migrate from one quadrant to another during the course of their
life cycle. Over time, market forces are always pushing a market toward
an equilibrium where supply meets demand. At the same time, other
forces also infl uence a market so it fl uctuates back and forth around the
equilibrium point. At times demand outstrips supply and at other times
there is more supply than there is demand.
Companies in the supply chains that supply a market must be able
to adjust their operations over time as their markets migrate from one
quadrant to another in order to remain competitive. For instance, in
growth markets, supply chains that do the best are the ones that have
the highest levels of customer service as measured by order-fi ll rate and
on-time delivery. All the companies in the supply chain must focus on
delivering this performance in order to succeed.
As a growth market moves on to a steady market, the most profi table
companies will be those that are able to maintain high levels of existing
customer service and also broaden the scope of their customer services.
Metrics for Measuring Supply Chain Per formance 175
Dashboard Designs Are Different at Each Level
OPERATIONAL Dashboard #
Mon Tue Wed Thu Fri
Orders Shipped
% Actual
Plan
Wk1 Wk2 Wk3 Wk4 Wk5
# Actual
Plan
Wk1 Wk2 Wk3 Wk4 Wk5
% Plan
Actual
Wk1 Wk2 Wk3 Wk4 Wk5
STRATEGIC Dashboard
# Actual
Plan
Qtr1 Qtr2 Qtr3 Qtr4 Qtr5
% Plan
Actual
Qtr1 Qtr2 Qtr3 Qtr4 Qtr5
$
A B C D E
Average Gross Margin 40%
30%10%
0%
20%
TACTICAL Dashboard #
Actual
Plan
Mo1 Mo2 Mo3 Mo4 Mo5
$ Plan
Actual
Mo1 Mo2 Mo3 Mo4 Mo5
# Plan
Actual
Mo1 Mo2 Mo3 Mo4 Mo5
# Actual
Plan
Mo1 Mo2 Mo3 Mo4 Mo5
Dashboard Designs Are Different at Each Level
Order Fill Rate Sales by Market Segment
Inventory Turns
Days Sales Outstanding
Inventory Days of Supply Inventory Carrying Cost
Order Fulfillment Lead Time
Line Items Picked
Invoice Error Rate
Obsolete Inventory Rate
People at different levels in an organization need to design their dashboard displays so that they get quick and easy access to the data they need to do their jobs and monitor their progress.
EXHIBIT 5.2
176 ESSENTIALS of Supply Chain Management
In addition, profi table companies will be the ones that achieve the best
levels of internal effi ciency. They can no longer focus only on customer
service.
As steady markets become mature markets, the supply chains that
serve them must again develop their performance in another category.
Mature markets require companies to develop the capabilities needed
to accommodate high levels of demand fl exibility. Then in the midst of
mature markets, new developing markets can appear and the ability to
create new products and bring them to market becomes critical.
Adaptability itself is now as important to survival and success as the
four performance categories. Market evolution is now often measured
in years and sometimes in months. Gone are the days when markets
changed more slowly over decades. No company has the luxury of being
able to focus on optimizing any single mix of performance capabilities
over the long term.
A company may become very skilled at internal effi ciency and cus-
tomer service as called for in a steady market. The company needs to
remember though that its markets will change. The company will have
to add skills in the area of demand fl exibility as some of its markets
mature. The company may even need to de-emphasize some of its inter-
nal effi ciency policies in order to emphasize its performance in product
development so that it can participate in a promising developing market.
The key here is that a company needs to know when to shift its empha-
sis from one mix of performance categories to another.
A ship at sea needs to watch the wind and the waves and respond
appropriately when the weather changes. So too must a company watch
the supply and demand situation in its markets and respond appropri-
ately when one of its markets enters a new quadrant. If the collection
and display of market and company performance data alert a company
to respond sooner to a market change than its competitors, then the
company has indeed developed an important tool for its success and
survival (see Exhibit 5.3).
Metrics for Measuring Supply Chain Per formance 177
Market Conditions Shift Over Time
A market (call it Market ‘X’) follows a life cycle. It develops and then it goes on to become a growth market which leads to a steady market and then a mature market and so on. Over time the forces of supply and demand are always pushing the market toward a steady state where supply and demand are equal yet at the same time other forces disrupt this balance.
The supply chains that support Market ‘X’ need to be able to provide first one kind of performance and then another as the market moves through its life cycle. The companies that are most successful in supplying this market are those that can adapt their performance appropriately to follow the market as it changes.
EXHIBIT 5.3
178 ESSENTIALS of Supply Chain Management
Sharing Data Across the Supply Chain As markets migrate from one quadrant to another, there are great de-
mands placed on the supply chains that support them. In fact, it is some-
times the operation of the supply chain itself that can push a market
from one quadrant to another. A case in point is illustrated by the beer
game simulation described in Chapter 6. This simulation shows how a
slight change in demand by the end customer or the market can cause
wildly escalating product demand forecasts to be sent to companies fur-
ther down the supply chain. This “bullwhip” effect results in the pro-
duction of large quantities of inventory which can then outstrip the
real demand in the market. This event becomes the event that pushes
a market out of the steady quadrant and into the mature quadrant. As
excess inventory gets used up, it gradually brings the market back into
the steady quadrant.
The cure for the bullwhip effect is better sharing of data among
all the companies in a supply chain. Companies need to work through
their concerns about sharing data that many of them might consider
confi dential. There are serious questions to be answered. What data is
it reasonable to share? How can privacy of critical data be maintained?
What are the benefi ts of sharing data and how can they be quantifi ed?
Hau Lee is a professor at Stanford University’s business school and
director of the Stanford Global Supply Chain Management Forum. He
envisions the supply chain as an “intricate network of suppliers, distribu-
tors, and customers who share carefully managed information about de-
mand, decisions, and performance, and who recognize that success for
one part of the supply chain means success for all.”
If each company had demand information from the other com-
panies in its supply chain, it would help everyone to make the best
decisions about how much manufacturing capacity to build and how
much inventory to hold. Companies need to see demand information
Metrics for Measuring Supply Chain Per formance 179
from their immediate customers and also from the end customers that
the supply chain ultimately supports.
In addition to sharing demand data across the supply chain, com-
panies need to share decisions they make that have supply chain impli-
cations. A company could be unaware of decisions made by one of its
customers or one of its customer’s customers that will have a big impact
on product demand. For instance, a chain of retail stores may decide to
run a special promotion on a certain group of products. An analysis of
past seasonal sales data would not predict the spike in demand that will
result from running this promotion. So if the retail store chain does not
share this decision with its suppliers, there is a very good chance they
will be caught short and not be able to deliver enough product to sup-
port the promotion.
It is also important for companies to let each other know how well
they are doing in the performance of their supply chain activities. These
metrics can then be combined to provide a holistic picture of the per-
formance of the entire supply chain. When each company in a supply
chain sees how the supply chain is working overall, then each com-
pany can make better individual decisions about where performance
improvements are needed.
At present, companies are most likely to share demand informa-
tion with each other. There is already a lot of precedent for doing this.
However, companies are much less likely to share their decisions or
performance metrics because they are afraid that if this information
gets out, it could wind up in the hands of their competitors and be
used against them. The need for sharing this information continues to
grow though. Customers continue to demand more and more from
their supply chains. In an interview with CIO Magazine for an article
titled “The Cost of Secrecy,” Professor Hau Lee said, “If you are late
because your distributor is late, your customers will go to a competitor
whose distributor isn’t late. That is more than a company-to-company
180 ESSENTIALS of Supply Chain Management
Benefits of Data Sharing across the Entire Supply Chain
An individual company can achieve high levels of customer service to its customer. However, this customer may not be the end use customer that the supply chain ultimately serves, in which case, the company may find that its suc- cess is short lived.
Company ‘A’ may be part of a supply chain (Supply Chain ‘Y’) that actually maintains higher levels of inventory across the entire supply chain to deliver the required level of customer service. A competing supply chain that does not maintain as much inventory will be more profitable and can take more market share.
Whole supply chains can become more efficient if they are able to better coordinate their operations. As supply and demand conditions change, coordination of inventory levels is critical to business success.
EXHIBIT 5.4
Metrics for Measuring Supply Chain Per formance 181
competition. We’re going to see more supply-chain-to-supply-chain
competition.”
Companies that can work together to create effi cient supply chains
are going to be the ones that do the best over the long term. Companies
that can fi gure out how to share data effectively will be the ones to
create the most competitive supply chains. Customers are attracted to
effi cient supply chains and they gain market share at the expense of less
effi cient supply chains (see Exhibit 5.4).
Chapter Summary A useful model of markets can be constructed using the basic com-
ponents of supply and demand. Using these two components results in a
model that defi nes four market quadrants:
1. Developing—New markets and new products where both sup-
ply and demand are low and uncertain
2. Growth—Markets where demand is higher than supply and
supply is uncertain
3. Steady—Established markets where supply is high and demand
is high and both are stable and predictable
4. Mature—Markets where supply exceeds demand and where de-
mand can be unpredictable
The markets in each quadrant have a unique set of performance
requirements that they place on their supply chains. Developing markets
require performance in the areas of customer service and product devel-
opment. Growth markets demand customer service above all else. Steady
markets call for customer service and for internal effi ciency, and mature
markets require customer service, internal effi ciency, and demand fl exi-
bility. In order to succeed, companies and supply chains must excel in
the performance areas that are required by the markets they serve.
182 ESSENTIALS of Supply Chain Management
Customer service performance is measured by metrics such as order-
and line-item fi ll rate, on-time delivery, and item-return rates. Internal
effi ciency refers to the ability of a company or supply chain to use its
assets as profi tably as possible. Popular measures of internal effi ciency are
metrics such as inventory value, inventory turns, and return on sales. De-
mand fl exibility describes the ability of a company or supply chain to be
responsive to sudden market demands for greatly increased quantities of
product or for additional products outside the normal bundle of prod-
ucts provided. Product development measures an organization’s ability
to design, build, and deliver new products to serve their markets as those
markets evolve over time. Performance in this area is most important in
developing markets.
183
CHAPTER 6
Supply Chain Coordination
After reading this chapter you will be able to
● Understand a common supply chain dynamic that is a major contributor to the “boom to bust” business cycle
● Appreciate the factors that contribute to this supply chain dynamic
● Gain an overview of the Global Data Synchronization Network (GDSN) and see how it can help improve supply chain coordination
● Evaluate methods such as collaborative planning, forecast- ing, and replenishment (CPFR) to improve coordination and combat the bullwhip effect
T he spread of high-speed data communication networks and computer
technology has made it possible to manage supply chains with a
level of precision just not feasible even as recently as the 1990s.
Those organizations that learn to use the techniques and technologies
that are now available can build supply chains that have a competitive
advantage in their markets.
Because the capability exists to react much more quickly to changes
in market demand, this capability is now a point of competition. Busi-
ness competition based on supply chain effi ciency is becoming a central
fact in many markets. To develop this capability, individual companies
Essentials of Supply Chain Management, Third Edition by Michael Hugos
Copyright © 2011 John Wiley & Sons
184 ESSENTIALS of Supply Chain Management
and entire supply chains need to learn new behaviors and they need to
enable these new behaviors with the use of appropriate technology.
The Bullwhip Effect One of the most common dynamics in supply chains is a phenomena
that has been dubbed “the bullwhip effect.” What happens is that small
changes in product demand by the consumer at the front of the supply
chain translate into wider and wider swings in demand experienced
by companies further back in the supply chain. Companies at differ-
ent stages in the supply chain come to have very different pictures of
market demand and the result is a breakdown in supply chain coordi-
nation. Companies behave in ways that at fi rst create product shortages
and then lead to an excess supply of products.
This dynamic plays out on a larger scale in certain industries in
what is called a “boom to bust” business cycle. In particular this af-
fects industries that serve developing and growth markets where de-
mand can suddenly grow. Good examples of this can be found in the
industries that serve the telecommunications equipment or computer
components markets. The cycle starts when strong market demand
creates a shortage of product. Distributors and manufacturers steadily
increase their inventories and production rates in response to the de-
mand. At some point either demand changes or the supply of product
exceeds the demand level. Distributors and manufacturers do not at
fi rst realize that supply exceeds demand and they continue building
the supply. Finally the glut of product is so large that everyone realizes
there is too much. Manufacturers shut down plants and lay off workers.
Distributors are stuck with inventories that decrease in value and can
take years to work down.
This dynamic can be modeled in a simple supply chain that contains
a retailer, a distributor, and a manufacturer. In the 1960s a simulation
game was developed by the Massachusetts Institute of Technology’s
Supply Chain Coordination 185
Sloan School of Management that illustrates how the bullwhip effect de-
velops. The simulation game they developed is called the “beer game.” It
shows what happens in a hypothetical supply chain that supports a group
of retail stores that sell beer, snacks, and other convenience items. The
results of the beer game simulation teach a lot about how to coordinate
the actions of different companies in a supply chain.
Peter Senge in his book, The Fifth Discipline (Senge, Peter M., 1990,
The Fifth Discipline: The Art and Practice of the Learning Organization, New
York: Doubleday/Currency, Chapter 3), devotes a chapter to exploring
how the bullwhip effect gathers momentum and what can be done to
avoid it. The beer game starts with retailers experiencing a sudden but
small increase in customer demand for a certain brand of beer called
Lover’s Beer. Orders are batched up by retailers and passed on to the
distributors who deliver the beer. Initially, these orders exceed the in-
ventory that distributors have on hand so they ration out their supplies
of Lover’s Beer to the retailers and place even larger orders for the beer
with the brewery that makes Lover’s Beer. The brewery cannot instantly
increase production of the beer so it rations out the beer it can produce
to the distributors and begins building additional production capacity.
At fi rst the scarcity of the beer prompts panic buying and hoard-
ing behavior. Then as the brewery ramps up its production rate and
begins shipping the product in large quantities, the orders that had
been steadily increasing due to panic buying suddenly decline. The
glut of product fi lls up the distributors’ warehouses, fi lls all the retailers’
unfi lled back orders, and exceeds the actual consumer demand. The
brewery is left with excess production capacity, the distributors are
stuck with excess inventory, and the retailers either cancel their beer
orders or run discount promotions to move the product. Everybody
loses money. Exhibit 6.1 illustrates how each company sees product
demand and the distortion that causes such havoc.
The costs of the bullwhip effect are felt by all members of the
supply chain. Manufacturers add extra production capacity to satisfy
186 ESSENTIALS of Supply Chain Management
Product Demand Distortion “The Bullwhip Effect”
Inventory levels in supply chain over time illustrating the wild swings that develop as product demand distortion moves from customer to retailer to distributor to manufacturer. Swings in product demand appear more pronounced to companies further up the supply chain. This distortion makes effective supply chain management very difficult.
EXHIBIT 6.1
Supply Chain Coordination 187
an order stream that is much more volatile than actual demand. Dis-
tributors carry extra inventory to cover the variability in order levels.
Transportation costs increase because excess transportation capacity
has to be added to cover the periods of high demand. Along with
transportation costs, labor costs also go up in order to respond to the
high demand periods. Retailers experience problems with product
availability and extended replenishment lead times. During periods of
high demand, there are times when the available capacity and inven-
tory in the supply chain cannot cover the orders being placed. This
results in product rationing, longer order replenishment cycles, and lost
sales due to lack of inventory.
Coordination in the Supply Chain Research into the bullwhip effect has identifi ed fi ve major factors that
cause the effect. These factors interact with each other in different
combinations in different supply chains, but the net effect is that they
generate the wild demand swings that make it so hard to run an effi cient
supply chain. These factors must be understood and addressed in order
to coordinate the actions of any supply chain. They are:
1. Demand Forecasting
2. Order Batching
3. Product Rationing
4. Product Pricing
5. Performance Incentives
Demand Forecasting
Demand forecasting, based on orders received instead of end user de-
mand data will inherently become more and more inaccurate as it moves
188 ESSENTIALS of Supply Chain Management
up the supply chain. Companies that are removed from contact with
the end user can lose touch with actual market demand if they view
their role as simply fi lling the orders placed with them by their immedi-
ate customers. Each company in a supply chain sees fl uctuations in the
orders that come to them that are caused by the bullwhip effect. When
they use this order data to do their demand forecasts, they just add fur-
ther distortion to the demand picture and pass this distortion along in
the form of orders that they place with their suppliers.
Clearly, one way to counteract this distortion in demand forecasts
is for all companies in a supply chain to share a common set of demand
data from which to do their forecasting. The most accurate source of
this demand data is the supply chain member closest to the end-use cus-
tomer (if not the end-use customers themselves). Sharing point-of-sales
(POS) data among all the companies in a supply chain goes a long way
toward taming the bullwhip effect because it lets everyone respond to
actual market demand instead of supply chain distortions.
Order Batching
Order batching occurs because companies place orders periodically
for amounts of product that will minimize their order-processing and
transportation costs. As discussed in the section on inventory control in
Chapter 2, companies tend to order in lot sizes determined by the eco-
nomic order quantity (EOQ). Because of order batching, these orders
vary from the level of actual demand and this variance is magnifi ed as it
moves up the supply chain.
The way to address demand distortion caused by order batching
is to fi nd ways to reduce the cost of order-processing and transpor-
tation. This will cause EOQ lot sizes to get smaller and orders to be
placed more frequently. The result will be a smoother fl ow of orders
that distributors and manufacturers will be able to handle more ef-
fi ciently. Ordering costs can be reduced by using electronic ordering
Supply Chain Coordination 189
technology. Transportation costs can be reduced by using third-party
logistics suppliers (3PLs) to cost effectively pick up many small ship-
ments from suppliers and deliver small orders to many customers.
Product Rationing
This is the response that manufacturers take when they are faced with
more demand than they can meet. One common rationing approach is
for a manufacturer to allocate the available supply of product based on the
number of orders received. Thus if the available supply equals 70 percent
of the orders received, the manufacturer will fi ll 70 percent of the amount
of each order and backorder the rest. This leads distributors and retailers
in the supply chain to raise their order quantities artifi cially in order to
increase the amount of product that gets rationed to them. This behavior
greatly overstates product demand and it is called “shortage gaming.”
There are several ways to respond to this. Manufacturers can base
their rationing decisions on the historical ordering patterns of a given
distributor or retailer and not on their present order sizes. This eliminates
much of the motivation for the shortage gaming that otherwise occurs.
Manufacturers and distributors can also alert their customers in advance
if they see demand outstripping supply. This way product shortages will
not take buyers by surprise and there will be less panic buying.
Product Pricing
Product pricing causes product prices to fl uctuate, resulting in distor-
tions of product demand. If special sales are offered and product prices
are lowered, it will induce customers to buy more product or to buy
product sooner than they otherwise would (forward buying). Then pric-
es return to normal levels and demand falls off. Instead of a smooth fl ow
of products through the supply chain, price fl uctuations can create waves
of demand and surges of product fl ow that are hard to handle effi ciently.
190 ESSENTIALS of Supply Chain Management
Answers to this problem generally revolve around the concept of
“everyday low prices.” If the end customers for a product believe that
they will get a good price whenever they purchase the product, they will
make purchases based on real need and not other considerations. This in
turn makes demand easier to forecast and companies in the supply chain
can respond more effi ciently.
Performance Incentives
These are often different for different companies and individuals in a
supply chain. Each company can see its job as managing its position in
isolation from the rest of the supply chain. Within companies, individuals
can also see their jobs in isolation from the rest of the company. It is
common for companies to structure incentives that reward a company’s
sales force on sales made each month or each quarter. Therefore as the
end of a month or a quarter approaches, the sales force offers discounts
and takes other measures to move product in order to meet quotas. This
results in product for which there is no real demand being pushed into
the supply chain. It is also common for managers within a company to
be motivated by incentives that confl ict with other company objectives.
For instance, a transportation manager may take actions that minimize
transportation costs at the expense of customer service or inventory car-
rying costs.
Alignment of performance incentives with supply chain effi ciencies
is a real challenge. It begins with the use of accurate activity-based cost-
ing (ABC) data that can highlight the associated costs. Companies need
to quantify the expenses incurred by forward buying due to month-end
or quarter-end sales incentives. Companies also need to identify the ef-
fect of confl icting internal performance incentives. The next step is to
experiment with new incentive plans that support effi cient supply chain
operation. This is a process that each company needs to work through
in its own way.
Supply Chain Coordination 191
Eliyahu Goldratt wrote a book titled, The Goal, about a factory manager’s quest to save his factory from being closed down for lack of profitability. It chronicles the process that the manager and his staff go through as they learn how to save their fac- tory. What they learn is how to apply the principles of what Mr. Goldratt calls the “Theory of Constraints.”
Mr. Goldratt and others have realized that the theory of con- straints applies equally well to the operation of a whole supply chain as to the operation of a single factory within a supply chain. Lawrence Fredendall and Ed Hill in their book, Basics of Supply Chain Management (Fredendall, Lawrence D., and Ed Hill, 2001, Basics of Supply Chain Management, Boca Raton, FL: St. Lucie Press), have put forth a clear explanation for how to apply the theory of constraints to synchronize the operations of a supply chain.
The theory of constraints provides a useful model to conceptu- alize and manage the supply chain within a single company or across a collection of companies. The theory of constraints is based upon the idea that all systems have at least one constraint and that it is better to manage constraints than to try to eliminate them. This is because when one part of a system ceases to be a constraint, a different constraint will occur in another part of the system. This is inevitable because the capacities of each part of a system are not all the same. So instead of forever reacting to new constraints or bottlenecks as they appear, why not choose a small group of constraints and manage them deliberately and efficiently?
To apply this model, the first step is to define the goal and decide what measurements will be used to measure progress toward the goal. Mr. Goldratt’s definition of the goal for a manufacturing company also works for a supply chain. The goal is defined as
EXECUTIVE INSIGHT
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192 ESSENTIALS of Supply Chain Management
“Increase throughput while simultaneously reducing both inventory and operating expense.” Throughput is the rate at which sales to end customers occur.
Once a goal has been defined and there is agreement on how to measure progress toward the goal, it is possible to apply the five focusing steps. These steps help clarify the situation being inves- tigated and lead to the decisions necessary to reach the goal. The five steps are:
Identify the System’s Bottlenecks or Constraints—Trace out the workflows and the paths that materials travel in a factory or a sup- ply chain. Find out where slowdowns and backups occur.
Decide How to Exploit These Bottlenecks—Figure out how to maximize the operation of those activities that are bottlenecks. The rate of throughput for the entire system is set by the rate of throughput achieved by the bottlenecks. Ensure the bottlenecks operate at maximum capacity by providing them with enough inventory so that they can continue to operate even if there are occasional slowdowns elsewhere in the system.
Subordinate Everything Else to the Above Decision—Do not try to maximize the operation of a non-bottleneck operation. Additional productivity achieved by non-bottleneck operations that exceeds the capacity of the bottlenecks to process will be neutralized any- way by the slowdowns and backups caused at the bottlenecks. Synchronize all system operations to the rates that can be effi- ciently processed by the bottleneck operations.
Elevate the System’s Bottlenecks—Add additional process- ing capacity to the bottleneck activities. Since the rate of throughput of the entire system is set by the throughput of the bottlenecks, improvements in the bottlenecks will increase the efficiency of the entire system and provide the best return on investment.
If, in a Previous Step, a Bottleneck Has Been Broken, Go Back to Step 1—As the capacity of one system bottleneck is elevated,
EXECUTIVE INSIGHT (CONTINUED)
Supply Chain Coordination 193
it may cease to be a bottleneck. The bottleneck may transfer to another operation that could keep up before but now cannot keep up with the new increase in capacity. Watch the entire system to see where slowdowns and backups occur; they may shift from one area to another. If this occurs, start again at Step 1.
The theory of constraints says that the throughput of the whole system is set by the capacity of the bottlenecks. Exhibit 6.2 shows a sample diagram of workflows and bottlenecks in a factory. This model of workflows in a factory can be applied to the workflows in a supply chain. One constraint or bottleneck in every supply chain is the demand that is generated by the market that the supply chain serves. In many cases, market demand is the only constraint because supply of products equals or exceeds demand. In cases where demand exceeds supply there will be some other constraints elsewhere in the supply chain. If we apply this model to a supply chain, we get a powerful method to organize and man- age supply chain operations.
EXHIBIT 6.2
Flow of Work and Inventory through a Factory
FLOW OF WORK AND INVENTORY THROUGH A FACTORY
The bottlenecks or constraints in the flow of work through this factory are operations C and E in Exhibit 6.2. The productivity set by these two operations sets the pace for the entire factory. Productivity improvements in the other operations will not result
EXECUTIVE INSIGHT (CONTINUED)
(Continued)
194 ESSENTIALS of Supply Chain Management
in any improvement in the productivity of the factory as a whole. Apply the five focusing steps to manage this system and move it toward the goal defined for it.
A very effective response to the bullwhip effect is to manage the entire supply chain as a single entity and to synchronize it to the timing of actual market demand. Exhibit 6.3 illustrates this idea. This can happen if the supply chain participants closest to the end-use customers share their sales numbers and their sales fore- casts with the other companies in the supply chain. Each company can then manage their actions based on the most accurate data about market demand.
Buffers in the supply chain are determined by the degree of uncertainty about future market demand and the service levels required by the market. The lower the uncertainty about demand, the smaller the buffers can be and still maintain high service levels. Companies can manage their buffers by using either pro- ductive capacity or inventory, whichever is most cost effective for them.
Synchronized supply chains avoid the volatile waves of demand that are generated by the bullwhip effect. And increased predict- ability makes the productivity of each company easier to manage and the supply chain as a whole becomes more efficient and profitable.
FLOW OF INVENTORY THROUGH A SYNCHRONIZED SUPPLY CHAIN
This model is called “drum-buffer-rope.” Market demand is the constraint on the system and it sets the drumbeat or pace of the supply chain. Individual companies manage uncertainty in their stage of the supply chain by using a buffer of either inventory or productive capacity. Buffers are kept low because uncertainty is minimized by sharing market demand data. This data is the rope that ties the participants together and allows them to synchronize their actions.
EXECUTIVE INSIGHT (CONTINUED)
Supply Chain Coordination 195
EXHIBIT 6.3
Flow of Inventory through a Synchronized Supply Chain
Market Demand
ManufacturerRaw Material RetailerDistributor
Buffer Buffer Buffer Buffer
Sales & Forecast Data
Supply Chain Product Data Standards Historically, companies have assigned their own part numbers to the items
that they buy and sell. This worked well enough in a slower time when
supply chains were less complex and when products themselves were
less complex. Those were times we now refer to as the “good old days.”
Increasing competition and demands from customers to deliver products
faster and cheaper shapes the world we live in today. At the same time,
the array and complexity of products in our economy have increased
dramatically and that trend will clearly continue and even accelerate.
In order to be competitive and also profi table, companies need to
fi nd ways to reduce or eliminate costs associated with routine and re-
petitive business transactions. Those transactions often fall in the areas
of purchasing, billing, accounts receivable, and accounts payable. It is
in these areas that the confusion caused by translating part numbers is
most noticeable. Time spent translating one part number to another part
number for the same item adds very little, if any, value to the transaction.
The errors that result from errors in translation are the cause of many
problems in invoicing and making payments. These problems consume
EXECUTIVE INSIGHT (CONTINUED)
196 ESSENTIALS of Supply Chain Management
people’s time and slow down cash fl ow. All these expenses simply eat
away at profi t margins that are already thin enough.
In addition to the operating problems caused by using different
part numbers for the same item, another consequence is a lack of
accuracy and clarity in sales history data. Part number translation er-
rors result in sales of some items being undercounted and sales of oth-
er items being overcounted. And sales of many items are simply not
counted at all or they are lumped under a miscellaneous part number
such as the famous “9999” part number. Sales history data is usually
the basis for forecasting future demand and this fuzziness in the data
hampers efforts to improve demand forecasts, production scheduling,
and inventory management.
In order for companies to coordinate effectively, they need to have
a single part number that stays with a part as it makes its way through
the supply chain. That number is the electronic product code (EPC)
number. Companies that do business together need to be able to tag
every item that they buy and sell with an EPC number. They can still
use their internal part numbers for internal operations if they wish.
But when they communicate with each other they need to use EPC
numbers so as to eliminate the need to do part-number translations.
There are more valuable and profi table things that can be done with the
time and money that now goes into translating part numbers and dealing
with translation-related problems.
Global Data Synchronization Network
The Global Data Synchronization Network (GDSN) is a network of
independently owned and operated databases that can exchange data
with each other and the GS1 Global Registry. The GS1 Global Registry
acts as a central coordinator between all the other databases to pro-
vide for timely and traceable distribution of verifi ed product descrip-
tive information between all the databases. It is the locator and routing
Supply Chain Coordination 197
mechanism for fi nding source data and sending requested data between
databases.
GS1 is a global, not-for-profi t organization of member organiza-
tions, including GS1 US, representing more than 100 countries around
the world. GS1 is based in Brussels, Belgium. GS1 US is the former Uni-
form Code Council and consists of the EAN UCC System, UCCnet,
EPCglobal US, RosettaNet, and UNSPSC. GS1 US is based in New
Jersey, USA (www.gs1us.org). Companies join the GS1 Global Registry to keep connected to their
trading partners that also join the Global Registry. Parties in a supply
chain—manufacturers, logistics providers, distributors, retailers—then
subscribe to the database of their choice and through these databases
they can both publish data about their products to other parties as well
as request and receive data from other companies about their products.
This is illustrated in Exhibit 6.4.
The GDSN is being administered by GS1 and increasingly is being
used by companies in consumer goods retail and related areas. It allows
data about products to be continuously updated as new products are re-
leased, existing products evolve, and obsolete products are discontinued.
The benefi ts are signifi cant beginning with the fact that each company
needs only to make a single connection to their selected database or
“data pool” as GDSN calls them. Once they do this they can send and
receive data to and from any other company that is connected to any
other data pool that is part of the GDSN.
Other benefi ts include things such as elimination of the need for
companies to maintain massive cross-reference tables to translate be-
tween the different part numbers for the same product that are used
by different supply chain partners. This reduces many ordering and
billing errors that consume people’s time and result in delays in prod-
uct deliveries and cash fl ows between companies. It also simplifi es
order tracking and tracing individual items as they move through a
supply chain.
198 ESSENTIALS of Supply Chain Management
Global Data Synchronization Network (GDSN)
EXHIBIT 6.4
Source Data Pool
Recipient Data Pool
GS1 Global Registry
1. Load Item and Location Data
2. Register Data
3. 3. Request for Subscription Data
3.
4. 4. Publish Requested Data
Seller Or
Manufacturer
Buyer Or
Retailer
1. Load Item and Location Data – the seller or manufacturer registers with a GS1 certified data pool and uploads item and location data to their data pool.
2. Register Data – a small subset of item and location data is sent by the data pool to GS1 Global Registry.
3. Request for Subscription Data – the buyer or retailer subscribes to a data pool and to categories of products or to particular suppliers to receive the related item and location data. Buyer requests data from their data pool. The data pool requests this data from the GS1 Global Registry and the Global Registry sends the request to the data pool containing this data.
4. Publish Requested Data – the seller’s data pool provides requested item and location data to the data pool of the buyer and the buyer’s data pool sends the data to the buyer. Buyer updates its systems with this data. Buyer and seller now have identical item and location data—data synchronization is complete.
Source: GS1 US (formerly known as Uniform Code Council Inc)
Publish Requested Data
Request for Subscription Data
Request for Subscription Data
Supply Chain Coordination 199
Product Classifi cation
Products that move through a supply chain need to be identifi ed and
traced so that people know how many products are moving through
their supply chains. Products also need to be classifi ed so that people
know what types of products they are handling. All supply chains
handle a mix of different product types and that mix changes over
time. As the product mix changes, the supply chain itself must change.
There are two major standards presently in use for product classi-
fi cation. The fi rst one is the United Nations Standard Products and
Services Code (UNSPSC). The United Nations Development Program
(UNDP) and Dun & Bradstreet Corporation (D&B) jointly developed
the UNSPSC in 1998. The UNSPSC is a hierarchical classifi cation
with fi ve levels. These levels allow analysis by drilling down or rolling
up to analyze expenditures and product usage at each level. Each level
in the hierarchy has its own unique number. Starting with the highest
level, the fi ve levels are segment, family, class, commodity, and business
function.
The second major product classifi cation standard presently in use is
the GS1 Global Product Code or GPC. The GPC was developed by GS1
and is used in the GDSN to identify different types of products. The GPC
is also a hierarchical classifi cation scheme and it has four levels: Segment;
Family; Class; and Brick. These two product-classifi cation schemes are
not mutually exclusive and they can be used together. It does require
all parties to agree on the rules they will use to translate product codes
between UNSPSC numbers and GPC numbers.
Collaborative Planning, Forecasting, and Replenishment To facilitate the coordination that is needed in supply chains, an indus-
try group known as the Voluntary Interindustry Commerce Standards
(VICS) (www.vics.org) has set up a committee to investigate collaborative
200 ESSENTIALS of Supply Chain Management
planning, forecasting, and replenishment issues (CPFR). This committee
documents best practices for CPFR and creates guidelines to follow for
CPFR.
Supply chains where people use technology to support a CPFR
process are the most effi cient supply chains, because they can best man-
age the factors that give rise to the bullwhip effect.
The CPFR process is divided into the three activities of planning, fore-
casting, and replenishment. Within each activity there are several steps:
Collaborative Planning
• Negotiate a front-end agreement that defi nes the responsibilities of the companies that will collaborate with each other
• Build a joint business plan that shows how the companies will work together to meet demand
Collaborative Forecasting
• Create sales forecasts for all the collaborating companies
• Identify any exceptions or differences between companies
• Resolve the exceptions to provide a common sales forecast
Collaborative Replenishment
• Create order forecasts for all the collaborating companies
• Identify exceptions between companies
• Resolve the exceptions to provide an effi cient production and delivery schedule
• Generate actual orders to meet customer demand
CPFR in Action For an example of how CPFR can work let’s return to the example of
Nimble Co. In the section on product design in Chapter 3, we saw how
Nimble Co. developed a home entertainment system that was much
Supply Chain Coordination 201
simpler to manufacture than a competitor’s system. This simpler design
is in turn supported by a less-complex supply chain that reduces produc-
tion costs and increases responsiveness to market demands. All of this is
central to the competitive success that Nimble Co. is enjoying.
Nimble Co. has collaboration agreements in place with its supply
chain partners and has an ongoing planning, forecasting, and replenish-
ment process in place with these partners. Nimble Co. receives point of
sale (POS) data that shows the actual sales of its systems in retail stores.
From these same retailers, Nimble Co. receives regular updates of their
sales forecasts and their inventory levels of Nimble Co. home entertain-
ment systems. Nimble Co. uses this data to plan its production schedule
and it also shares this data with the component manufacturers who pro-
vide parts for its home entertainment system. This way the component
manufacturers can plan their own production schedules.
In looking at the sales data and forecasts, Nimble Co. sees that de-
mand for their product is growing faster than anticipated in their yearly
plan, and they need to increase production. Nimble Co. revises its pro-
duction schedule for the year and takes the new plan to its key com-
ponent suppliers to negotiate additional purchases of their components.
It turns out that one component supplier cannot quickly ramp up their
production but a second supplier has a component that could fi ll the
need with just a slight modifi cation to the design of one part of Nim-
ble Co.’s home entertainment system. Because all affected parties know
what is going on and have enough lead time, the design changes are
made and production schedules are increased to meet the rise in product
demand without any retailers running out of inventory.
The benefi ts illustrated in this scenario are numerous. To begin
with, the bullwhip effect is diminished because all companies in the
supply chain can see real-time sales data and share sales forecasts. This
allows everyone to optimize their production schedules, inventory lev-
els, and delivery schedules. Next there are the benefi ts associated with
Nimble Co. being able to quickly see a real rise in customer demand
202 ESSENTIALS of Supply Chain Management
and coordinate with its suppliers to increase production schedules over
previously planned levels. Even though one component supplier was
not able to accommodate Nimble Co.’s increased production schedule,
another supplier had a workable substitute. Changes were made to the
product design, production was increased, and no retailer lost sales rev-
enue due to running out of inventory.
Those companies that can create collaborative supply chains will
have a signifi cant competitive advantage. Collaboration is not easy to
implement and it will take time to become more common in business.
However, prominent companies are already beginning to lead the way.
Companies such as Wal-Mart, Dell, and Procter & Gamble share POS
data with all the other companies in their respective supply chains. The
companies in these supply chains are also starting to share inventory
data with each other. Sharing this kind of information provides a basis
for each company to make decisions about its own activities that will
yield better effi ciencies and profi ts for itself and for the supply chain as
a whole.
How to Start Supply Chain Collaboration The best place to start in any effort to promote collaboration is to
measure the bullwhip effect within your company. Over a period of time
such as a quarter or a year, compare the volume and frequency of orders
you receive from your customers with the volume and frequency of
orders you place with your suppliers. Plot them out on a graph so every-
one can see the divergence between incoming customer orders and your
outgoing supplier orders. What is the extent of this divergence? Where
is your company located in the supply chain—is it toward the front of
the chain close to the end customer or is it further toward the back of
the chain? Remember, the distortion caused by divergence of incom-
ing orders with outgoing orders increases as it moves back through the
supply chain.
Supply Chain Coordination 203
Many companies are not aware of the cost of the bullwhip effect on
their supply chains. Traditionally, demand variability caused by the bull-
whip effect was taken as a given and companies worked on their own to
develop better capabilities to respond to fl uctuations in demand. It may
instead be far more effi cient for companies to work together to actually
reduce the fl uctuations in demand. A company can either try to opti-
mize its individual response to fl uctuating demand or it can collaborate
with other companies to reduce the fl uctuations themselves.
Once you have established the magnitude of the bullwhip effect in
your company, then get some estimates of the cost consequences in dif-
ferent areas of the company. What is the effect of this demand variability
on production costs and scheduling? What is the effect on transporta-
tion costs and shipping and receiving costs? What inventory levels are
needed to maintain service levels in such a volatile situation and what
is the associated carrying cost? What is the effect on product availability
and order lead times—are sales lost because of lack of inventory? These
estimates show the cost to the company of dealing with demand fl uctua-
tions. This is the basis upon which to discuss what it might be worth to
fi x the bullwhip effect.
The Tao of Supply Chains: Effective supply chain collaboration requires that the people involved be able to see accurate and timely data showing inventory levels at different stages in the sup- ply chain. What follows is a story about creating a simple supply chain visibility system that enabled very effective collaboration.
Sun Tzu was a Taoist philosopher who lived in China about 2,500 years ago. He wrote a book called The Art of War. It isn’t so much a book about war as it is a book about the art of competition and collaboration—whether in business, politics, the military, or even
EXECUTIVE INSIGHT
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204 ESSENTIALS of Supply Chain Management
sports. I’ve puzzled through this book several times, and the con- cepts that I’ve taken away have helped me develop and preserve a reputation for IT agility.
For six years I was the chief information officer (CIO) of Network Services Company. Network Services is a nationwide distribution cooperative that provides foodservice items, janitorial supplies, and printing paper. It is wholly owned by its 80+ member compa- nies. They each have their own facilities and internal IT systems and they have their own local customers. They also work together to serve national account customers. The members’ collective revenue was then more than $7 billion, and Network’s total national account revenue was more than $500 million, growing by double-digit percentages every year. We provided customers with a tailored package of products and supply chain services to lower their overall operating costs.
One of our biggest national account customers was a chain of stores that each holiday season used specially printed paper items to pro- mote its holiday theme. Those items were used in the customer’s 4,500 stores during November and December, and when January arrived any remaining inventory had to be written off. The same holi- day print designs were never used two years in a row. In years past, there had been excess inventory of around 4 percent, amounting to almost $600,000 in costs that had to be written off by the customer.
This retail chain hired a new purchasing manager who decided we could all do better than in prior holiday seasons. He called us out to the company’s headquarters that summer for a meeting. There he announced his intention to reduce excess inventory of the specially printed holiday items by 50 percent or more. We still had to maintain 100 percent product availability for all of its stores and minimize expensive movements of inventory from one region to another to meet unexpected demand. He asked us how we were going to work with him to make that happen. I told him we understood what he wanted and that we’d be back in touch with the specifics in a few weeks.
EXECUTIVE INSIGHT (CONTINUED)
Supply Chain Coordination 205
As we flew home, our sales director on the account told me this was a high-visibility project with the customer, and we had to fig- ure out how to do it. He reminded me that it was already halfway through the summer, so we had to be ready to go in 90 days because we would begin stocking inventory in our distribution cen- ters by October. And, of course, we couldn’t spend lots of money on this because margins were tight. In addition, all the parties in this supply chain used different enterprise resource planning (ERP) systems. And even within Network Services, the 26 member companies that served the account used different ERP systems. Several times on that flight, I experienced a sudden falling sensa- tion in my stomach, and it wasn’t due to air turbulence.
At times like these my identity as IT Agility Man hangs in the bal- ance. Can I rise to the challenge, or will I flee in panic? Agility means doing three things: First, taking a deep breath; second, taking another deep breath; then, remembering The Art of War and asking, “What would Master Sun Tzu do?”
The concepts that I’ve been able to absorb from Master Sun tell me that apparent complexity is really composed of simple underly- ing patterns. If I can discern those underlying patterns, then I can devise simple and effective responses. So what was the pattern here? As I saw it, the need was to track daily product usage, con- stantly update demand forecasts, move inventory so as to cover demand, and use it all up by the end of the season.
That meant effective collaboration among all parties in the sup- ply chain to respond as actual demand unfolded. If our initial assumptions about demand were not entirely accurate (and they never are), we needed to be able to reposition inventory among distribution centers earlier and more efficiently. No sudden air freighting of paper goods to stores across the country. So, I asked myself, “What can IT provide that will enable this collabo- ration?” Obviously, what was needed was a continually updated, end-to-end view of product in the supply chain that was visible at all times to people at my company, the manufacturers, and
EXECUTIVE INSIGHT (CONTINUED)
(Continued)
206 ESSENTIALS of Supply Chain Management
the customer. That would be the basis for our collaboration and decision making.
I knew of several fine software vendors’ products that could do that, but they cost more money than I had to spend and took more time to install than I had available. So much for the orthodox ideas. What else could I do? Master Sun says, “Therefore, those skilled at the unorthodox are infinite as heaven and earth, inex- haustible as the great rivers.” Wow. What unorthodox ideas could I come up with?
Master Sun says, “There are only five notes in the musical scale, but their variations are so many that they cannot all be heard. There are only five basic colors, but their variations are so many that they cannot all be seen.” Does this mean that there is a combination of basic IT components that I could use to quickly create my end-to-end supply chain picture and keep it constantly updated?
What basic IT components do all parties in this supply chain have easy access to, and how could I combine them into the system I needed? I’m not going to give you the whole answer because then you wouldn’t get to practice your own agility and figure it out for yourself. But I will give you some hints. The components are spreadsheets, text files, e-mail, a few Web pages, a relational database, and some Java programs that took about three weeks to write and test.
We assembled these components into a system that collected data from all members of the supply chain. The data consisted of inventory amounts that were in production, in warehouses, and on order. It also included invoice data that showed our deliveries to the customer’s stores, which allowed us to track actual demand at the store levels and regional levels.
The system was up and running by October. It was extremely cost effective to build. We used it to facilitate conference calls that increased in frequency as the season progressed. On those calls,
EXECUTIVE INSIGHT (CONTINUED)
Supply Chain Coordination 207
we all reviewed the numbers and projected run-out dates. We made decisions and continued to tweak the system to incorporate new views of the data and new calculations.
We reduced excess inventory from 4 percent in prior years to 1.3 per- cent that year on increased total sales, and the dollar value of the excess inventory dropped to less than $200,000. As we reviewed the holiday season results in January, the new purchasing manager said he was quite pleased with our performance. We worked with him and the manufacturers to document what we learned, make further improvements, and extend the system to cover the rollout of other new products—not just holiday items. Thank you, Master Sun.
If you want to know more about how I designed and built this supply chain visibility system you can contact me by e-mail at: [email protected] and I’ll be glad to share the details with you.
Sales and Operations Planning Sales and operations planning (S&OP) is, to a large degree, a further
elaboration of the planning process described in Chapter 2 (page 42).
It also shares elements in common with the CPFR process described
in this chapter (page 199). As companies develop effective S&OP pro-
cesses internally and collaboratively with their supply chain partners,
they will see signifi cant improvements in their supply chain manage-
ment capabilities.
The Association for Operations Management (APICS, formerly
American Production and Inventory Control Society), endorses a defi -
nition of sales and operations planning provided by Tom Wallace in his
book Sales & Operations Planning:
Sales & Operations Planning (S&OP) is a business process that helps com-
panies keep demand and supply in balance. It does that by focusing on
EXECUTIVE INSIGHT (CONTINUED)
208 ESSENTIALS of Supply Chain Management
aggregate volumes—product families and groups—so that mix issues—
individual products and customer orders—can be handled more readily.
It occurs on a monthly cycle and displays information in both units and
dollars. S&OP is cross functional, involving General Management, Sales,
Operations, Finance, and Product Development. It occurs at multiple lev-
els within the company, up to and including the executive in charge of
the business unit, that is, division president, business unit general manager,
or CEO of a smaller corporation. S&OP links the company’s Strategic
Plans and Business Plan to its detailed processes—the order entry, master
scheduling, and purchasing tools it uses to run the business on a week-to-
week, day-to-day, and hour-to-hour basis. Used properly, S&OP enables
the company’s managers to view the business holistically and gives them
a window into the future. (Tom Wallace, Sales & Operations Planning, T.F.
Wallace & Co., Cincinnati, OH, 2000.)
The purpose of S&OP is to routinely review customer demand
for different products and the sources of supply for those products, and
then re-plan or adjust existing plans to best match supply with demand.
The process focuses on changes to earlier supply and demand fore-
casts and helps managers understand how well the company is doing
in the process of balancing supply and demand. The primary aim is to
continuously adjust company operating procedures so as to accomplish
its strategic goals and annual sales targets in light of expected future
conditions.
The continuous adjustment of sales and operations plans as forecasts
change is the method by which a company takes steps each month to
best meet its annual sales targets. The S&OP process can be thought of
as having fi ve main steps as shown in Exhibit 6.5 below.
S&OP takes a phased and iterative approach to the planning and
operations in a company. Instead of attempting to do one master plan
each year and then spend the rest of the year following that one plan,
S&OP takes the approach of continuously reevaluating demand and
supply conditions and continuously adjusting plans in light of changing
Supply Chain Coordination 209
EXHIBIT 6.5
conditions. It is a process of constantly responding to change. Fixed an-
nual plans worked better in the slower and more predictable industrial
economy of the last century. The real-time unpredictable nature of the
economy of this century makes it critical for companies to constantly
respond to changing conditions.
Companies are encouraged to take an “outside-in” approach to their
S&OP planning. People should begin their forecasting and planning by
considering the effect of events that are largely outside of their control
such as the actions of customers, partners, and competitors. These ac-
tions typically have the greatest impact, either positive or negative, on a
company’s ability to meet its sales and operating targets. Collaboration
with customers and partners (if not with competitors) provides for more
accurate information about these possible actions and thus makes the
S&OP process more effective. This is where practices from CPFR can
be benefi cial to S&OP.
Sales Forecasting
Finalize Plans &
Implement
Reconcile Plans
Supply Planning
Demand Planning
Collect sales data, analyze trends, make forecasts
Finalize plans and schedule production
Match supply and demand and assess financial implications
Review supply capacity and schedule operations to meet demand
Check forecasts, review demand variability, adjust inventory and customer service policies
Sales & Operations Planning Cycle
This planning cycle is done on a monthly basis, and increasingly, it needs to be done on a weekly or even daily basis in order to respond effectively as conditions change.
210 ESSENTIALS of Supply Chain Management
In a world now awash in data thanks to computers, the Internet,
and the global reach of telecommunication networks, it is important
for people in the S&OP process to know the data they need and fi nd
ways to get that data quickly and accurately. The collection of mass-
ive amounts of unnecessary data or inaccurate data will slow down the
planning process and prevent people from making effective decisions in
a timely manner. Good S&OP practice defi nes the minimum amount of
data needed to make certain decisions and focuses on getting that data
quickly and guaranteeing its accuracy.
Chapter Summary One of the most common dynamics in supply chains is a phenomenon
that has been dubbed “the bullwhip effect.” What happens is that small
changes in product demand by the consumer at the front of the supply
chain translate into wider and wider swings in demand, as experienced
by companies further back in the supply chain. Companies at different
stages in the supply chain come to have very different pictures of mar-
ket demand and the result is a breakdown in supply chain coordination.
Companies behave in ways that at fi rst create product shortages and then
lead to an excess supply of products.
Many companies are not aware of the cost of the bullwhip effect on
their supply chains. Traditionally, diffi culties in predicting demand caused
by the bullwhip effect were taken as a given and companies worked on
their own to develop better capabilities to respond to these hard-to-
predict fl uctuations in demand. It may instead be far more effi cient for
companies to work together to actually reduce the fl uctuations in de-
mand or more accurately predict those changes in demand. A company
can use CPFR to better forecast changes in demand and supply and it
can use S&OP to optimize its individual response to fl uctuating demand
and supply conditions.
Supply Chain Coordination 211
The GDSN is a network of interoperable databases that allows
all parties in a supply chain to continuously update and request data
about different products. The GDSN is administered by the GS1
organization. GS1 is a global not-for-profi t organization devoted to
setting standards and providing for effi cient data transfer between all
parties in global and regional supply chains. Effi cient transfer of up-
to-date and accurate information is a basic requirement for supply chain
coordination.
213
CHAPTER 7
Supply Chain Innovation for the Real-Time Economy
After reading this chapter you will be able to:
● Consider trends that make coordination and collaboration key requirements for success in twenty-first century supply chains.
● Discuss the potential of real-time simulation and massively multi-player online games as a source of ideas for new supply chain operating models.
● Appreciate the need for universal, easy, and inexpensive data connections between all parties in a supply chain and see why these connections will improve supply chain performance and profitability.
● Start to assess the potential for using social media to enhance supply chain capabilities.
Coordination and Collaboration in Supply Chains Innovation in supply chains starts with the realization of how much has
changed over the last 20 years or so and how that affects the way supply
chains need to be organized and operated. In complex and high-change
environments like our real-time global economy it is hard for a single
Essentials of Supply Chain Management, Third Edition by Michael Hugos
Copyright © 2011 John Wiley & Sons
214 ESSENTIALS of Supply Chain Management
company to forecast demand and act effectively in isolation. In this envi-
ronment, coordination is more powerful than control. Profi ts come from
being able to plug into supply chain networks and then develop a repu-
tation in those networks for having the best service and best products
at good prices. Companies do not need to have the lowest prices, they
just need to be “in the ballpark” or within a few percentage points of
the market average, because most customers are looking for something
in addition to low prices.
The relentless price-driven pursuit of cost savings alone doesn’t pro-
duce the profi ts it once did because this focus causes companies to op-
timize effi cient production of existing products at the expense of their
ability to change and create new products as markets evolve. Companies
optimized for effi ciency are like cars optimized for speed. They go fast
and win races as long as the road is straight and fl at; but when the road
twists and turns they cannot handle the corners and go fl ying off the
road and crash. Winding roads need cars that are responsive, not just fast.
And that is why coordination and collaboration are so important.
There is an inescapable tension between effi ciency and responsive-
ness. They’re at opposite ends of a spectrum; companies need to position
themselves at a point on the continuum between those two that best
meets their present circumstances. And as circumstances change, they
need to keep repositioning themselves. Failure to do this has been the
downfall of many fi ne industrial-age companies in the last decade; they
stayed at the effi ciency end of the continuum for too long while their
markets evolved and customers went elsewhere.
Traditional Pursuit of Effi ciency Is Now Less Profi table
This traditional tendency to focus too much on effi ciency is apparent
when senior managers of a company are quoted saying things such as,
“Clients turn to us to eliminate cost and increase effi ciency in their
supply chains”. Such companies often go on to announce they are
Supply Chain Innovation for the Real-Time Economy 215
employing a system that is described as, “an integrated extension of our
clients’ multi-channel, global supply chains aimed at improving global
operating effi ciency and time to market, while reducing cost.” (What
exactly does that mean?)
These phrases are corporate code words for systems designed to assist
companies in implementing traditional effi ciency-oriented low-price
strategies. Big-clout companies attempt to implement systems like this
to give themselves control over their suppliers in the name of achieving
greater effi ciency. And what happens is these systems shift profi ts from
the suppliers to the big-clout companies. Big-clout companies then be-
come complacent with their profi ts and the suppliers lose their motiva-
tion to do anything new because they aren’t making any money. So then
when the market changes, everybody (the whole supply chain) fl ies off
the road and crashes as demand for existing products drops and new
products have not been developed to take their place.
Wealth is now created by supply chains that enable companies to
better collaborate and coordinate their activities so as to keep up with
changing markets and keep delivering new products that customers
want and will pay profi table prices to acquire. Successful and profi table
companies understand that customers want a good price but that doesn’t
mean they want the lowest price as long as they get other features they
want. People want products that keep responding to their changing de-
sires and circumstances.
As a case in point, consider what happened to that once-simple
product called the mobile phone. In the late 1990s Motorola owned
the market and their StarTac phone was a popular, low-cost, and
high-quality product. But Motorola focused too much on a low-cost
approach and optimized itself and its supply chain to make low-cost,
high-quality mobile phones that eventually nobody wanted to buy any-
more. Customers moved on to other mobile phones that responded to
their changing desires. First Nokia came out with colorful and stylish
phones and customers bought them even though they cost more and
216 ESSENTIALS of Supply Chain Management
had some quality problems. Then Blackberry came along and com-
bined e-mail with a mobile phone and every business exec wanted
one even though they cost more and had some quality problems. Now
everybody wants an iPhone or something that competes with it such
as an Android. Customers are paying more and accepting some quality
problems in order to get what they want. Low price is not the deciding
factor in how most customers select these products.
The iPhone is a rapidly changing mix of tangible and intangible
values and features delivered via a mix of hardware and software that is
responsive to evolving desires of its growing customer base. There are
profi ts to be made by everybody in the iPhone supply chain because
customers will pay more for the product. The iPhone is a like a sym-
phony orchestra; Apple is the conductor of the orchestra but it’s only
one party in the process that creates the success the product is enjoy-
ing. Companies in the iPhone orchestra pay attention to Apple and co-
ordinate their actions with each other to keep up with the fast pace of
change because they are all making money (or at least believe they soon
will be).
Apple isn’t trying to create all the innovation itself; everybody is
innovating and coordinating with each other to keep the ball rolling
because iPhone is more than a mobile phone; it’s a growing ecosys-
tem of products and services that is taking on a life of its own. The
phone is actually just one of many applications that run on the iPhone
platform.
Time to Get Agile and Reinvent Traditional Supply Chain Operations
As more and more products follow a trajectory similar to the mobile
phone, there’s a huge opportunity to provide collaboration platforms for
all parties in a supply chain to come together and get better and better
at doing what they do to create and deliver new products. There’s an
Supply Chain Innovation for the Real-Time Economy 217
opportunity to reinvent supply chains by supplementing traditional sup-
ply chain practices with collaboration and coordination practices.
Single companies using their own factories once designed and
made the products of the industrial economy; now it is supply chains
of inter-related companies working together to evolve products in
a process of constant response to market change. Responsive supply
chains trump merely effi cient supply chains because only responsive
supply chains provide the motivation needed for innovation and con-
tinuous change (see Chapter 10, Exhibit 10.1 “Strengthening Supply
Chain Alliances”).
What would happen if traditional supply chain operations were
combined with practices from collaborative planning, forecasting, and
replenishment (CPFR) and with approaches taken from sales and opera-
tions planning (S&OP) as discussed in Chapter 6? What would happen
if we looked at supply chains as responsive and agile collections of col-
laborative projects instead of continuing to try to manage them as cen-
trally controlled assembly-line style operations optimized for effi ciency?
Centrally controlled assembly lines optimized for effi ciency worked well
in the slower moving and more predictable industrial economy of the
last century where product life cycles were measured in years or decades
instead of months or quarters. In the real-time economy of this century,
conditions change too fast for effi ciency to be the only focus. As soon as
a supply chain is optimized for one set of circumstances, those circum-
stances change and what was optimal is no longer optimal.
Massively Multi-Player [Serious] Supply Chain Games There is a class of online computer games known as massively multi-
player online role playing games (MMORPGs). In these massively
multi-player online games, also known as MMOs, players from all
over the globe log into virtual worlds via the Internet; they learn dif-
ferent roles and skill sets, and come together in self-selecting teams
218 ESSENTIALS of Supply Chain Management
to carry out daring missions in pursuit of common goals. Question:
How is this any different from the challenges that we face in design-
ing and operating supply chains in the global real-time economy we
now live in?
Another way to look at these MMOs is to call them real-time simu-
lation modeling systems because that is literally what they are. The word
“game” makes MMOs seem as if they are merely toys and that is un-
fortunate. Popular MMOs such as World of Warcraft, EVE-Online, or
EverQuest bring together hundreds of thousands of simultaneous online
players from countries around the globe to interact in complex, realis-
tic three-dimensional worlds based on themes from Star Wars science
fi ction to Lord of the Rings epics.
MMOs are not to be confused with single-person shooter games
where individual players blast aliens and tough guys, steal cars, and get
into street fi ghts. Those games develop fast eye-hand coordination but
not much else. And neither are we talking about virtual social worlds
such as Second Life.
What we are talking about is online games where there are rules and
politics and opportunities to collaborate with others and build your rep-
utation and your fortune. To play these games, players have to interact
with each other and build relationships and put together plans and go on
missions. They join guilds or corporations that exist in these games; they
develop specifi c skills related to the roles they play (roles like pilot, trader,
wizard, warrior, hunter, and priest); and they develop reputations and rat-
ing levels based on their successes and failures.
These are games that provide what is known as an “unscripted
emergent experience”. These games start from an initial set of condi-
tions and then depending on the actions and interactions of the players,
there is the potential for an almost infi nite number of outcomes—just
like in the real world. In Chaos Theory this is known as “The Butter-
fl y Effect”. In the world of MMOs this interaction between players is
referred to as “The Sandbox”. (This concept is eloquently illustrated in a
Supply Chain Innovation for the Real-Time Economy 219
short video created by the makers of the MMO called EVE Online. You
can view this video on YouTube; to fi nd it do a search on “EVE Online:
The Butterfl y Effect”.)
The potential for using MMOs to develop skills people need to
succeed in the global economy is starting to get serious attention. A
study titled “Virtual Worlds, Real Leaders” was done by IBM and some
professors from Stanford University and MIT who work together at
a company named Seriosity (http://www.seriosity.com/downloads/
GIO_PDF_web.pdf). They focused their study in particular on the
MMO named World of Warcraft and came up with some interesting
insights.
Consider what could happen if a massively multi-player online game
(like World of Warcraft or EVE Online) was used to monitor and co-
ordinate the operation of a real-world business process like operating
global supply chains. Games aren’t just for kids anymore as the median
age of gamers (presently 36) continues to rise, and games aren’t just for
entertainment anymore either. There is a rapidly growing category of
games called “serious games” used to deliver training and skills develop-
ment for real world situations (militaries around the world make heavy
use of such games).
Operating a global supply chain is a game with some pretty chal-
lenging dynamics. Players need to fi gure out how to deliver products
where and when they are needed to meet demand while at the same
time minimizing inventory levels and holding down transportation and
manufacturing costs. If people succeed in keeping down inventory levels
and costs but fail to meet product demand, they lose. And if they always
deliver the products but fail to keep the other factors under control,
then costs get out of hand and people don’t make any money. So how
do people and companies learn to excel in this kind of risky business
environment?
MMOs provide an engaging and unifying framework to com-
bine several technologies discussed in Chapter 4: business intelligence
220 ESSENTIALS of Supply Chain Management
(BI), simulation modeling, and business process management (BPM).
MMOs take advantage of real-time reporting of actual supply chain
status (business intelligence) and display this data in a manner that is
easy for players to understand and respond to. Then people can use
gaming to try out different plans of action to see the probable result
(simulation modeling). And they can then select the best plan and
coordinate with each other to carry out the plan successfully (busi-
ness process management). MMOs for supply chain operation can be
delivered to people all over the world using cloud computing and
wireless broadband Internet connections.
Learning by Trial and Error Alone Is a Lot Riskier than It Used to Be
In the old days, companies had to learn mostly by trial and error, making
mistakes, and hoping to learn fast enough so they didn’t go out of busi-
ness before they got good at what they did. But the learning curve is
much steeper now. The rising costs of fuel oil and other raw materials are
forcing companies around the world to rethink and redesign the supply
chains built up over the last 25 years. Supply chains must continually ad-
just as prices and product demand forecasts change. With profi t margins
so thin and markets evolving so quickly, learning by trial and error alone
is an increasingly risky proposition.
Supply chains can be defi ned as collections and combinations of just
four things: facilities, routes, vehicles, and inventory. Suppose companies
could use a simulation game that provided a map of the world where
people from different companies working together in a supply chain
could design and evaluate different supply chain options. They could
point and click on the map to defi ne facilities (factories, warehouses,
stores, airports, harbors, etc.) and their locations. They could then de-
fi ne routes (roads, rails, air routes, sea routes, etc.) to move inventory
between facilities and defi ne vehicles (trucks, trains, airplanes, ships, etc.)
Supply Chain Innovation for the Real-Time Economy 221
that will use these routes to move inventory. Then suppose companies
could also defi ne the production volumes of the factories, storage capac-
ity of the warehouses, and movement capacity of the different modes of
transportation.
Once these facilities and transportation routes are defi ned, people
could associate operating costs with each facility and each mode of
transportation. And people could specify expected inventory demand
at the locations where end customers supplied by the supply chain pur-
chase fi nished products. Simulations can be run to assess the ability and
operating costs of a given supply chain to meet expected demand for
products.
Users can experiment with different supply chain designs and run
simulations to assess their effectiveness. Simulations will identify the
most effi cient supply chain designs for each study. These supply chains
could then be put into production in the real world.
For each facility, users could defi ne operating parameters to use in
monitoring daily operations. These parameters monitor things such as
the inventory levels of individual products at each facility, the expected
demand for products that each facility must meet, and the operating
costs. This real-time system (this serious game modeled on a MMO)
then collects actual performance data every day from each of the facili-
ties in the supply chain and updates the status of inventory and operating
costs on a daily basis.
The daily monitoring of supply chain operations enables all au-
thorized parties to see status of inventory and product usage. The sys-
tem sends alerts to appropriate parties when actual inventory, demand,
and costs exceed acceptable operating parameters as defi ned for each
facility.
As a companion to this book I have collaborated with a group of
people to create a MMO to use for gaining a better understanding
of the dynamics that underlie supply chains and their operations.
This game allows people from all over the world to collaborate in the
222 ESSENTIALS of Supply Chain Management
design and operation of supply chains. It can be used to model real or
imaginary supply chains and simulate their operations. It will show
the performance characteristics and operating costs of these supply
chains under different circumstances. The purpose of this game is to
engage people in an interactive experience that accelerates their learn-
ing and increases their mastery of the skills involved in supply chain
management.
The game is titled “SCM Globe” and it can be accessed through my
website at www.MichaelHugos.com.
A Sequence of Screens Illustrates These Capabilities
The fi rst screen shown in Exhibit 7.1 shows a design for a pharma-
ceutical supply chain; facilities and routes that move inventory between
them are shown. A pharmaceutical manufacturing facility is located in
Pittsburgh and a route connects it to Newark International Airport.
From Newark there are two air routes that move material to Heathrow
Airport in the United Kingdom and Barcelona Airport in Spain. From
Heathrow Airport a route is defi ned to move product to a hub facility in
Stuttgart in Germany. From this hub, product is moved to patient sites in
Warsaw and Budapest. Also shown are routes to move product to a site
in Manchester directly from Heathrow Airport. From Barcelona Airport,
routes are shown to move products to sites in Lyon and Lisbon.
The next screen shown in Exhibit 7.2 illustrates how the system
simulates the operation of this supply chain. Shown on the screen are
some of the facilities and routes and a data display in the upper part of
the screen provides a readout of relevant variables that measure the oper-
ation of this particular supply chain. The data display shows daily values
for inventory and costs of operation. This enables users to see the charac-
teristics of a supply chain design and to modify the facilities, routes, and
vehicles used until an optimal design is achieved.
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Once a supply chain is put into operation, the system could use sim-
ple data interfaces with the existing systems of the facilities and vehicles
in the supply chain to collect data on a daily or even hourly basis and
display the status of inventory at each facility. As shown in Exhibit 7.3,
system users can click on any facility and get a data display showing cur-
rent status of inventory at that facility.
Support for Collaborative Operations and Decision Making
As the users of this system (this MMO sandbox) collaborate to design
effective supply chains to respond to changing conditions, the system
could constantly keep track of the operating characteristics of the sup-
ply chains that were created and the users could select those designs
that provided the best results. And then once that supply chain was in
operation, the system itself would collect live data feeds from the actual
facilities and parties in the supply chain and display real time status of
ongoing operations. This would be a powerful inter-company collabo-
ration platform. This platform combines the practices of collaborative
planning, forecasting, and replenishment (CPFR) and sales and opera-
tions planning (S&OP) as described in Chapter 6. It would be a serious
game whose object is for its players to monitor and manage their supply
chains so as to best respond to changing business conditions.
As demand for products fl uctuates, and as operating costs for fac-
tories, warehouses, and transportation modes change, companies and
their supply chain partners could constantly test out different ways to
meet demand while minimizing cost. If inventory planners and supply
chain operators could literally draw supply chain confi gurations on
an electronic map display and then simulate those confi gurations over
some time period, they would quickly learn what combinations pro-
duce the best results. They would become immersed and completely
involved.
Supply Chain Innovation for the Real-Time Economy 225
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Supply Chain Innovation for the Real-Time Economy 227
People would develop very accurate intuition about how best to re-
spond to changing business conditions. They would be able to constantly
adjust their supply chains to maintain the highest service levels at the
lowest costs. And companies using this supply chain system would con-
tinuously learn and adjust their supply chains while incurring less risk
and less cost than companies that learned only in the real world by trial
and error alone.
(Readers can use a version of this system at www.MichaelHugos.
com by clicking on the link for “SCM Globe”. Companies wanting to
explore using this system in their business can contact me about a more
full-featured version to collaborate with their customers and suppliers.)
Supply Chains and Simple Data Connections In all supply chains there are fi ve drivers: production, inventory, location,
transportation, and information. And the goal is to manage them so as
to “Increase throughput while simultaneously reducing inventory and
operating expense” as Eliyahu Goldratt so eloquently put it in his book
The Goal.
Accomplishing this goal requires constant adjusting of the fi rst four
drivers to get the right balance of effi ciency and responsiveness as the
world unfolds. The key to achieving this balance is to have timely and
accurate information and act effectively based on what it tells you. Infor-
mation is the central leverage point for running any good supply chain.
Continuous Balancing between Effi ciency and Responsiveness
One ever-present challenge in running an effi cient supply chain is
to cope with the effects of a dynamic called “The Bullwhip Effect,”
a illustrated in Exhibit 7.4. Small changes in demand for products at
the front of a supply chain create increasing distortion in the perceived
demand for those products as you move toward the back of the supply
chain.
228 ESSENTIALS of Supply Chain Management
Demand forecasting and the related S&OP tasks are the basis for
running effi cient supply chains, but in high change and unpredictable
times like these, it’s hard to do these tasks well. It takes good data and
requires people in different companies to collaborate to do these tasks
well, because a supply chain isn’t just one company, it’s a network of
companies. This is illustrated in Exhibit 7.4.
Effi cient supply chains reduce inventory and operating expense,
but it takes responsive supply chains to increase throughput. And to in-
crease throughput, supply chains have to provide what customers want.
Throughput is also known as sales, so to increase sales (as well as profi ts)
companies need to do more than just offer basic products at low prices.
They need to respond to opportunities to wrap their basic products in
blankets of value-added services (from e-business services to customer
service) that are tailored to fi t customers’ evolving needs and desires. This
is illustrated in Exhibit 7.5.
Good Supply Chain Strategy Is Based on Timely and Accurate Data
Because accurate and timely information is the central supply chain
driver, good strategy starts with improving the accuracy and fl ow of
data between companies working in a supply chain. All other strategic
decisions and tactical actions depend on this. Effective strategies support
creation of a “virtuous cycle” of continuous improvement, and good
information is what makes that possible. Exhibit 7.6 shows how this
virtuous cycle comes into being.
Most supply chains still do not have the accurate and timely data
they need because they lack effective electronic data connections be-
tween companies. Electronic data interchange (EDI) systems are used by
many large companies, but those systems are expensive and complicated.
In some instances EDI has been replaced by extensible markup language
(XML), yet those systems too are expensive and complicated.
Su pp
ly C
ha in
s N
ee d
to R
es po
nd t
o C
on tin
uo us
F lu
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in
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up pl
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em an
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ST O
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to m
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to m
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IT 7
.4
229
230 ESSENTIALS of Supply Chain Management
In most supply chains the big Tier 1 brand-name companies are a
minority, most companies are the smaller Tier 2, Tier 3, and so on com-
panies, and they still use e-mail, faxes, and spreadsheets to move data be-
tween each other because they can’t afford the complex and expensive
systems used by Tier 1 companies. Until simple data-connection solu-
tions are found, it will continue to be a problem to get timely and ac-
curate information to manage supply chains (Gatepoint Research, Pulse
Report Survey of Critical Supply Chain Trends: Summary Results, December
2009).
As data fl ows through these simple data connections it is then
possible to do comparisons between different data sets and display
Responsive Supply Chain
Increase product value and sales margins by wrapping products with a blanket of value- added services tailored to respond to specific customer needs and desires
Product Bundle
Customer A
Manufacturer & Distributor
Customer B
Customer C
• e-Business services
• Product Usage Data
• Compliance Reporting
• Customer Service
• Credit and financing
• Warehousing & Logistics
• Product training & support
• New Product Introductions
Wrap Products with Tailored Blanket of Value-Added Services
EXHIBIT 7.5
Supply Chain Innovation for the Real-Time Economy 231
continuously updated score cards that show performance of the sup-
ply chain overall and performance of each of the companies in that
supply chain. A sample score card is shown in Exhibit 7.7. When
everybody can see those score cards every day, they have the infor-
mation they need to start and maintain a virtuous cycle of continuous
improvement.
This visibility created by universal data connections is the basis for
effective supply chain management. These simple solutions and the
systems they support are better than the present complex solutions
because simple systems using good data a deliver better results than
complex systems using bad data (there is an old saying in the computer
world that goes like this, “garbage in, garbage out”).
Evolving Supply Chain Strategy
Learn to support different store
formats
Evolving relationships: stores; DCs; factories
• Big DC to serve many stores or smaller DCs to serve fewer stores?
• Keep inventory at DC or crossdock?
ELECTRONIC CONNECTIONS
WITH ALL PARTIES
• Automate routine transactions to increase productivity, cut errors
• Track and display performance data
Empower network of many suppliers and
producers
• How to support local suppliers?
• How to drive continuous improvement in forecasting and order fulfillment?
• How much inventory in stores?
• Replenish which products how often?
“Virtuous Cycle” of continuous improvement
Virtuous Cycle starts here
Virtuous Cycle Starts with Electronic Data Connections for All Parties
EXHIBIT 7.6
Sc or
ec ar
d fo
r Su
pp ly
C ha
in P
er fo
rm an
ce P
ro vi
de s
R ea
l- tim
e T
ra ns
pa re
nc y
E X
H IB
IT 7
.7
232
P er
fo rm
an ce
V is
ib le
to A
ll
K P
I Sc
or ec
ar d
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ct ro
ni c
In vo
ic e
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A S
N E
le ct
ro ni
c P
O
R et
ai le
r
D is
tr ib
ut or
M an
uf ac
tu re
r
P la
n vs
A ct
ua l
W k
1
W
k 2
W k
3
W
k 4
In ve
nt or
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ur ns
P la
n vs
A ct
ua l
W
k 1
W k
2
W
k 3
W k
4
O rd
er F
ill R
at e
%
Su pp
lie r
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e D
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R at
e
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P O
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T im
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er F
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at e
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oi ce
to A
S N
a nd
P O
to ca
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at e
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fe ct
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at e
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pl ay
K P
I sc
or e
ca rd
s th
ro ug
h da
sh bo
ar ds
v is
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to a
ll p
ar ti
es .
S et
c us
to m
er s
er vi
ce a
le rt
s fo
r qu
ic k
re sp
on se
. 90
% 70
%
80 %
P er
fe ct
O rd
er R
at e
10 0%
60 %
A
B
C
D
E
Supply Chain Innovation for the Real-Time Economy 233
A huge opportunity exists right now in global and local supply
chains to electronically connect all companies from the largest to the
smallest. And since simple solutions are the only ones that will work for
everybody, they are the only ones that will work at all.
I built a simple data connection and scorecard system like this to
connect more than 80 smaller companies in a national distribution
cooperative with the much larger companies of their customers and
manufacturers (see Chapter 9, “Conceptual Design for E-Business
Systems Infrastructure”). It connects the different ERP systems of these
companies, supports billions of dollars in commerce, and enables other
applications such as business intelligence, business process management
(BPM) and S&OP.
Many strategic experiments in organizations are enabled by information technology (IT) and organizations that employ a mindful approach to experimentation and their use of IT are like- ly to be in a better position to achieve the benefits they are look- ing for. Associate professor C. Ranganathan at the University of Illinois at Chicago believes that mindfulness at the individual level is characterized by openness to novelty, alertness to dis- tinction, sensitivity to different contexts, awareness of multiple perspectives, and an orientation to the present.
The idea of mindfulness has been extended to organizations, and research finds that mindfulness enhances an organization’s innovative ability as it fosters exploring a problem from multiple perspectives and focusing on business processes and ways to improve those processes. Organizational mindfulness is also associated with adaptive management of stakeholder expecta- tions as unexpected events occur. Mindful organizations practice continuous learning where organizational actions are based on
EXECUTIVE INSIGHT
(Continued)
234 ESSENTIALS of Supply Chain Management
what they have learned about themselves and their environment. Mindful organizations apply insights from their learning to their strategic IT experimentation.
Singapore-based YCH Group is one such mindful organization. They are a leading logistics and supply chain management company which provides integrated, end-to-end supply chain solutions to some of the world’s largest companies including Dell, Motorola, LG, Pfizer, and Unilever. With more than 500 mil- lion square-feet of warehouse space, YCH Group handles more than $50 million worth of goods for its multinational corporation (MNC) customers.
YCH Group’s intention is to help improve the business of their customers so that as their customers do well, YCH Group will also do well. To this end, YCH group engaged in strategic IT experimen- tation to integrate three supply chain flows in a single, integrated process. Those three flows are: 1) physical flows of inventory from one point to another; 2) information flow of data about the inven- tory; and 3) financial flow of ownership and related documents about the inventory.
YCH group pioneered using RFID for liquid and other controlled products in a bonded warehouse environment. A bonded ware- house is a licensed area that is used to store controlled items such as alcohol or cigarettes for re-export or local consumption. YCH group not only had to strictly adhere to the customs guide- lines, but also ensure integrity and security of data at any point of time. They developed a unique “One-Touch” strategy using RFID technology. The One-Touch strategy uses two key components. The first component is a software that ensures data is clean and error-free at the point of collection and that data integrity is main- tained seamlessly thereafter (hence, “one-touch”). And the second component is technology that ensures that the data filtered at the source is accurate. Chief Operating Officer James Loo explains further, “We were able to capture right data at the source, and manage this data through its lifecycle. One-Touch ensures that
EXECUTIVE INSIGHT (CONTINUED)
Supply Chain Innovation for the Real-Time Economy 235
despite multiple modifications, enhancements, and process flows, the core set of data is kept secure and intact. Data remains accu- rate and available for appropriate users in the value chain.”
Exhibit 7.8 depicts a typical process flow in a YCH bonded ware- house. When bonded goods arrive at the main distribution center, each pallet gets a radio frequency identification (RFID) tag. The tag contains product information as well as data on arrival time and designated storage location. Handheld readers are used to record and retrieve information from these tags. Forklift operators pick up the pallet and make their way to the designated storage location. The reader emits a light when this location is reached so that the operator knows the exact spot for storage. On receiv- ing orders from customers, the RFID reader is used to help staff locate the goods. This also makes it easier for customs officials to conduct spot checks; otherwise they have to walk all over the warehouse and move up the racks to find the pallet they are looking for.
The forklift driver then removes the goods from the storage area into the outbound (or staging) area. While the goods are en-route to the staging area, the RFID reader will send a signal to prompt the computer system to start printing the relevant documentation. By the time the forklift arrives with the goods, all relevant paper- work and labels are ready, making it easier to load the shipment onto the trucks with minimal delay. Before RFID was implemented, staff had to wait for the goods to arrive at the outbound area before preparing the dispatch documentation.
Through RFID, YCH group also gained end-to-end visibility of stocks as they pass through the supply chain. YCH can now ensure that the pallets and cartons comply with the picking and transfer order requirements. YCH can also track goods in the storage area as well as their movement throughout the supply chain. YCH’s stock-taking and verification have become error-free and easier. Each RFID gan- try has an LED panel so that the forklift driver knows that the goods
EXECUTIVE INSIGHT (CONTINUED)
(Continued)
236 ESSENTIALS of Supply Chain Management
E X
H IB
IT 7
.8
Pr oc
es s
Fl ow
i n
Y C
H -b
on de
d W
ar eh
ou se
s
Supply Chain Innovation for the Real-Time Economy 237
Social Media and Real-Time Feedback Facebook is defi ning a genre of software that will become as generic
and widespread as the spreadsheet and word processing. And that means
Facebook is probably not the last word in this genre. Maybe it’s only
an early incarnation. For example, the fi rst popular spreadsheet was
called Visicalc; it introduced the world to this genre of application. Then
Visicalc was succeeded by Lotus 1-2-3, and then Lotus was surpassed by
the current market leader, Excel.
Perhaps MySpace was the fi rst popular incarnation of this new gen-
re. Then MySpace was succeeded by Facebook. And maybe there is an-
other contender now in the works that will surpass Facebook. Things
happen fast these days. Software vendors are introducing systems that
are cloud-based, software-as-a-service (SaaS) applications that have sim-
ple user interfaces much like Facebook but also come with additional
features businesses need that Facebook and other current social media
applications lack—like better security, better administrative control, and
better user analytics (applications like Jive and Yammer are examples).
There may be a bigger and more compelling case for businesses
to build and spend time maintaining their social networks than there
have been captured by the reader and recorded in the warehouse management system. With this, YCH is able to offer visibility of the cargo for customs purposes and to facilitate planning through- out the distribution process. Custom clearance application forms and recommendations for replenishment are also automatically generated.
Adapted from a paper by Teo, T.S.H., Srivastava, S.C., Ranganathan C., and Loo, J.W.K. “A Framework for Stakeholder Oriented Mindfulness: Case of RFID Implementation at YCH Group, Singapore”, in European Journal of Information Systems, 2010.
EXECUTIVE INSIGHT (CONTINUED)
238 ESSENTIALS of Supply Chain Management
is for individuals to do this. If maintaining social media sites was part
of a paying job and if it was shown to generate measurable benefi ts
for companies that did it well, there would be lots of demand for this
activity.
Social media and related SaaS applications provide excellent real-
time communication and collaboration platforms for companies that do
business together. They provide real-time feedback that companies can
use to continually communicate with their supply chain partners and
adjust their daily operations to fi t real-world circumstances.
Business-oriented social media can be used for everything from
providing customer service and technical support to managing supply
chains and executing joint marketing and sales campaigns. Business-
oriented social media could well become, as Steve Jobs, CEO of Apple
once put it, “the next insanely great new thing”. It could enable com-
panies to monitor and manage their business ecosystems in real time as
our global economy continues to evolve.
If companies defi ned their target audience and then crafted appro-
priate messages, they could practically read their customers’ minds. They
would always know what customers wanted and could deliver the right
products at the right prices at the right time.
How is this possible? It’s possible if companies that do business to-
gether “friended” each other on Facebook or other similar types of so-
cial media platforms. For instance, if companies linked their company
Facebook pages with those of their repeat customers and their main
suppliers, they would have a powerful real-time communication plat-
form in place to work with all the companies in their extended supply
chain.
Once they had this real-time communication platform in place, the
next thing companies could do is use it to “communicate with” instead
of just “talk at” their customers and suppliers. Meaningful communi-
cation starts by asking relevant questions. Instead of a company telling
its customers what it has for sale, it could ask customers what they
Supply Chain Innovation for the Real-Time Economy 239
would like to see the company sell. Companies could ask customers
what their problems are and fi nd ways they might be able to help.
Companies could suggest ideas for products and services and see how
customers reacted.
Social media is a two-way medium. The power of social media is
that it puts out messages and also returns messages and does so in real
time. And that capability is what creates the feedback loops that enable
companies to understand what their customers want so they can stay
close to them over time as the world changes. This is how companies can
have the right product at the right price at the right place and right time.
Social media used this way connects companies with their best cus-
tomers and their most important suppliers. It makes possible the two-
way communication that generates the feedback they need to sense and
respond to constantly evolving situations and desires of customers and
suppliers.
Chapter Summary Collaboration and coordination are the keys to effective supply chain
performance and profi tability in this century. In the slower moving and
more predictable economy of the last century, most companies placed
their emphasis on the use of centralized command and control to achieve
performance and profi tability goals, but command and control tech-
niques do not perform well in fast-paced and unpredictable markets like
those we live with now. Practices from CPFR can be used to improve
collaboration and the S&OP process provides ways to improve coordi-
nation within and between companies.
A category of online computer games known as MMOs provides
technology and innovative ideas for creating the kind of real-time simu-
lation and monitoring systems that companies can use to work together
in global and regional supply chains. Because profi t margins are thin
and supply chains are complex it is increasingly risky for supply chain
240 ESSENTIALS of Supply Chain Management
practitioners to learn by trial and error alone; they are prone to mak-
ing expensive mistakes that can threaten a company’s viability. Using
MMOs, people can take advantage of real-time reporting of actual sup-
ply chain status (BI); they can try out plans of action to see the probable
result (simulation modeling); and they can then select the best plan and
coordinate with each other to carry out the plan successfully (BPM).
The larger companies that have been in existence for a while of-
ten use EDI or XML to make electronic connections and send supply
chain data to each other. These technologies work well for those that
can afford them, but they are expensive and complicated and smaller
and newer companies often do not have the capability or desire to work
with those technologies. They use simple methods such as e-mail and
faxes to send data to their supply chain partners, which causes delays in
data transmission and is the source of many errors in the data.
The spread of cloud computing and wireless broadband Internet
connections makes it possible to offer an inexpensive and easy-to-use
data connection technology. Such a system will not be able to do every-
thing that more complex EDI and XML systems can do, but it will still
deliver better results. This is because simple systems that deliver accurate
data in a timely manner will outperform complex systems hampered by
data that is not timely or accurate.
The use of social media to assist in the coordination of business
activities is only starting to be explored. There is an emerging class of
software that is patterned on social media but which also has additional
features such as better data security and better administrative monitoring
and control features. This kind of social media software used in busi-
ness can provide a real-time communication capability that companies
can use to stay close to the changing desires of their customers and the
changing trends in their markets.
241
CHAPTER 8
Defining Supply Chain Opportunities
After reading this chapter you will be able to
● Apply the market-analysis framework to define the type of markets your company serves and identify the performance capabilities most valuable to those markets
● Define performance targets for your company to succeed in the markets you serve—the goal
● Create a strategy and define the objectives needed to reach the goal
● Estimate the budget needed for this effort and calculate the return on investment (ROI)
● Create the high-level project plan that will guide the effort
N ow that conscious design and real-time management of a com-
pany’s supply chain is possible, how does a company use this abil-
ity to its competitive advantage? A well designed and managed
supply chain will enable a company to offer high levels of customer
service and at the same time hold its inventories and cost of sales to
levels lower than its competitors. This chapter will lay out a process to
use for defi ning the supply chain management opportunities available
to a company.
Essentials of Supply Chain Management, Third Edition by Michael Hugos
Copyright © 2011 John Wiley & Sons
242 ESSENTIALS of Supply Chain Management
The Supply Chain as a Competitive Advantage As companies such as Wal-Mart and Dell Computer have so clearly
shown, if a company can design and build a supply chain that is respon-
sive to market demands, it can grow from a small company to become
a major player. Effi cient supply chain operations are central to being
able to satisfy market demands and to do so in a way that is profi table.
Where once markets were shaped by the availability of product, now
they are shaped by the evolving demands (some might say whims) of
the end-use customers. Availability of most products is now taken for
granted. So in addition to the product itself, the market has a host of
other requirements in the areas of customer service, demand fl exibility,
and product development. A company needs to understand where it fi ts
in the supply chains of the markets it serves. Then it needs to decide
which activities it will focus on to deliver value.
Supply chains that deliver the best value to their end-use customers
generate a strong demand for products and services. They are good
places for producers, logistics providers, distributors, and retailers to do
business. The effi ciency of the entire supply chain greatly affects each
company’s ability to prosper, so standards of performance evolve in these
supply chains over time. New companies cannot enter unless they can
meet these standards. What this means is that companies who are good at
their core supply chain operations work together in self-selecting supply
chains to deliver the greatest value to the end-use customer.
It also means that there is great profi t potential to be had for com-
panies in a supply chain that learn to cooperate to generate effi ciencies
and cost savings for all. Skilled companies in specifi c markets that learn
to work together to achieve new levels of effi ciency and cost savings will
create supply chains that grow faster than other supply chains in their
markets.
We may even begin to look at a market in terms of the compet-
ing supply chains that support it instead of just the competing supplier
Defining Supply Chain Oppor tunities 243
companies within the market. Just as we now rate individual companies
by their profi tability and customer-service levels, we may begin to
measure entire supply chains on their overall performance in these areas.
Identify the Business Opportunity and Defi ne the Goal Supply chain opportunities generally come in one of two categories.
The fi rst category is to fi x or improve something already in place. The
second category is to build something new. In both categories you have
to fi rst defi ne the goal and then set about accomplishing that goal. De-
pending on which type of opportunity you are pursuing, the way to
accomplish the goal will be different.
If you are pursuing an opportunity that is in the category of “fi x
or improve something already existing,” then use Mr. Goldratt’s theory
of constraints as your guidelines for taking action. These guidelines are
summarized in an executive insight section in Chapter 6 (see page 191).
If you are going after an opportunity in the “build something new” cat-
egory, then use the process outlined in this chapter.
New markets emerge, existing markets evolve, and mature mar-
kets fade away. A market creates a demand for a bundle of products
and services to support it. Over the life span of a market, its supply
chain evolves in response to the forces of supply and demand. Com-
panies that supply a market must evolve along with the demands of
that market. What are the markets your company serves and who
are the end-use customers in these markets? Who are the producers
in these markets? Who are the distributors, the logistics providers,
and the retailers? What are the products and services demanded by
this market?
What is the supply and demand situation in the markets you serve?
The supply chain opportunities available to a company depend on
which quadrants the markets it serves are in. Use the market-analysis
framework to determine which market quadrants your company deals
244 ESSENTIALS of Supply Chain Management
with. Which quadrants are your markets in today? Which quadrants do
you think they will be in two years from now? Compare your organiza-
tion against competing organizations in your markets. Identify whether
you lead, equal, or lag your competitors in the areas of:
• Customer Service
• Internal Effi ciency
• Demand Flexibility
• Product Development
Each market is best served by some combination of performance in
these four areas. Defi ne whether your company needs to lead, equal, or
even excel in each of these areas. Identify the position your company
needs to take in the four areas to best align itself with the demands of
the markets it serves.
As discussed in Chapter 5, a company must lead in demand fl exibil-
ity if its customers are in a mature market, and it must lead in internal
effi ciency if its customers are in steady markets. A company must excel
in product development if it serves developing markets, and companies
must meet high customer service standards in all of the markets they
serve. Set the performance targets your organization needs to achieve
alignment with the markets it participates in. These performance targets
infl uence the goals a company selects and they become the measures of
its success.
Create the Strategy Once a business goal is defi ned and the related performance targets are
set, the next step is to create a strategy to accomplish this. Strategy can
be defi ned as simply, “the use of means to achieve ends.” In other words,
a strategy uses the business operations (means) of an organization to
achieve its goals (ends).
Defining Supply Chain Oppor tunities 245
To defi ne the strategy, begin by looking at the supply chain opera-
tions that are performed in your company. Achieving the performance
targets that have been set will require improvements in one or more of
the four categories of business operations that are used to manage the
supply chain:
1. Plan
2. Source
3. Make
4. Deliver
Use Brainstorming to Generate Ideas
Brainstorm a large list of improvement ideas for the operations under each
of the four categories. Ask the question, “What seems impossible to do,
but if it could be done, would dramatically change the way we do busi-
ness?” Look for ways to change the business landscape—ways to give your
organization a signifi cant competitive advantage by doing something new
and different. Where no new ideas are found, look for ways to signifi cantly
improve existing operations to get greater performance and increased cost
savings. Better effi ciencies in existing operations will rarely provide huge
business wins, but they help ensure the company’s survival.
Take the time to work up a large list of ideas. These ideas are the
raw material from which the business strategy will emerge. When a
suffi ciently large body of ideas has been generated, review the lists and
select three to six or so of the ideas that seem to have the most impact.
These are ideas that will deliver improvements in multiple operations
or performance categories. They are also ideas that promise the greatest
payback and have the highest likelihood of success. These are the ideas
that now need to get further attention. They will be the foundation
upon which the strategy is based (see Exhibit 8.1).
246 ESSENTIALS of Supply Chain Management
Improve Selected Business Operations to Meet Performance Targets
PERFORMANCE CATEGORIES
BUSINESS OPERATIONS
CUSTOMER
SERVICE
As measured by: Fill Rate; On-Time Delivery;
Product Returns
INTERNAL
EFFICIENCY
As measured by: Inventory Turns; Return on Sales;
Cash-to-Cash
DEMAND
FLEXIBILITY
As measured by: Cycle Times; Upside Flex; Outside Flex
PRODUCT
DEVELOPMENT
As measured by: New Prod. Sales;
% Revenue; Cycle Time
Demand Forecasts X
Product Pricing X X
Inventory Management
X
Procurement X X
Credit & Collections X
Product Design X
Production Scheduling
X X
Facility Mgmt. X X
Order Management X
X
Delivery Scheduling
Return Processing X X
D E
L
I
V
E
R
M A K E
S O U R C E
P L A N
X
X X
X
X
X X
X
X
Network Services set a goal and performance targets that called for improvements in the categories of customer service and demand flexibility. To excel in these two categories, Network Services Co. had earlier made major improvements in its credit and collections operations. Next, it decided to improve its demand forecasting, product pricing, and order management operations.
EXHIBIT 8.1
Defining Supply Chain Oppor tunities 247
Examine this handful of most promising ideas that have been se-
lected. How will these ideas play out over the next few years? How do
these ideas work together to form a big-picture sequence of events that
will take the organization from where it presently is to where it wants
to go—the accomplishment of its business goals? What things have to be
done, what new operating procedures and information systems need to
be created in order to carry out these ideas? What are the best guesses
as to the time it will take to create these new operating procedures and
systems?
Look to see how these ideas relate to each other. Does the imple-
mentation of one idea build upon the implementation of a previous
idea? What sequence should be followed in the implementation of these
ideas? What kind of changes in operations, technology, and staffi ng are
called for to implement each idea and how can these changes be done
in a manageable way? How can the implementation of these ideas be
broken up into phases that can each be completed in three to nine
months? A phase needs to create deliverables that provide value in their
own right and that can be put to use as soon as the phase is completed
(see Exhibit 8.2).
It is important to both see the big picture that stretches over a period
of several years and also to segment this big picture into smaller phases.
This way the company is able to begin receiving tangible benefi ts from its
work in a relatively short period of time. It can also respond to new devel-
opments in the business environment in a timely manner by adjusting its
strategy, as necessary, as it completes each phase. There is a saying that sums
up this approach very nicely: “Think big, start small, and deliver quickly.”
Create a Conceptual System Design The strategy to achieve the business goals is expressed in the conceptual
design. The conceptual design is the high-level outline of a system or a
set of systems. Generate several different conceptual designs for systems
248 ESSENTIALS of Supply Chain Management
EXHIBIT 8.2
Defining Supply Chain Oppor tunities 249
that will meet the desired performance criteria. Approach the concep-
tual design fi rst from the perspective of the business processes that are
supported. Sketch out the different operations that are performed and
note the kind of information that is required by and created by each
operation.
Then add further defi nition to these process fl ows by specifying
the data fl ows into and out of each operation. For each operation, es-
timate the volume and frequency of the data fl ows and also the source
and destination of each data fl ow. In addition, for each operation, de-
fi ne the types of people (if any) who will perform this work. How
many people will there be? What are the skill levels of the different
types of people? This kind of business process diagram is illustrated in
Exhibit 8.3.
Next, decide which operation will be automated, which will be
manual, and which will be part automated and part manual. As a rule,
people will like systems that automate the rote and repetitive tasks and
empower them to do the problem-solving and decision-making tasks
more effectively. People really are the most valuable resource of any
company, so design systems that make maximum use of their skills.
Technology’s role is to support the people who use it, not the other
way around.
Evaluate the existing computer system’s infrastructure in your or-
ganization. Look for ways to build on that infrastructure. The most cost-
effective systems are those that deliver valuable new capabilities to an
organization quickly and with a minimum of effort.
Select the simplest combinations of technology and business pro-
cesses that will meet the specifi ed performance criteria. Balance the
need for simplicity with the ability to increase the capacity of the
system to handle greater volumes of data and to add new functional-
ity as the business operations grow in volume. And remember that
markets move over time from one quadrant to another, so build a
supply chain infrastructure that is fl exible enough to change with the
250 ESSENTIALS of Supply Chain Management
Diagram of the Business Process Flows
This diagram shows the business process flows that were included in the design of the first version of the Network Services e-business system.
EXHIBIT 8.3
needs of the markets your company serves. Do not design a system
that locks the company into one way of operating and that is not
capable of evolving to support new operations.
Defining Supply Chain Oppor tunities 251
Create high-level schematic diagrams to illustrate each conceptu-
al system design. In these diagrams use simple shapes like cubes and
cylinders and spheres to represent different components of the design.
Connect these shapes with lines and arrows to show the direction of
data fl ow and activity. Do not get too technical or detailed in these dia-
grams. Their purpose is to quickly communicate the basic structure of
the proposed designs. See Exhibit 8.4 on page 256 for an example of a
conceptual system design.
These schematic diagrams are invaluable in communicating the
features of the different designs to a wide audience of people. Re-
views and comments should be sought from people who will use the
new system, people who will pay for it, and people who will build it.
Thoughtful input from a wide audience of people is very helpful in se-
lecting the best design and then in adjusting that design to increase the
likelihood that it will succeed.
Strategic Guidelines for Designing Systems Designing supply chain systems or any other kind of system can quickly
become a very complex undertaking. The business manager can come
to feel overwhelmed by the possible choices and be tempted to leave
this activity to the technical experts. Do not give in to this temptation.
Business management must remain actively involved with the technical
people in creating the conceptual design for the system. It is in this activ-
ity that the business manager can exercise very effective control over the
strategy that the company will take to accomplish its goal. This activity
cannot be left entirely to technical people because they usually do not
have the depth of business knowledge that is needed to make the best
decisions.
The best approach is for business and technical people to work to-
gether and generate a number of possible conceptual designs. Evaluate
the goodness of each conceptual design by applying the seven guidelines
252 ESSENTIALS of Supply Chain Management
for the design of new systems. These guidelines provide a basis to com-
pare different designs and to select the conceptual design that has the
best chance of success. A design that respects all seven of these guide-
lines is the best. It may still be a workable design if one or two of these
guidelines are violated (as long as it is not the fi rst of the seven guidelines
shown). If guidelines are violated, there need to be very good reasons
for doing so and specifi c compensations made to cover those violations.
If three or more guidelines are broken, then the conceptual design is
seriously fl awed and it is very unlikely that the design can be success-
fully built.
The seven system design guidelines are:
1. Closely Align System Designs with the Business Goals and Performance
Targets They Are Intended to Accomplish—For any systems devel-
opment project to be a success it must directly support the or-
ganization to achieve one or more of its goals. No new system
can be effective until you have fi rst identifi ed or created the
business opportunity that will make the system worth building,
and no new system will bring any sustained benefi t to your
company unless it supports the effi cient exploitation of the
business opportunity it was built to address.
2. Use Systems to Change the Competitive Landscape—Ask yourself
what seems impossible to do today, but if it could be done,
would fundamentally change what your company does in
a positive way. Put yourself in your customers’ shoes. In the
words of the Nordstrom’s motto, think of what would “sur-
prise and delight” your customers. Look for opportunities to
create a transformation or value shift in your market. Find ways
to do things that provide dramatic cost savings or productivity
increases. Place yourself in your competitor’s shoes and think
of what course you could take that would be the least likely to
be foreseen or quickly countered or copied. As long as you are
Defining Supply Chain Oppor tunities 253
able to do something of value that your competitors cannot,
you have an advantage. If you are going to take bigger risks
and incur larger costs to develop a system, then make sure it is
a system that will change the competitive landscape. This is the
kind of system that can deliver benefi ts that might justify bigger
risks and costs.
3. Leverage the Strengths of Existing Systems Infrastructure—When
existing systems have proven over time to be stable and res-
ponsive, fi nd ways to incorporate them into the design of new
systems. The purpose of strategy is to best use the means avail-
able to the organization to accomplish its goal. The design of
a system is the embodiment of the strategy being used. Build
new systems on the strengths of older systems. That is what
nature does in the evolutionary process. New systems provide
value only insofar as they provide new business capabilities.
Time spent replacing old systems with new systems that do
essentially the same things will not, as a general rule, provide
enough value to justify the cost.
4. Use the Simplest Possible Combination of Technology and Business
Procedures to Achieve the Maximum Number of Performance Targets—
A simple mix of technology and process that can achieve several
different performance targets increases the probability that at
least some performance targets can actually be achieved. This is
because simple combinations of technology and business pro-
cess reduce the complexity and the risk associated with the
systems. Using a different combination of technology and busi-
ness process to achieve each different performance target multi-
plies the cost and the complexity of the entire undertaking and
reduces the overall probability of success.
5. Structure the Design so as to Provide Flexibility in the Development
Sequence Used to Create the System—Break the system design
into separate components or objectives and, as much as possible,
254 ESSENTIALS of Supply Chain Management
run the work on individual objectives in parallel. Try not to
make the achievement of one objective dependent on the pri-
or achievement of another objective. In this way, delays in the
work toward one objective will not impact the progress toward
other objectives. Use people on the project who have skills that
can be used to achieve a variety of different objectives. If you
use the same technology to achieve several different objectives,
it is much easier to shift people from one objective to another
as needed because the skill sets used are the same. Your project
plan should foresee and provide for an alternative plan in case
of failure or delays in achieving objectives as scheduled. The
design of the system you are building should allow you to cut
some system features if needed and yet still be able to deliver
solid value to the business.
6. Do Not Try to Build a System Whose Complexity Exceeds the Or-
ganization’s Capabilities—The beginning of wisdom is a sense
of what is possible, so don’t bite off more than you can chew.
When defi ning business goals and the systems to reach those
goals, aim for things that are within your reach. Set challenging
goals, but not hopeless goals. The people in your organization
need to have confi dence in themselves in order to rise to a
challenge. Avoid exhausting their confi dence in vain efforts to
reach unrealistic goals.
7. Do Not Renew a Project Using the Same Project Organization
or the Same System Design after It Has Failed Once—A mere
reinforcement of effort or just trying harder is not a suf-
fi cient enough change to ensure the success of a project after
it has failed once. People are probably demoralized after the
fi rst failure and will not rise to the challenge of doing the
work again unless there are meaningful changes in the pro-
ject approach. The new approach must clearly refl ect what
Defining Supply Chain Oppor tunities 255
was learned from the previous failure and offer a better way
to achieve the business goal and performance targets.
Strategic System Guidelines The seven system design guidelines are:
1 Closely align systems with the business goals and perfor- mance targets they are intended to accomplish.
2 Use systems to change the competitive landscape.
3 Leverage the strengths of existing systems infrastructure.
4 Use the simplest possible combination of technology and business procedures to achieve the maximum number of performance targets.
5 Structure the design so as to provide flexibility in the devel- opment sequence used to create the system.
6 Do not try to build a system whose complexity exceeds the organization’s capabilities.
7 Do not renew a project using the same project organization or the same system design after it has failed once.
TIPS & TECHNIQUES
As Chief Information Officer (CIO) of Network Services Company I applied the strategic guidelines for designing systems to create the design for its supply chain and e-business systems infrastruc- ture. Because of my adherence to these strategic guidelines this system was built in a shorter time and for considerably less money than similar systems built by our competitors. This system continues to be used and enhanced as necessary to meet the evolving business needs of the company.
IN THE REAL WORLD
(Continued)
256 ESSENTIALS of Supply Chain Management
I created a conceptual design for Network Services’ systems infrastructure that would best enable it to meet its performance targets. This design was presented to an audience that ranged from the board of directors to senior management to the people who would build the systems infrastructure and the people who would use the systems. Feedback from all these people helped to finalize the design. The schematic diagram for this conceptual design is shown in Exhibit 8.4.
EXHIBIT 8.4
Conceptual Design for E-Business Systems Infrastructure
The systems infrastructure is composed of four main compo- nents that work together to provide a flexible and cost-effective infrastructure that can change as business conditions evolve and can handle greater and greater volumes of data as business operations grow. The four main components are:
IN THE REAL WORLD (CONTINUED)
Defining Supply Chain Oppor tunities 257
1 The Extranet—A high-speed, Internet-based network to provide all member companies with a secure environment in which to exchange information and work together to serve national accounts (also known as a virtual private network or VPN).
2 Web-Based E-Commerce Systems—A suite of systems accessed via the Network Services web site. A packaged system from a software-as-a-service (SaaS) provider named Tibersoft was used to provide order entry, inventory, and order status. Network Services developed the sales history report- ing system. This suite of e-commerce systems was also made available to member companies to serve their local customers.
3 NSC Data Warehouse—A collection of databases to support the web-based e-commerce operations and internal NSC oper- ations such as proposal development, price file maintenance, account book creation, and sales reporting.
4 Data Delivery System (NetLink-NSC)—A two-way, Internet- based data-transfer system to allow each member com- pany’s internal systems to read and write data in a common format to support delivery of seamless and consistent nation- al account service. This component incorporated and reused software from an earlier system that provided for receipt and error checking of invoice data from media companies.
The greatest value for the company lay in the construction of the data warehouse to house the databases and in building the data delivery system called “NetLink-NSC.” Those components working together best meet the performance criteria defined by the com- pany. In order to meet the financial performance criteria and reduce project risk, we decided to lease the use of an existing web-based product catalog and order-entry system instead of building our own.
Defi ne Project Objectives When you look at a schematic diagram that illustrates a conceptual de-
sign, the system is shown as a set of high-level components. Defi ning
these high-level components is a somewhat subjective process since
IN THE REAL WORLD (CONTINUED)
258 ESSENTIALS of Supply Chain Management
there is a range of possible ways to design a system—some better than
others. The better designs will defi ne high-level components that are
highly cohesive in the functions they perform. This means that each
component performs a set of tasks that are all closely related to a single
and well-defi ned activity. For instance, a highly cohesive component in a
conceptual design could be an order-entry system. This component does
all the things that need to be done for a customer to enter an order and
that is all it does.
A component that is not cohesive would be a component that did
order entry and also managed a database of sales information and also
routed orders to different business locations. Showing all those activities
as one component in a schematic design does not provide enough defi -
nition of the design to enable people to evaluate it effectively. This com-
ponent should be broken down into three separate components—one
for order entry, one for database management, and one for data trans-
mission.
The building of each of these high-level components defi nes a set
of specifi c, measurable activities or objectives that need to be achieved
in order to create the system. There will tend to be somewhere between
three and nine high-level components and all other components will
resolve into sub-components of these high-level components. Why only
three to nine high-level components? Because most of us are just regular
folks and we cannot comprehend at a glance or remember more than
seven (plus or minus two) things at a time. A clear and simple system de-
sign goes a long way toward insuring the success of the project because
the people involved with it can understand it.
If a conceptual design is produced that is so complex only a genius
can understand it, then the conceptual design is useless. People will not
be able to use it to effectively guide their work in the detailed design and
building of the system. Without a clear conceptual design, the people
involved with building, using, and paying for the system will all have
different ideas about what the company is trying to accomplish. People
Defining Supply Chain Oppor tunities 259
working on the different parts of the system will fi nd it increasingly
diffi cult to coordinate their actions with each other. The level of tension
and misunderstanding and arguing will rise higher and higher as the
work continues.
The development of each component in the conceptual system de-
sign becomes an objective in the project to build the system. Similar to
the way that a long-term strategy is broken down into self-suffi cient
phases that each provide value in their own right, the building of a new
system should be broken down into a set of objectives that each provide
value in their own right. An objective should not be just an intermedi-
ate step along the way that depends on the completion of some future
step to be of value. Objectives should each be achievable in three to nine
months (or less). Look for objectives that can be achieved quickly. These
will begin providing value and repaying the cost of the project before it
is even entirely fi nished. Once achieved, an objective should become a
base from which other objectives can be achieved.
Also be careful not to defi ne objectives that lock the project into
some rigid sequence of development activities. The world rarely goes
according to plan, so the plan must be fl exible in order to adapt as real-
ity unfolds. Begin work on as many objectives as possible at the same
time (in parallel). As much as possible, make the tasks needed to achieve
each objective independent of the tasks needed to achieve the other
objectives. This provides maximum fl exibility, so that if one objective is
delayed, it will not also delay the completion of other objectives being
done in parallel. Resources can then be shifted from one objective to
another as needed to respond to situations that arise.
Create an Initial Project Plan and Budget It is always a challenge to create a project plan early in the project when
there are so many things that are not entirely known. There will be
much agonizing and grumbling about the plan. People will feel that
260 ESSENTIALS of Supply Chain Management
they are being asked to commit to something that they know very lit-
tle about and that whatever they say will come back to haunt them.
In an attempt to give themselves as much wiggle room as possible,
some people will create plans that are so high level and vague that
they are little more than smoke screens. Other people will plunge into
the task with determination and produce a plan showing minute detail
about things that can hardly be defi ned yet. These plans are little more
than wishful thinking about a future that will probably be nothing like
what is shown.
So what is to be done? Let’s start with a defi nition. Simply stated,
a plan is a sequence of non-repetitive tasks that lead to the achieve-
ment of one or more predefi ned objectives that do not yet exist. A
plan should not be confused with an operating schedule, which is a
repetitive sequence of tasks that perpetuate an already existing state of
affairs. This means that the plan should focus on laying out the tasks that
need to be performed to achieve each objective that was identifi ed in
the conceptual system design. Do not clutter up the project plan with
repetitive tasks that are related to ongoing administrative or business
operations.
Create a section of the overall project plan for each objective. In
the section of the plan for each objective, list the major tasks need-
ed to achieve that objective. There will be tasks related to designing
and then building the deliverables necessary for each objective. Show
the dependencies between the tasks related to an objective and show the
dependencies between the objectives.
When estimating how long each task will take, remember the old
saying that “any job will expand to fi ll the time available.” Use a tech-
nique called “time boxing” to defi ne the time limits for each task. This
technique calls for a trade-off between the work involved in carrying out
a task and the time that is available. Realistic and adequate time periods
must be assigned to each task but then it is up to the people doing the
work to tailor the job to fi t the time that is allocated. When setting these
Defining Supply Chain Oppor tunities 261
time boxes, get input from the people who will be asked to do the work.
In a good plan the time boxes for each task are aggressive and they require
people to work hard and stay focused, but they should not be so aggres-
sive as to make people feel they have no chance of getting the work done.
A useful way to think about the work on a project and the cor-
responding time boxes is to divide time spent on a project into three
main steps and assign an overall time box to each of the main steps. Then
within each step, subdivide the time available to accommodate the tasks
that are involved. The three steps and their durations are:
1. Defi ne What Is Going to Be Done—the goal and the objec-
tives (2–6 weeks or can be shortened to 2 days)
2. Design How That Will Be Done—the detailed specifi cations
(1–3 months or can be shortened to 7 days)
3. Build What Is Specifi ed (2–6 months or can be shortened to
13 days)
For each objective set a time box for the design step and the build
step. Don’t worry about the defi ne step as that is what you are doing
right now and showing it on the plan is not necessary. Look at the tasks
that are required to achieve each objective. For example, let’s say that
Objective A has a one-month time box for design and a two-month
time box for build. Decide which tasks fall into the design step and
which tasks are in the build step. Allocate the time available in design
among the tasks involved and do the same for the tasks in the build step.
You have now subdivided the larger design and built time boxes for Ob-
jective A into smaller time boxes for the tasks that are involved.
Assigning time boxes is an iterative process. It involves adjusting both
the time allocations and the scope of the work that will be done. It will
probably take several passes through the plan before you have something
that seems reasonable—something that is both aggressive and yet still
doable. See Exhibit 8.5 for an example of an initial project plan.
262 ESSENTIALS of Supply Chain Management
How to Create an Initial Project Plan
The Network Services Co. e-business project objectives were defined by the conceptual system design. The conceptual design had four
components:
1 The Extranet
2 Web-Based E-Commerce Systems
3 The Data Warehouse
4 The NetLink-NSCTM Data Delivery System
Thus, the creation of each of these four components became a proj- ect objective. There was also a fifth objective to address the strategy of providing technical skills and resources to member companies. This initial project plan laid out the time boxes for the effort needed to achieve each objective. These time boxes defined the amount of time available for each activity. Work was then tailored to fit the times available.
EXHIBIT 8.5
Defining Supply Chain Oppor tunities 263
Estimate the Project Budget and ROI This is the step where you answer one of the most fundamental questions
about the project—“Is this project worth doing?” Once a plan has been
constructed, the budget can be created. Project plans and budgets are just
two sides of the same coin. Plans show the time, people, and material
needed to get things done and budgets show the cost of the people and
material over the time frames involved. Although, in many cases, the cost
and benefi ts related to a project cannot be defi ned with absolute certainty,
it is still a valuable exercise to get as accurate an estimate as possible.
The value comes in two areas. The fi rst is that this is an opportunity
to create a consensus among the people who have to pay for the system.
Everyone whose budget will be affected by the project should have an
opportunity to review the costs and the benefi ts of the project. It is
often hard to assign specifi c values to the benefi ts but it must be done.
When in doubt, understate the benefi ts—just make sure that the benefi t
numbers are ones that people can understand and support. The sum of
these benefi t numbers is the value of the project and it is very important
to have agreement on the value of a project.
The value of the project is the main reference point to keep in mind
when evaluating the rest of the project. The value of the system is what
tells you how much can be spent to build the system. If the costs to de-
velop a system add up to more than the benefi ts that will be produced,
then there are two choices. Either fi nd a less expensive way to produce
those benefi ts or simply do not do the project. Businesses exist to make
a profi t, and that is a discipline that all business people must live with.
Defi ne the Specifi c Costs and Benefi ts From a fi nancial perspective, a system generates a stream of costs and
benefi ts over the length of time in which it is built and used. As a rule, a
system should pay for itself and return an appropriate profi t within one
264 ESSENTIALS of Supply Chain Management
System Development Sequence
These three steps provide a useful way to think about the work that has to be done to create a new system. Under each step is shown the deliverables that need to be produced, estimating guidelines for how long each step should take to complete, and how much of the total project budget should be spent on that step.
For those of you who will go on to run projects to develop supply chain systems, you can find a more in-depth discussion of the three step, Define-Design-Build process in my book, Building the Real-Time Enterprise: An Executive Briefing. In particular see Chapter 8, “Developing Systems in Real-Time” and Chapter 9, “A Powerful Reinforcing Feedback Loop.”
TIPS & TECHNIQUES
Defining Supply Chain Oppor tunities 265
to three years, because after that time the system will usually need major
enhancements or a complete reworking. Specifi c benefi ts need to be
identifi ed and estimates made of their dollar value. Measure system costs
and benefi ts on a quarterly basis. Subtract costs from benefi ts to arrive
at the quarterly cash fl ow generated by the system. Calculate the value
of that cash fl ow using whatever method the fi nancial decision makers
would like (net present value, internal rate of return, etc.). The higher
the risk involved in building and operating the system, the higher the
profi t that the system should generate.
System Costs
In a system development project there are three types of costs:
1. Hardware and Software—Costs for the hardware, software, and
communication network components that need to be pur-
chased from vendors for the new system design.
2. Development—Costs as estimated by the time and cost needed
to achieve each project objective. Each task that is part of the
work plan for an objective will require some number of people
with certain skills for some period of time. Each task will also
require certain technology and perhaps other expenses, such
as travel, hotel rooms, and meals. Set a standard cost for each
kind of person and estimate the labor expenses for each kind of
person for each step in the system development life cycle: the
defi ne step; the design step; and the build step.
3. Operations—Costs have a number of components. Estimate
labor expenses for the kinds of people that will be needed
for ongoing operation and support of the new system. Esti-
mate the line charges and usage fees for the communication
network and technical architecture used by the system.
266 ESSENTIALS of Supply Chain Management
Obtain yearly licensing and technical support costs from
vendors of the hardware and software components used by
the new system.
System Benefi ts
There are four types of benefi ts provided by a new system:
1. Direct Benefi ts—productivity increases and cost savings due to
the capacity increases brought about by a new system. Defi ne
the new functions the system provides that the company does
not now have. Estimate the productivity increases and labor
savings that these new features provide.
2. Incremental Benefi ts—monetary benefi ts that may not be sole-
ly a result of the new system but are measurable and due in
some signifi cant degree to the capabilities of the new system.
This may be an increased ability to attract and retain new cus-
tomers and the extra revenue that generates. It may be the new
system’s ability to help the company avoid bad decisions or
manage and plan for certain business expenses and the reduced
costs that result.
3. Cost Avoidance Benefi ts—savings related to the increased ca-
pacity provided by the new system and the company’s ability
to grow the business without having to hire new staff or hire as
many new staff as would otherwise be the case.
4. Intangible Benefi ts—hard to quantify into a monetary amount,
but should be identifi ed and listed. These benefi ts include such
things as maintaining a competitive advantage through better
intelligence and adaptability; superior service levels that solidify
customer relationships; and leveraging the abilities of talented
employees and increasing their job satisfaction.
Defining Supply Chain Oppor tunities 267
Sample Cost/Benefit Analysis
ITEM PRICING SYSTEM—TOTAL ESTIMATED COSTS AND BENEFITS
Project Description
Build system to assist staff of account development group to more quickly create contract proposals and explore impact of different product costs and pricing structures. Monitor status of existing contracts and provide notice before cost supports expire.
Project Costs and Benefits (Dollars in Thousands)
Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 5 Totals
Hardware & Software
(7.0) (7.0)
Development Costs (68.5) (68.5)
Operating Costs 0.0 (1.2) (1.2) (1.2) (1.2) (4.8)
Total Costs (75.5) (1.2) (1.2) (1.2) (1.2) (80.3)
Direct Benefits 0.0 8.4 8.4 8.4 8.4 33.6
Incremental Benefits
0.0 30.0 30.0 30.0 30.0 120.0
Cost Avoidance Benefits
0.0 18.2 18.2 18.2 18.2 72.8
Total Benefits 0.0 56.6 56.6 56.6 56.6 226.4
Net Benefits ($75.5) $55.4 $55.4 $55.4 $55.4 $146.1
Cumulative Benefits ($75.5) ($20.1) $35.3 $90.7 $146.1 Discount Rate 5% (5% per Qtr. = 20% Annual Discount Rate)
Net Present Value 115.2
TIPS & TECHNIQUES
(Continued)
268 ESSENTIALS of Supply Chain Management
TIPS & TECHNIQUES (CONTINUED)
Detailed Schedule of Costs
Cost of Hardware & Software (Dollars in Thousands)
Item Description Cost Application Server Server to run the system—allocate
1/3 of server cost 3.0
Personal Computers PCs for use by staff—allocate 1/3 of cost
3.0
Programming Language Allocated cost of programming language and tools
0.5
SQL Server Database Allocated cost of SQL Server and tools 0.5
Total $7.0
Cost of Development (Dollars in Thousands) Task Description Cost Define Phase 5 days at average cost of $900 per day 4.5
Design Phase 15 days at average cost of $900 per day 13.5
Build Phase—Coding 30 days at average cost of $900 per day 27.0
Build Phase— Test & Train
30 days at average cost of $650 per day 19.5
Build Phase—Roll Out 5 days at average cost of $800 per day 4.0
Total $68.5
Cost of Operation (Dollars in Thousands)
Activity Description Cost
Qtr 1
Qtr 2 Incremental costs of operating the system 1.2
Qtr 3 Incremental costs of operating the system 1.2
Qtr 4 Incremental costs of operating the system 1.2
Qtr 5 Incremental costs of operating the system 1.2
Total $4.8
Defining Supply Chain Oppor tunities 269
Detailed Schedule of Benefits
DIRECT BENEFITS (revenue and cost savings due to productivity improvements)
Direct Benefit 1 Save staff time on proposal creation: 10 pro- posals per Qtr.; 20 Hrs. per proposal; $35/Hr.
Direct Benefit 2 Do 2 additional proposals per Qtr.; 20 Hrs. per proposal; $35/Hr.
Value of Incremental Benefit (Dollars in Thousands)
Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 5
Save time on proposals 7.0 7.0 7.0 7.0
Do 2 additional proposals 1.4 1.4 1.4 1.4
Total Direct Benefit $0.0 $8.4 $8.4 $8.4 $8.4
INCREMENTAL BENEFITS (benefits due in part to new system, e.g., attract new customers, make better decisions, etc.)
Incremental Benefit 1 Win more proposals due to better pricing decisions: $30,000 per Qtr. in additional profits
Incremental Benefit 2 —
Value of Incremental Benefit (Dollars in Thousands)
Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 5 Win more proposals 30.0 30.0 30.0 30.0
Incremental Benefit 2 — — — —
Total Incr. Benefit $0.0 $30.0 $30.0 $30.0 $30.0
COST AVOIDANCE BENEFITS (savings related to growing business without needing to add new staff or incurring other expenses)
Cost Avoidance 1 Avoid hiring more staff as business grows: half a person per year; $35/Hr.
Cost Avoidance 2 —
TIPS & TECHNIQUES (CONTINUED)
(Continued)
270 ESSENTIALS of Supply Chain Management
TIPS & TECHNIQUES (CONTINUED)
Value of Cost Avoidance (Dollars in Thousands)
Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 5 Avoid hiring more staff 18.2 18.2 18.2 18.2
Cost Avoidance 2 — — — —
Total CA Benefit $0.0 $18.2 $18.2 $18.2 $18.2
INTANGIBLE BENEFITS (benefits that are hard to quantify in dollar amounts but that should be identified and listed)
Maintain Competitive Advantages
• Item Pricing system should be a competitive benefit for next 2 yrs.
• After that, it will simply become a necessary tool to do business
Provide Superior Service Levels
• Provide customers and prospects with timely and accurate proposals
Increase Job Satisfaction
• Release staff from tedious and time consuming pricing calculations
• Allow staff to focus on more valuable and interesting work
Chapter Summary The work of defi ning supply chain opportunities will be complete when
the following fi ve deliverables are produced:
1. A clear statement of the business goal to be accomplished.
2. The performance criteria required from the system. These
criteria fall into four measurement categories: (1) internal
Defining Supply Chain Oppor tunities 271
effi ciency; (2) customer service; (3) demand fl exibility; and (4)
product development. These are the conditions of success that
the system must meet.
3. A conceptual design for a system to accomplish the business
goal and meet the performance criteria. The system design is
composed of people, process, and technology. The conceptual
design is the embodiment of the strategy being used to attain
the goal.
4. A defi nition of the project objectives that are needed to build
the system. The objectives are the things that must be built to
create the system outlined in the conceptual design.
5. A cost/benefi t analysis that verifi es that the project is worth
carrying out. The senior business executive or management
group who is responsible for accomplishing the business goal
that the system will address must confi rm that this analysis
is valid.
In formulating supply chain improvement projects, it is a far better
approach to successfully carry out a sequence of small steps than to at-
tempt to make a great leap forward and risk falling short. In an approach
that involves taking a sequence of smaller steps, the stakes at each step are
modest and the work is more manageable, so success is easier to achieve.
In the approach of taking a great leap forward, the stakes are high—the
work is enormous, success is harder to achieve, and the cost of failure
is high.
273
CHAPTER 9
Creating Supply Chains for Competitive Advantage
After reading this chapter you will be able to
● Understand how one company created customized supply chains for its customers and in doing so created a strong competitive advantage for itself
● See how to apply concepts and techniques presented in this book to respond to real-world supply chain challenges and opportunities
● Gain some insight into how to leverage supply chain capabilities into longer-term alliances with the customers and suppliers with whom you do business
I n many organizations supply chain management has gone from poor
cousin to high strategy over the last 25 years. We have seen how com-
panies such as Wal-Mart and Dell have risen to market prominence
through their development and use of highly effi cient supply chains.
What can we learn from their success and the successes of other com-
panies about creating supply chains that become major competitive
advantages?
Essentials of Supply Chain Management, Third Edition by Michael Hugos
Copyright © 2011 John Wiley & Sons
274 ESSENTIALS of Supply Chain Management
In this chapter we will use a case study of a fi ctitious company named
Charlie Supply, Inc. to present ways in which a company can create supply
chains that deliver key competitive advantages. We start with a description
of Charlie Supply and its business goal. Then we discuss an initial business
situation and a follow-on situation. For each situation there are exercises
to work through that explore ways the company can recognize supply
chain opportunities and respond effectively to capitalize on them.
I invite your e-mail responses ([email protected]) to the supply
chain solutions I offer in this chapter. What do you agree with? What
would you do differently? Why?
Charlie Supply Inc.—The Initial Business Situation Charlie Supply, Inc. is a $2.8 billion company that distributes food-
service items, janitorial supplies, and equipment. The company has
grown rapidly over the last fi ve years. It has acquired 13 separate com-
panies during that time. Eight of these companies were major regional
distributors of janitorial and/or foodservice supplies and fi ve recent
acquisitions were smaller distributors who specialized in one or the
other of these product lines. Each had good reputations with their
local customers and Charlie Supply acquired them in order to round
out its geographical coverage in areas where it needed a stronger local
presence.
Charlie Supply has followed a policy of decentralized manage-
ment and left the companies it acquired largely free to run their own
operations as they see fi t. Each company or “business unit” as they are
called, has certain sales targets and profi tability levels that they need to
meet. They are also required to buy 80 percent of their inventory from
an approved list of manufacturers where the company has negotiated
special purchasing and support contracts.
The business units serve their own local customers and, increas-
ingly, they work together to win contracts from large national account
Creating Supply Chains for Competitive Advantage 275
customers. Local customers often pay a higher price for their products
but they also buy smaller amounts. National accounts negotiate lower
prices but they buy much more. National account business is growing
because more big customers want a single supplier who can service all
their facilities across the country and also deliver a range of products and
customized supply chain services to help them manage their business
and lower their operating costs.
The information technology (IT) infrastructure of each of the busi-
ness units varies widely. Some of the bigger business units that have mul-
tiple branch locations now run a single, full-featured enterprise resource
planning (ERP) system provided by a leading software vendor. Other
business units still use custom-built suites of systems developed when
they were independent companies. The smaller business units run several
different ERP packages designed for smaller companies. These systems
have been adequate to support operations up to this point. They run on
a range of different computer hardware and operating systems. In two
cases IT vendors have informed a smaller business unit that they must
upgrade or else lose technical support on their hardware and software in
the next 24 months.
All of the business units have interfaced their individual ERP systems
to a system that Charlie Supply developed to enable the business units
to exchange key data fi les with systems at corporate headquarters. That
system is called the Inter-Company Communications Link (ICCL).
All of the business units and company headquarters can electronically
exchange six documents between their internal ERP systems and the
ICCL system. Those documents are: (1) purchase orders; (2) invoices; (3)
advance ship notices; (4) customer price books; (5) product masters; and
(6) inventory stock status. There is a transaction-processing database built
into ICCL that stores these documents and provides for some limited
usage reporting.
The ICCL system also has connections to many of the company’s
customers and with the manufacturers whose products the company sells.
276 ESSENTIALS of Supply Chain Management
It can send and receive purchase orders and invoices between the business
units and these customers and manufacturers. The system does have some
drawbacks in the way that it does error checking, so errors in orders, in-
voices, and product data can take longer to detect and correct than would
be the case if every business unit was using the same ERP system.
The Business Goal
Charlie Supply just fi nished its four-year strategic plan. Among other
things, this plan calls for the company to grow its total sales to $5 billion
over the next four years. Management has decided that this growth
should come from increasing sales to local customers by 50 percent and
by growing national account sales by an additional $1 billion. To support
this growth the company realizes it will need to review and reengineer
selected business processes and the information systems that support
those processes.
Senior management spent a lot of time defi ning the company’s mission
or goal for the next four years. There were some who felt the goal should
be a specifi c revenue target. Others felt this was too limiting and should
instead be more of a statement of the company’s intention. It was decided
that the goal would be a statement of senior management’s intent and
that there would be a short list of performance requirements such as the
$5 billion sales target and others that would be the tangible measures of
success that the company will use. The company’s goal is stated as follows:
“Create the low cost and highly responsive supply chain needed to be the
distributor of choice in the markets we serve.”
Business Strategy
Charlie Supply is a distributor, and distribution is a tough business.
Gross margins are under more pressure than ever and national account
Creating Supply Chains for Competitive Advantage 277
customers especially are continuously squeezing them. Charlie Supply
needs to differentiate itself in some signifi cant way or else engage in a
“grim race to the bottom” with its competitors as gross margins get
squeezed to small single digit percentages.
Results of some of the analysis done during the strategic planning
process are shown in Exhibit 9.1. Based on the markets being served
and the strengths of the company, senior management has decided on
a strategy it will use to accomplish the company’s goal. The strategy is
to develop a suite of supply chain service offerings that can be mixed
and matched to meet unique customer needs. The company will fi nd
customers who need these services in addition to the products them-
selves and who will pay a few additional percentage points on the item
prices in order to get them. It may not be possible to charge individu-
ally for specifi c supply chain services but management believes that
the services can be bundled with the company’s products and sold as
a total package.
The business plan calls for the company to place its main focus on
selling to new national accounts. Management feels the need to stabilize
company growth and market share by acquiring a portfolio of multi-
year contracts with big customers who each generate annual revenues
of $10 million or more. Charlie Supply already has a group of national
accounts and it is starting to see a good deal of similarity in the requests
from these companies.
These big customers are consolidating their procurement activities
and looking for single suppliers who can support them nationwide. It
is also most likely that these big customers are the ones who value the
supply chain services Charlie Supply can offer. This is especially true if
these customers are in certain vertical markets where the products that
Charlie Supply provides are central to the customer’s daily operations.
Given Charlie Supply’s product offerings, that means customers such as
national restaurant and grocery store chains, big property management
companies, and building maintenance companies, to name a few.
278 ESSENTIALS of Supply Chain Management
Results of Business Analysis for Strategic Plan
MATURE
Customer Service Demand Flexibility Internal Efficiency
(Market Served)
STEADY
Customer Service Internal Efficiency
(Market Served)
S U P P L Y
DEVELOPING
Customer Service Product Development
GROWTH
Customer Service
D E M A N D
The performance requirements for success in each market quadrant are shown in this table. Charlie Supply currently participates in the supply chains of MATURE and STEADY markets (see page 138, A Framework for Performance Management).
Competitive Analysis LAG EQUAL LEAD EXCEL
Customer Service X
Internal Efficiency X
Demand Flexibility X
Product Development X
Competitive analysis shows Charlie Supply to equal its main competitors in two of the performance areas and to lag in one area and lead in the other. Charlie Supply has long had a reputation for good customer service and it shows in the customer surveys. Because of all its recent acquisitions though there is still some redundancy in its facilities and systems and although its operations are well run, they do not enjoy the economies of scale and thus are not as efficient as those of its main competitors.
EXHIBIT 9.1
Creating Supply Chains for Competitive Advantage 279
One national account in particular is growing fast. This customer
is a national restaurant chain named Green Planet. These cozy neigh-
borhood restaurants serve prepared organic foods from brownies and
chicken salad sandwiches on whole grain bread to full frozen dinners
that can be heated and served to patrons at the restaurants or sold to cus-
tomers who take them home to eat. In addition to providing great food,
Green Planet is committed to promoting sound environmental practices
and prides itself on its use of products that are environmentally friendly
and recyclable.
Because of its great food and the growing public awareness and de-
mand for organic food, the company’s growth has been tremendous and
it is opening up more and more restaurants every month. The company
is continuously challenging Charlie Supply with new requests and
requirements. It needs both products and supply chain services to sup-
port its growth and manage its operating costs.
Exercise Number 1: Supply Chain Strategy and Projects
Imagine that you are the Charlie Supply executive in charge of de-
livering the supply chain capabilities the company’s strategy calls for.
Take some time to consider how you would go about doing this. What
kind of projects would you start? What would you do about the vari-
ous different ERP systems used by the business units? How would you
schedule the work to be done over the next 12 months?
Go back to Chapter 8 and look at the table in Exhibit 8.1. Which
of these business operations would you improve and why? Then look
at Exhibit 8.5. What would your initial project plans to improve these
business operations look like? When you make your plans, follow the
time boxes suggested in the Defi ne-Design-Build system development
sequence (see Chapter 8). See the sample cost/benefi t analysis at end
of Chapter 8 and use that template to do a cost/benefi t and return on
investment (ROI) calculation for your proposed projects.
280 ESSENTIALS of Supply Chain Management
Take some time now to write up your solution. State the business
operations you will improve and why. Sketch out the initial plans for the
projects to improve these operations and do quick ROI calculations for
these projects. When you are fi nished, compare your ideas to the solu-
tion set I offer in the following section. My solution is not meant to be
the defi nitive answer. It is based on my experience and on discussions
with others who have thought about this. Use it as a point of reference
to evaluate your own ideas.
Solution to Exercise Number 1
Since Charlie Supply serves steady and mature markets, competitive
opportunities lie in improving the capabilities of customer service, de-
mand fl exibility, and internal effi ciency. Given that the company already
has a lead in the customer-service category, the company will get the
best results by building on that strength and improving its customer-
service capabilities to make them even more valuable to its customers.
There is also an opportunity to pull ahead of its competitors in the area
of demand fl exibility. Improvements in these capabilities can be used to
differentiate the company in the eyes of its customers and to provide
value that its competitors cannot provide. Exhibit 9.2 shows where the
company will make its improvements.
If you elected to make improvements in the company’s internal ef-
fi ciency so that it would equal or even lead its competitors in this area
then I believe you have made a mistake. See the seven strategic de-
sign guidelines for designing systems presented in the last chapter on
pages 252–255. The second guideline says to use systems to change
the competitive landscape and the third guideline says to leverage the
strengths of existing systems. If you elected to improve internal effi ciency
by doing something such as putting all the business units on the same
ERP system, you are merely making a “me too” move to try to catch up
with your competitors. It will be a very expensive move as well.
Creating Supply Chains for Competitive Advantage 281
By improving internal effi ciency, you are not changing the competi-
tive landscape because it is unlikely that you will actually exceed the
internal effi ciency of your competitors anytime soon. And by focusing
on trying to improve a weakness you are also missing the opportunity to
leverage existing systems where you are already strong and could quickly
get even stronger. Internal effi ciency lags the competition, but it is not so
bad as to endanger the company as long as it avoids engaging in a price
war with its competitors. And the company has no intention of getting
into a price war, anyway.
Charlie Supply defi ned six performance targets that it would strive
to achieve in the areas of customer service and fl exibility. These perfor-
mance targets are:
1. Take Orders Any Way the Customer Wants (Customer Service)—as
measured by ability to take customer orders through its own
Charlie Supply Decides to Build on Its Strengths to Differentiate Itself
Competitive Analysis LAG EQUAL LEAD EXCEL
Customer Service X X
Internal Efficiency X
Demand Flexibility X X
Product Development X
The decision was made to undertake improvements in customer service and demand flexibility as the way to achieve its business goal. Improvements in these two areas best leverage the company’s existing strengths and they will significantly differentiate Charlie Supply from its competitors. They will change the competitive landscape in the company’s favor.
EXHIBIT 9.2
282 ESSENTIALS of Supply Chain Management
web order entry system, or by electronic data interchange
(EDI), by extensible markup language (XML), or by direct,
computer-to-computer fi le transfer protocol (FTP) with cus-
tomer systems.
2. Deliver Uniform Quality of Service to All Customer Locations (Cus-
tomer Service)—as measured by order-fi ll rate, on-time delivery
rate, and item-return rates.
3. Support Customer Accounting (Customer Service)—as measured
by ability to submit customized, accurate, and timely invoices
and statement bills via whatever medium the customer requests
whether it be EDI, XML, FTP, or e-mail attachments.
4. Support Customer Purchasing and Budgeting (Customer Service)—
by providing them with data for planning and managing their
purchasing budgets through online reports showing product
purchases by customer location, by item, supplier, and volume
over any period from one day to two years.
5. Be a Valuable Partner in the Supply Chain (Demand Flexibility)—as
measured by order-fi ll rate and backorder frequency and back-
order quantities.
6. Participate in Markets as They Evolve (Demand Flexibility)—as
measured by ability to anticipate and stock additional products
outside of the company’s present bundle of products as demand
for them emerges.
Twelve-Month Project Objectives
To meet these performance targets I would make improvements in four
business operations that support supply chain performance. As shown
in Exhibit 9.3 those operations are: (1) demand forecasting; (2) inven-
tory management; (3) order management; and (4) delivery scheduling.
The main thrust of these improvements is to deliver improved customer
Creating Supply Chains for Competitive Advantage 283
service and demand fl exibility. However, since all four of these business
operations also affect internal effi ciency, improvements here will result
in some increase in the company’s internal effi ciency as well. This is also
shown in Exhibit 9.3.
When I look at the four business operations that are to be im-
proved, it is clear that all four of them will benefi t from the creation
of an enterprise data warehouse. This will be my fi rst project. The data
warehouse will provide data to enable better demand forecasting, bet-
ter inventory management, better order management, and better deliv-
ery scheduling.
There is already a transaction-processing database that is part of the
ICCL system. This database is the data source that can be tapped to
populate the enterprise data warehouse. The daily transaction docu-
ments (purchase orders, invoices, advance ship notices, product masters,
price books, and inventory status) that ICCL handles form the foun-
dation from which a very clear and detailed supply chain operations pic-
ture can emerge. This picture can be updated on a daily or even hourly
basis as transactions fl ow through ICCL.
My second project happens once the fi rst version of the enter-
prise data warehouse is in place. Software packages can be interfaced
to the data warehouse. I would interface two packages and make both
packages accessible over the Internet. The fi rst package is demand fore-
casting and the second one is delivery scheduling. This will enable
people in the business to do more frequent 30- to 90-day forecasts as
market conditions change from month to month. These more frequent
short-term forecasts will tend to be more accurate and will provide the
input needed for better inventory management. Using the delivery-
scheduling package, people in the individual business units will be
able to continuously monitor and optimize their delivery routes as the
business grows.
My third project would improve inventory management through
the combination of better product demand forecast data and also better
284 ESSENTIALS of Supply Chain Management
Charlie Supply Strengthens Performance in Customer Service and Demand
Flexibility by Improving Four Business Operations
PERFORMANCE CATEGORIES
BUSINESS OPERATIONS
CUSTOMER
SERVICE
As measured by: Fill Rate; On-Time Delivery;
Product Returns
INTERNAL
EFFICIENCY
As measured by: Inventory Turns; Return on Sales;
Cash-to-Cash
DEMAND
FLEXIBILITY As measured by:
Cycle Times; Upside Flex; Outside Flex
PRODUCT
DEVELOPMENT As measured by: New Prod. Sales;
% Revenue; Cycle Time
Demand Forecasts
Product Pricing X X
Inventory Management
Procurement X X
Credit & Collections X X
Product Design X
Production Scheduling
X X
Facility Mgmt. X X
Order Management
XX
X X
X
Delivery Scheduling
Return Processing X
X
D E
L I
V E
R
M A K E
S O U R C E
P L A N
X
X
X
X
X
X
X
EXHIBIT 9.3
Creating Supply Chains for Competitive Advantage 285
training in the use of the existing inventory management systems already
in place at the business units. The best practices for effective inventory
management have been widely understood since the late 1980s. Most
inventory-management systems developed since the mid-1990s have
incorporated the functionality needed to implement these best prac-
tices. No new systems are needed. What is needed is a renewed com-
mitment to rigorous staff training and increased levels of profi ciency in
using the full functionality provided by existing inventory-management
systems.
The increased training and the more accurate forecasting data will
enable product managers to do a much better job of inventory manage-
ment. New product demand can be better anticipated and inventory
turns can also be increased. Once people have been trained, they should
also have quarterly (not yearly) bonus incentives that keep them focused
on delivering high levels of performance month after month.
The fourth project I would do is a project to improve how the ICCL
system handles errors and status reporting. This will improve order man-
agement because problems and delays that affect customer deliveries,
payments, and so on, will be spotted much sooner. This will enable cus-
tomer-service representatives to be much more proactive problem solvers
with their customers. They will be able to coordinate with customers and
manufacturers more effectively to resolve issues as they arise.
These error handling improvements can be delivered very cost ef-
fectively by using business process management (BPM) software and in-
terfacing it to the ICCL system and its transaction-processing database.
The BPM software will provide a user-friendly Web browser-based
interface and enable business people in customer service, credit, billing,
and so on to defi ne the set of rules they want to apply to each of the
company’s customers and manufacturers. Then the BPM system will
monitor the data fl owing through the ICCL system and send e-mail
alerts to appropriate people when it detects exceptions to these pre-
defi ned rules.
286 ESSENTIALS of Supply Chain Management
The time boxes and the scheduling of these four projects are shown
in Exhibit 9.4. Notice how they are run in parallel as much as possible.
Only project two depends on the prior completion of an earlier project.
Exercise Number 1: Project Completion Schedule
Quarter 1 Quarter 4Quarter 2 Quarter 3
BUILD data warehouse version 1.0
DESIGN data warehouse
DESIGN interfaces
BUILD demand forecasting interface
BUILD delivery scheduling interface
DESIGN inventory training & bonuses
IMPLEMENT training & bonuses
DESIGN error handling for ICCL
BUILD customer service error modules
BUILD other needed error modules
BUILD credit and billing error modules
Project 1: Develop Data Warehouse
Project 2: Interface Software Packages
Project 3: Inventory Management Training
Project 4: Improve ICCL Error Handling and Reporting
Agree on Projects and Budgets
DEFINE projects
Set aggressive but achievable time boxes to accomplish the work involved in each project. Tailor the work to fit the time available. Remember that each project will produce the first version of a system or process. First versions need to have only the most immediately useful features. Get these versions into use as quickly as possible. Further features can be added in following years depending on how business needs unfold.
EXHIBIT 9.4
Creating Supply Chains for Competitive Advantage 287
The other projects all run independently, so a slowdown in one does not
impact completion of the others.
It is also important to notice the time boxes allocated to the design
and build steps in each project. These time boxes must be strictly adhered
to and that means tailoring the work in each step to the time available.
Remember, each of these projects will produce just the fi rst version of a
system. Every feature does not need to be designed and built in this fi rst
version, just the most immediately useful features. Then further features
can be added to these systems in following years as needed. This is agile
systems development.
The projects are almost all scheduled for completion by the end of
the third quarter. It is good to do most project work in the fi rst three
quarters of the year. Use the fourth quarter for fi nishing things up that
got delayed earlier in the year and for planning the following year’s
projects. The fourth quarter also has the year-end holidays and for many
businesses this is a very busy period. Development projects in the fourth
quarter can hamper a company’s ability to handle year-end business.
Integrated Supply Chain Knowledge Manager
Charlie Supply’s strategy is to differentiate itself by excelling at cus-
tomer service and leading in demand fl exibility. Both of these capabili-
ties are directly empowered by the data that these projects will enable
the company to collect. The company’s customers and its manufac-
turers will come to realize the value of the data Charlie Supply can
provide them and this will enhance the company’s image and business
relationships.
These projects combine to put Charlie Supply in a position to be-
come the organization that knows the most about the supply chains it
participates in. This leverages Charlie Supply’s position as the distributor
(the humble middleman) and enables the company to use its position
to collect more information about daily supply chain operations than
288 ESSENTIALS of Supply Chain Management
either its customers or the manufacturers whose products it sells. Sup-
ply chain coordination and effi ciency will become increasingly impor-
tant in the markets Charlie Supply serves. And since coordination and
effi ciency require lots of accurate and timely data, Charlie Supply will
be the company people turn to for the data they need. It is important
to remember that the success of these projects depends on “having the
right people on the bus,” as Jim Collins puts it (Good to Great, New York,
HarperCollins Publishers, 2001). All the visioning and planning is for
naught if we can’t execute. And execution is a people function, so having
the right people is a must.
New Opportunities Emerge—The Follow-On Situation The successful completion of the projects just discussed has enabled
Charlie Supply to grow steadily for several quarters. It is becoming well-
known to the customers and the manufacturers in the vertical markets it
serves. Its ability to maintain consistently high levels of customer service
is indeed making the company the “distributor of choice” as stated in
the company’s business goal.
Big customers realize that by doing business with Charlie Supply
their total cost of use for the products they use is actually lower than
would be the case if they merely bought from the supplier with the
lowest prices. Charlie Supply’s systems allow it to tailor a customized
package of products and supply chain services that meet each customer’s
unique needs. Customers also benefi t from getting access to usage
reports showing the items purchased every day at every one of their
locations. This data is very useful in monitoring and managing current
operating expenses. It is also valuable in planning operating budgets for
the coming year.
Manufacturers who sell to markets served by Charlie Supply are
also coming to realize that Charlie Supply is a very effi cient channel to
market for their products. Charlie Supply’s systems enable it to exchange
Creating Supply Chains for Competitive Advantage 289
electronic purchase orders and invoices with suppliers using any format
(from ASCII to XML) and any medium (from EDI to FTP) that is most
convenient to each supplier. This lowers transaction costs, reduces error
rates, and speeds up cash fl ow. And with select manufacturers, Charlie
Supply also shares daily customer usage data. This enables better demand
forecasting and production scheduling.
Charlie Supply Identifi es a New Growth Market
The markets served by Charlie Supply are mature markets for the most
part and they have been so for some time. The products sold to these mar-
kets are mostly commodities and supply almost always meets or exceeds
customer demand. Under conditions like this you might assume that there
is nothing new and exciting going on. That is exactly the assumption that
Charlie Supply’s competitors made. They continued to focus on improv-
ing their internal operating effi ciencies. While they were occupied with
these activities, Charlie Supply was paying attention to some emerging
sales trends and some interesting developments in its markets.
Charlie Supply has just signed up a large new customer that shares a
number of similarities with another important customer—Green Planet.
These customers are very interested in purchasing environmentally
friendly green products. Both customers are willing to pay a higher price
for green products as long as they can be shown to work effectively and
meet expectations.
The director of marketing at Charlie Supply has done some research
and believes the developing market of green products is just about to go
into a very strong growth phase. Manufacturers’ research and develop-
ment efforts are starting to yield products from green cleaning chemi-
cals to biodegradable plastics for use in making disposable cups, plates,
and eating utensils. Combined with this is the growing trend for certain
infl uential companies and state and city governments to specify the use
of green products whenever possible.
290 ESSENTIALS of Supply Chain Management
Based on this market research and the company’s own recent sales
experience, the senior management of Charlie Supply has entered
into strategic alliances with some manufacturers of green products.
To demonstrate its commitment, the company has made major stock
purchases of inventory from these manufacturers. The company’s entire
sales force is now being educated about these products and new bonus
plans give big incentives to sell green products to customers.
In return for this early support, the manufacturers of these green
products have guaranteed that they will always provide the company
with as much product as they can sell. Even if customer demand exceeds
supply, these manufacturers will make sure that Charlie Supply will re-
ceive as much of their products as it needs. What this means is that if the
green market takes off the company will have a secure supply of highly
sought after (and thus very profi table) products. While other distributors
may not be able to get as much inventory as they need, Charlie Supply
will. So customers will come to Charlie Supply when they need a guar-
anteed source of supply for these products.
Exercise Number 2: Participating in a Growth Market
You have just been promoted to vice president of supply chain operations
for Charlie Supply. As a sign of how important this position has become
you now report directly to the CEO. The CEO has asked you to prepare a
supply chain strategy that you will present to the board of directors.
What will your strategy be and why? What projects will you propose
to support this strategy and how will you schedule them over the next
12 months? How will you support the company’s new strategic alliances
with the manufacturers of green products? Which of the four market
capabilities will you improve and what business operations will you use
to bring about these improvements? Take some time now to think about
these things and draw up your plans. When you are fi nished compare
your plans with the solutions I offer in the following section.
Creating Supply Chains for Competitive Advantage 291
Solution to Exercise Number 2
In a growth market the single most important market capability is cus-
tomer service. Even though the company already excels in customer
service, the company will still get the best results by further improving its
customer service capabilities. The company’s brand image will be shaped
by its abilities in this area. This will make it even more attractive to its
important customers.
There is also an opportunity for the company to pull ahead of its
competitors in the area of product development. Improvements in this
area can be used to support and strengthen strategic alliances with select-
ed manufacturers. In the eyes of these manufacturers the company will
be seen as a desirable supply chain partner for identifying market needs
and bringing out new products. Exhibit 9.5 shows where the company
will make its improvements.
Charlie Supply Continues to Build on Its Strengths for Competitive Advantage
Competitive Analysis LAG EQUAL LEAD EXCEL
Customer Service X
Internal Efficiency X
Demand Flexibility X
Product Development X X
Continue to invest in improving already strong customer service capabilities because that capability is what defines the company’s value and its brand identity in the eyes of its customers. By making improvements in the product development area the company can increase its value as a strategic partner with manufacturers. These improvements will change the competitive landscape in the company’s favor.
EXHIBIT 9.5
292 ESSENTIALS of Supply Chain Management
Once again, if you decided to make investments in improving the
company’s internal effi ciency then you have made a mistake. You got
some improvements in internal effi ciency from the fi rst round of pro-
jects completed earlier but at the same time your competitors continued
to focus on improving their internal effi ciency. You still lag them in this
area. You are not going to change the competitive landscape by improve-
ments there because you cannot be better than your competition.
Internal effi ciency is important in mature and steady markets where
customers are very price sensitive and companies need to lower their
operating costs so they can compete for business by offering lower
prices. However it is not a decisive capability in developing or growth
markets. Focus instead on reinforcing the strengths the company already
has in customer service because they are what you need to succeed in
the growth market the company wants to enter.
Improvements in capabilities related to product development will
also yield a competitive advantage for the company. As a distributor,
Charlie Supply does not actually design or make new products. But it
can be very much involved in identifying emerging market demands and
introducing customers to new products that meet those demands. To the
extent that Charlie Supply is seen by manufacturers to have superior
capabilities in this area, it will strengthen the company’s ability to attract
and provide value to key strategic alliance partners. These decisions are
shown in Exhibit 9.6.
The company identifi ed fi ve performance requirements that it
would strive to achieve in the areas of customer service and product
development. These requirements are:
1. Effectively Employ Collaborative Planning, Forecasting, and
Replenishment (CPFR) Procedures with Key Customers and
Manufacturers (Customer Service)—as measured by the ability
to accurately forecast product demand and manage inventory
to cover actual demand.
Creating Supply Chains for Competitive Advantage 293
Charlie Supply Strengthens Customer Service and Improves Product
Development Capabilities PERFORMANCE
CATEGORIES
BUSINESS OPERATIONS
CUSTOMER
SERVICE
As measured by: Fill Rate; On-Time Delivery;
Product Returns
INTERNAL
EFFICIENCY
As measured by: Inventory Turns; Return on Sales;
Cash-to-Cash
DEMAND
FLEXIBILITY As measured by:
Cycle Times; Upside Flex; Outside Flex
PRODUCT
DEVELOPMENT As measured by: New Prod. Sales;
% Revenue; Cycle Time
Demand Forecasts X
Product Pricing X X
Inventory Management
X
Procurement X X
Credit & Collections X X
Product Design X
Production Scheduling
X X
Facility Mgmt. X X
Order Management X
X
X
X
X
X
Delivery Scheduling X
Return Processing X
X
D E
L I
V E
R
M A K E
S O U R C E
P L A N
X
X
X
EXHIBIT 9.6
294 ESSENTIALS of Supply Chain Management
2. Track Product Movement through the Supply Chain from
Manufacturers to End Use Customers (Customer Service)—as
measured by the ability to provide accurate end-to-end supply
chain inventory visibility, which is updated on a near real-time
basis.
3. Design Responsive Supply Chain Networks (Customer
Service)—as measured by the ability to optimize on-going sup-
ply chain performance for high levels of product availability at
the lowest operating costs.
4. Track Product Sales and Usage to More Quickly Spot Market
Trends (Product Development)—as measured by the ability to
plot trends based on near real-time data updates and quickly
spot developments of interest.
5. Provide Effi cient Pickup and Return Processing of Recycla-
ble Products (Product Development)—as measured by the
ability to optimize retrieval of recyclable material from end-
use customer locations.
Twelve-Month Project Objectives To meet these performance targets I would make improvements in
fi ve business operations. As shown in Exhibit 9.3 (see page 284), those
operations are: (1) demand forecasting; (2) inventory management; (3)
order management; (4) delivery scheduling; and (5) return processing.
The main thrust of these improvements will be to deliver improved
customer service. And to a lesser extent these improvements will also
strengthen the company’s capabilities in product development. This is
illustrated in Exhibit 9.3.
The fi rst project I will start is a project to train selected staff at
headquarters and the business units in the techniques and process of
CPFR (see Chapter 6, page 199). As people learn how to best use the
Creating Supply Chains for Competitive Advantage 295
systems already available to enable better supply chain collaboration
they will see improvements in demand forecasting and inventory man-
agement.
The second project will be to start a pilot application using passive
radio frequency identifi cation (RFID) to better track pallet- and case-
level shipments of some of the green cleaning chemicals. These products
will be much in demand and thus valuable. That makes it worthwhile
to track these products more accurately as they move through the sup-
ply chain. RFID tags could be used to track pallets and perhaps cases of
these products. Knowing where these products are at all times will im-
prove the company’s ability to deliver them to the customer when and
where they are needed.
The next project will be to extend the business process management
(BPM) system to monitor sales of selected green products. As soon as
sales of these products are made to a new customer or if sales increase
signifi cantly to any existing customer the BPM system will send alerts
to appropriate people.
The fourth project will be to interface a network-modeling soft-
ware package to the enterprise data warehouse. Once this is done it will
enable Charlie Supply to collaborate with its manufacturing partners
to design and test the effi ciency of different network confi gurations for
making, moving, storing, and delivering inventories of green products.
This will work both for delivering products to customers and also for
picking up used products that can be recycled. Exhibit 9.7 shows the
project schedules.
The last project will be to implement dashboards and performance
scorecards that are updated in real-time or at least on a daily basis. These
dashboards and scorecards will be displayed and updated by using the
BPM software that has already been installed. Different sets of perform-
ance targets will be defi ned for each group involved in supply chain op-
erations and performance toward these targets will be tracked on score-
cards designed for use by each of these groups.
296 ESSENTIALS of Supply Chain Management
Exercise Number 2: Project Completion Schedule
Quarter 1 Quarter 4Quarter 2 Quarter 3
DESIGN RFID pilot
BUILD RFID pilot system
DESIGN sales tracking rules
BUILD BPM extension to sales
BUILD performance scorecards using BPM
DESIGN scorecards
Agree on Projects and Budgets
DEFINE projects & budgets
DESIGN CPFR training & bonuses
IMPLEMENT CPFR training & bonuses
Project 1 : CPFR Training and Implementation
DESIGN interfaces
BUILD network modeling interface to data warehouse
Project 2 : Implement RFID Pilot
Project
Project 3 : Use BBM Package to Track Sales and Emerging Trends
Project 4 : Interface Network Modeling Package to Enterprise Data Warehouse
Project 5 : Implement Real-Time Performance Scorecards
Again, aggressive but achievable time boxes are set to accomplish the work involved in each project. Tailor the work to fit the time available and remember that each project produces versions of systems that need to have only the most immediately useful features. Other features can be added later as actual business conditions dictate. The work is also heavily loaded in the first three quarters of the year so that the fourth quarter can be used as a wrap up and review period to prepare for the following year’s projects.
EXHIBIT 9.7
There will be scorecards to track performance for groups doing
business operations such as demand forecasting, inventory management,
procurement, credit and collections, delivery scheduling, and return pro-
cessing. Go back to Chapter 5 and review the metrics for performance
Creating Supply Chains for Competitive Advantage 297
measurement and diagnostics suggested by the supply chain oper-
ations reference (SCOR) model. See the sample dashboards shown in
Exhibit 5.2 on page 175.
The operating capabilities provided to people by the fi rst four
projects should all be used to increase performance levels. These perform-
ance capabilities are refl ected in each group’s performance targets. Their
dashboards and scorecards track their actual performance. The point is
to make different business processes visible. Then devise quarterly bo-
nus programs that encourage people to learn to improve and constantly
make the adjustments needed to maintain high levels of performance in
on-going business operations. As this happens, the whole company will
come alive (see Exhibit 9.7).
Respond Effectively to the Opportunities of Growth Markets
In a world where customer demand drives markets, not product supply,
Charlie Supply must be very good at seizing the opportunities presented
to it by a growth market. This kind of market does not come along every
day, so these opportunities cannot be squandered if the company expects
to be successful. The company must develop the skills it needs in its people
to keep up with events as the green products it sells move out of their
development stage and into a major growth market.
Avoid getting bogged down in complicated, time consuming, and
overly expensive projects. Charlie Supply must move fast and light, just
like Alexander the Great! This means creative use of simple tactics and
off-the-shelf technology that empowers and motivates people to work
together (see Chapter 1, page 7). The company’s mission is to conquer
as much market share in this green growth market as possible before
product supply catches up with customer demand and market condi-
tions change.
Because of its excellent customer-service capabilities and manufacturer
alliances, Charlie Supply can compete well against any other distributor in
298 ESSENTIALS of Supply Chain Management
this growth market. But when supply catches up with demand and market
conditions shift into steady and then mature, the two main competitors
of Charlie Supply will have an advantage because of their greater internal
effi ciency. They will be able to offer lower prices to lure customers and
still earn larger profi t margins than Charlie Supply. In steady and mature
markets Charlie Supply has to focus on specifi c customers with unique
needs and avoid getting into price wars with its competitors.
One last point to remember is the power of market perceptions.
Charlie Supply should maximize use of public relations to strengthen
its appeal to customers. The company should be seen as an innovator
and leader in the use of green products in its own operations. For in-
stance, the company can convert some of its own delivery vehicles
to use biodiesel fuel. Biodiesel is a fuel made from vegetable oil that
can be used in a regular diesel engine. It is clean, renewable diesel
fuel from waste vegetable oil that can be sourced from restaurants and
other foodservice operations (often for free). It makes good business
sense and the publicity this generates will be invaluable for building
the company’s reputation. Customers who value green products will
want to do business with Charlie Supply because the company clearly
shares their values.
Strategic Alliances for Competitive Advantage To round out our discussion of creating effective supply chains for com-
petitive advantage, we need to discuss alliances and how to form them.
Effective supply chains are fi rst and foremost alliances between coop-
erating companies. Many people feel that we are entering a time when
competition will not just be between individual companies but instead
will be between contending supply chains. If this is so then it is clear
that some of the most strategic alliances companies make are in regard to
their supply chains. This includes both selecting the suppliers they work
with as well as selecting the customers they sell to.
Creating Supply Chains for Competitive Advantage 299
Let’s start with a working defi nition of what a “strategic alliance”
is. Companies must fi nd ways to outsource activities that are not part
of their core value proposition. In this way each company focuses more
attention and investments on improving its ability to deliver value to
its customers. So a truly strategic alliance is a relationship with another
company that enables the fi rst company to better fulfi ll its core val-
ue proposition to its customers. Strategic alliances can be formed with
other companies to perform a wide range of support activities that are
necessary but not directly connected to producing the core value prop-
osition. This concept of strategic alliances is illustrated in Exhibit 9.8.
Structuring Strategic Alliances
Although the details of every alliance are unique, there is still a com-
mon set of characteristics that all strategic alliances have in common.
This is true for a supply chain alliance as well as any other alliance. A
relationship not exhibiting all of these characteristics is not a strategic
relationship. Strategic alliances display four characteristics:
1. Delivery of a customized blend of products and services to
meet a specifi c set of business needs
2. Coordination of inter-company operations so as to achieve
predefi ned performance targets
3. Longer term, three- to fi ve-year contract time frames for the
alliance partners to work together
4. Prospects for mutually profi table business growth over the
life of the contract
Delivery of a customized blend of products and services to meet
a specifi c set of business needs is the foundation of any strategic alli-
ance. A strategic alliance starts when a company has a set of needs that
go beyond short-term cost reduction. This creates the opportunity for
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Creating Supply Chains for Competitive Advantage 301
an alliance partner to confi gure and deliver an offering to meet these
needs. It is the customized offering that provides the greatest value to the
company receiving it, and also the best profi t margins for the company
delivering it. If there is no need for a customized offering and simple
commodity products or services will suffi ce, then there is no need for a
strategic alliance.
Coordination of inter-company operations so as to achieve prede-
fi ned performance targets indicates that both companies consider the
relationship to be important and not just an arm’s length business trans-
action. It also indicates that the performance targets are challenging and
require more effort to achieve than merely negotiating a reduction in
the prices that one company charges the other. Once the business re-
quirements of the fi rst company are clearly defi ned, then key perfor-
mance indicators (KPIs) should be identifi ed to measure the effi ciency
of the alliance partner in fi lling these requirements.
A longer-term, three- to fi ve-year contract means that both com-
panies agree to make a commitment to the alliance that will provide
time for learning to work together and for improving the effi ciency of
the alliance. The extended time commitment allows the alliance partner
to invest in staff and technology for delivering the customized offering
and meeting the required performance targets. Unless there is a longer-
term time frame for the relationship, there will not be much incentive
for the two companies to make the effort or the investments that are part
of a successful strategic alliance.
Prospects for mutually profi table business growth over the life of
the contract are the reasons why two companies go to the trouble
of forming an alliance. If there are prospects of profi table business
growth for only one company, then whatever the relationship may
be, it certainly cannot be called an alliance. In a strategic alliance one
company outsources support functions in order to concentrate more
on its core value proposition. An alliance partner takes on support
functions and delivers a customized package of goods and services
302 ESSENTIALS of Supply Chain Management
that best fi ts the fi rst company’s business requirements. The alliance
is motivated by the prospect of growth for each partner. As the fi rst
company grows its core business, the alliance partner grows its out-
sourcing business.
Sustainable Growth and Productivity
If a company merely leverages its buying power to ratchet down the
prices it pays to its suppliers, there comes a point where the suppliers
will no longer make money in the relationship. They will then either go
broke or resign the business because of lack of profi ts. Then the company
has to fi nd new suppliers and it may be hard to fi nd them if the business
was so unprofi table to the previous suppliers. Relationships of this sort
are common enough in business, but they are not to be confused with
what we are calling strategic alliances.
Strategic alliances require sustainable growth and productivity.
And that calls for a process that generates rewards in the form of cost
savings and/or revenue growth for both parties. In addition to gen-
erating rewards, this process must preserve and nurture the underlying
source of these rewards. Effective cost management means managing
a ratio of costs versus benefi ts so as to achieve a desired result. Costs
can actually rise as long as the result is still a favorable ratio of costs
and benefi ts.
It is this reality—that costs can rise as long as a favorable cost/benefi t
ratio is achieved—that is the foundation of a sustainable strategic alli-
ance. If the alliance is benefi cial it should result in your company being
able to reduce operating expenses in noncore areas so as to concentrate
on operations that produce your central value proposition. If your com-
pany is successful and grows, this results in increased operating costs to
support the growth. These increases in operating costs are the increases
in revenue and profi ts that your strategic partners need in order to make
the alliance work for them.
Creating Supply Chains for Competitive Advantage 303
The key to sustainable alliances is to defi ne a set of performance
targets that, if achieved, will clearly generate measurable benefi ts such as
increased revenue, decreased operating costs, growth of market share, and
so on. Make sure that the benefi ts can be measured and that a monetary
value can be assigned to them. The purpose of the alliance then becomes
to coordinate activities between companies so as to achieve these benefi ts.
And the alliance is sustained because both your company and the alliance
partner share in the benefi ts that are produced.
The alliance makes money every month from a hundred small ad-
justments that fi ne-tune operations so as to achieve performance targets.
Since the business environment is constantly changing, constant small
adjustments are required to deliver the best possible operating results.
In effect, the agreement between two companies to cooperate is the
capital in the strategic alliance. The continuous steam of cost savings and
revenue enhancements that come from this cooperation is the interest
earned on this capital. And to continue the analogy, we can say that the
better companies become at cooperating with each other, the higher the
rate of interest they earn on their alliances.
In the rush to get as much profi t from a situation as quickly as poss-
ible, it is common for companies to fall into a pattern of behavior that in
effect kills the golden goose. A strategic alliance cannot be a relationship
where the only real objective is expense reduction. All strategic alli-
ances provide a mix of benefi ts. Make sure the mix of benefi ts is clearly
defi ned and their value is understood. Then make sure the benefi ts are
accurately tracked and the rewards shared between both parties.
Chapter Summary Charlie Supply maximizes its supply chain opportunities by building on
its strengths to differentiate itself from its competitors. Charlie Supply is
a distributor that has developed a suite of supply chain services it uses to
customize its total offering to meet specifi c customer needs. By taking
304 ESSENTIALS of Supply Chain Management
this approach, the company has chosen to focus its efforts on doing busi-
ness with customers who need and will pay the price to get the supply
chain services that Charlie Supply has to offer.
This means Charlie Supply will not go after a broad base of cus-
tomers on the basis of offering the lowest prices on products. It cannot
hope to compete this way because its competitors have more effi cient
internal operations. They will be able to make more money in a purely
price-based competition. Charlie Supply chooses instead to focus its
resources on developing its capabilities where it is already strong and
where it can use these strengths to the best advantage.
Charlie Supply invests in improving its customer service and other
capabilities that help it win business from the kind of customers it
desires to do business with. Its strategy is to excel in areas valued by
its target customers. In order to concentrate the resources to excel in
these areas, the company accepts that it will lag its competitors in other
areas such as internal effi ciency. Its internal effi ciency is good enough,
as long as the company does not try to compete solely on the basis of
product prices.
When Charlie Supply encounters the opportunity to distribute new
environmentally friendly green products to a growth market, it moves
quickly to capture market share. It makes early alliances with selected
manufacturers, takes large inventory positions in green products, and
trains and motivates its sales force to fi nd customers for these products.
Charlie Supply maximizes use of its existing IT infrastructure. When
systems are stable and work well enough, they are left in place. Per-
formance improvements are gotten through training staff to use these
systems more effectively and through selected enhancements to these
systems.
New systems development is concentrated in the area of building
an enterprise data warehouse and then interfacing several packaged
software applications to it. These applications will help the company
improve in the areas of demand forecasting, delivery scheduling and
Creating Supply Chains for Competitive Advantage 305
routing, and inventory management. Improvements in these capabilities
can be used for signifi cant business advantage.
All new development projects are accomplished using the three-step
approach called Defi ne-Design-Build. The time frames for each step are
strictly adhered to and work is tailored to fi t the time available. Devel-
opment work is concentrated in the fi rst nine months of the year. The
last three months of the year are then available for fi nishing up delayed
projects and for planning development projects in the coming year.
Charlie Supply looks for opportunities to enter into strategic alli-
ances with its customers and suppliers. Strategic alliances display these
four characteristics:
1. Need for delivery of a customized blend of products and ser-
vices to meet a specifi c set of business needs
2. Need for coordination of inter-company operations so as to
achieve predefi ned performance targets
3. Longer-term, three- to fi ve-year contract time frames for the
alliance partners to work together
4. Prospects for mutually profi table business growth over the
life of the contract
307
CHAPTER 10
The Promise of the Real-Time Supply Chain
After reading this chapter you will be able to
● Appreciate the “always-on” connection and what it means
● Assess the profit potential inherent in the self-adjusting feedback loop and explore how it can be harnessed to drive your supply chain
● Discuss the concept of emergent systems
The pace of business change and innovation is both exciting and relentless. Over the next decade, innovative companies in differ-ent market segments will learn to design and deploy their supply chains to improve their competitive positions in the markets they serve.
They will create supply chains that enable them to develop and deliver
products and provide levels of service at price points that their competi-
tors cannot match.
We all sense that something profound has happened in the last
10 years or so. The Internet is a part of it, but it is not only about the
Internet. We learned that in the “dot com” bubble of the late 1990s and
early 2000s. It is more about what we can do by using the Internet than
it is about any particular technology.
Essentials of Supply Chain Management, Third Edition by Michael Hugos
Copyright © 2011 John Wiley & Sons
308 ESSENTIALS of Supply Chain Management
The Start of Something Big As a historical analogy, consider what happened some 200 years ago at
the beginning of an age that came to be known as the Industrial Age.
The people of the time sensed that a powerful potential had been re-
leased by the invention and spread of the steam engine.
The steam engine for the fi rst time provided a movable source of
power that could be generated on demand and effi ciently harnessed to
perform a wide variety of tasks. The Industrial Age was not so much
about the steam engine as it was about the things that could be done and
were done with the power that the steam engine made available. Once
it was born, the Industrial Age went on to outgrow the steam engine as
it evolved more advanced engine technologies such as internal combus-
tion, the jet, the electric motor, and atomic power.
The rise and spread of the Internet has created for the fi rst time a
global, multi-directional communications network that is “always-on.”
The cost of connecting to this network is so cheap that there is no
need for companies to save money by staying off-line and only con-
necting periodically. The normal state for companies is transitioning
from being off-line and unconnected to one of being on-line and
connected.
As more and more companies use the Internet and other communi-
cations networks to create always-on connections with each other, they
will fi nd ways to share data that enable them to better coordinate their
interactions. They will also learn faster and adapt to changing condi-
tions faster. These capabilities will clearly result in effi ciencies that can
be turned into business profi ts.
The always-on connection is a new light that sheds steady illumina-
tion on a landscape that had before been seen only in periodic snap-
shots. We are experiencing something similar to seeing a sequence of still
photos turn into a moving picture. As more pictures are taken at shorter
intervals, you cease to see a sequence of still photos and instead come
The Promise of the Real-Time Supply Chain 309
to see a continuous, moving image. This continuous, moving image is
what we see as we move from the snapshot or batch-time world into the
real-time world.
Supply chain management is a process of coordination between
companies. Those companies that learn to coordinate in real time will
become incrementally more and more effi cient. They will become more
profi table and quicker to see new opportunities than their competitors
who are still working in a batch-time world of snapshot pictures.
The Profi t Potential of the Self-Adjusting Feedback Loop The self-adjusting feedback loop is a very useful phenomena. An ex-
ample is the cruise control in an automobile. The cruise control con-
stantly reads the vehicle’s actual speed and compares that to the speed it
was set for. It responds to bring the actual speed in line with the desired
speed. It causes the engine to either accelerate or decelerate. The cruise
control’s goal is to achieve and maintain the desired speed. As the vehicle
travels down the highway it continuously monitors speed and operates
the engine to achieve its goal.
Other examples of a self-adjusting feedback loop at work are a ther-
mostat that controls the temperature in a room, or a guided missile that
zeros in on a heat source or a radar-emission source. Self-adjusting feed-
back loops use negative feedback to continuously correct their behavior.
Negative feedback occurs when a system compares its current state with
its desired state (or goal) and takes corrective action to move it in a di-
rection that will minimize the difference between the two states. A con-
tinuous stream of negative feedback guides a system through a changing
environment toward its goal.
Companies can learn to work together to achieve supply chain
performance targets that are profi table to all of them. They can learn
to constantly adjust their behavior day after day, hour by hour to
respond to events and continue to steer toward their performance
310 ESSENTIALS of Supply Chain Management
targets. The bullwhip effect can be controlled by the introduction of
negative feedback to dampen down the wild demand swings that oth-
erwise result.
The opportunity now exists to leverage the power of the self-
adjusting feedback loop across entire supply chains. Real-time data
sharing and close coordination between companies can be employed to
deliver operating effi ciencies that result in signifi cant profi ts over time.
The result of these continuous incremental adjustments to supply chain
operations is analogous to the growth of capital over time due to the
miracle of compound interest.
Harnessing the Feedback Loop to the Supply Chain How can the power of the self-adjusting feedback loop be brought to
bear in a supply chain? The answer is beginning to appear. As compa-
nies link up using always-on communication networks to conduct busi-
ness with each other, they begin to automatically collect useful data as a
by-product of their interactions: electronic purchase orders, order status,
order receipts, invoices, and payment status. It is no longer a huge admin-
istrative chore to regularly track performance in the areas of customer
service, internal effi ciency, demand fl exibility, and product development.
Customers are starting to use supply chain “report cards” to grade
the performance of their suppliers. The report cards are more accurate
and more frequently produced than was previously possible. The next
step is for companies to move beyond the use of these report cards as
merely convenient tools for beating up their suppliers. The opportunity
exists for customers and suppliers to use this data to work together to
meet mutually benefi cial performance targets. Companies can select
performance targets that will generate quantifi able benefi ts and profi ts
to reward them for the effort needed to achieve the targets.
Either one dominant company can set the performance targets or
groups of companies can negotiate among themselves to set targets. The
The Promise of the Real-Time Supply Chain 311
important thing is that all participating companies in a supply chain be-
lieve the targets are achievable and that when they are achieved there
will be rewards as a result. The desire to receive these rewards is what
brings the self-adjusting feedback loop into being.
The feedback loop happens when peoples’ interactions with each
other are cast in the form of a game whose object is to achieve the
performance targets. If companies and people in a supply chain have
real-time access to the data they need then they will steer toward their
targets. If they are rewarded when they achieve their targets then they
will learn to hit these targets more often than not. The profi t poten-
tial of negative feedback and the self-adjusting supply chain is now
unleashed.
Playing the Game of Supply Chain Management Human beings are social creatures who love to play games. This is a good
thing because through playing games we constantly learn and improve
our skills and our performance. Companies such as Wal-Mart and Dell
and their supply chain partners have in many ways begun to create an
evolving game out of managing their supply chains. They have steadily
learned and developed supply chains that are better than those of their
competitors and that are clearly business advantages for them.
There are only a few things required to start a game. In his book,
The Great Game of Business, Jack Stack lays out four conditions that are
needed (Stack, Jack, 1992, The Great Game of Business, New York, NY:
Currency/Doubleday). They are:
1. People must understand the rules of the game and how it is
played. They must know what is fair and what is not fair and
how to score points.
2. People must be able to pick the roles or positions they want
to play in the game. They also need to get the training and
312 ESSENTIALS of Supply Chain Management
experience necessary to keep developing the skills they need to
succeed in their positions.
3. All players must know what the score is at all times. They need
to know if they are winning or losing and they need to see the
results of their actions.
4. All players must have a personal stake in the outcome of the
game. There must be some important reward, either monetary
or psychological, that provides a reason for each player to strive
to succeed.
Basically, the game of supply chain management is a relatively sim-
ple game, as is soccer or basketball. Which is not to say that any of these
games can be mastered without years of practice and play. The main
techniques and operations of supply chain management are well enough
understood to be taught to a wide range of people in different supply
chain positions (see Chapters 2 and 3). The Internet is the way for every-
one to know the score at all times and see the results of their actions.
Profi ts generated by operating effi ciencies provide people with rewards
and the reason to strive to succeed.
In supply chain management, everyone can acquire and install tech-
nology, so technology alone cannot constitute a signifi cant competitive
advantage. The advantage lies in the way the game is played. Let’s go
back to the example of Alexander the Great (see Chapter 1). His army
did not have any technology that was not also possessed by his oppo-
nents. In fact Alexander deliberately used less technology. He simplifi ed
his army’s operations and equipment in order to make it more mobile
and more effi cient. His army could travel faster and lighter than those
of his adversaries.
Advantage goes to those players who learn to use simple technology
and simple tactics extremely well. Alexander’s soldiers were well trained
in how to use their technology and because of the simplicity of their
tactics, they could remember and use them effectively in the heat of
The Promise of the Real-Time Supply Chain 313
the moment when it really counted. After all is said and done, success is
often just a matter of consistent performance and making fewer errors
than your competition.
An example of the kind of system that makes the supply chain game
into a reality in the operation of global and regional supply chains is
the SCM Globe system described in Chapter 7. This system can be put
to several uses. In can train people in supply chain operations; it can be
used to design new supply chains and improve existing ones; and it can
be used as a collaboration platform between companies to monitor and
manage the workings of actual supply chains.
Strengthening Supply Chain Alliances Strengthen supply chain alliances by making sure three conditions are pres-
ent. These conditions are interdependent and all three must exist in order
for any of them to truly be effective. They are: (1) all parties in the supply
chain have easy access to relevant information and performance measures
updated on a real-time or near real-time basis so they know what the score
is; (2) people know how their actions infl uence the score and they have
the skills and opportunity to act effectively; and (3) people have a stake in
the outcome so that they will act to achieve the performance targets and
continuously learn to improve. This is illustrated in Exhibit 10.1.
Supply chain alliances depend on close coordination between com-
panies, and effective coordination can only happen when all parties have
easy access to the information they need to do their jobs. These alliances
are much like a game whose goal is to achieve the predefi ned perform-
ance targets. In order to play this game people need to know what the
score is at all times. They need to know if they are moving toward the
goal or away from it. They need current information that refl ects events
as they happen, not batch reports delivered 30 days after the end of the
last quarter. This allows them to make good, timely decisions and co-
ordinate effectively.
314 ESSENTIALS of Supply Chain Management
Strengthening Supply Chain Alliances
EXHIBIT 10.1
A supply chain alliance is strengthened when these three interrelated conditions are present.
1.
2. 3. People have
training and know how to act to achieve their
performance targets.
People have a stake in the
outcome so they are motivated to
act and continue to improve.
People have access to up-to-date
information so they always know what the score is.
Once people are able to see the score and track events as they hap-
pen, they need to understand how their actions infl uence the score. If
operating results are trending away from performance targets, people
need to know what to do to bring operations back on track. If results
are on target people need to know how best to sustain them. That means
people get the training they need to do their jobs well. It also means that
people have the opportunity and authority to act as they see fi t when
the need arises. If no action can happen until requests and permissions
are passed up and down a chain of command, then responses will be too
slow and people will become frustrated with the poor results.
When people can see the score at all times and when they know
how to act in order to achieve predefi ned performance targets, there is
one more condition that must be present in order for a strong alliance
to emerge. That condition is that people have a stake in the outcome.
The Promise of the Real-Time Supply Chain 315
Often this is in the form of a monetary reward when performance tar-
gets are achieved. Without a stake in the outcome, people become bored
or indifferent and they will not make the effort to constantly improve
and adjust operations to respond as the world changes. And without
this constant effort, challenging performance targets cannot be achieved
month after month, year after year.
Emergent behavior is what happens when an interconnected system of relatively simple elements begins to self-organize to form a more intelligent and more adaptive higher-level system. Steven Johnson in his book, Emergence: The Connected Lives of Ants, Brains, Cities, and Software, explores the conditions that bring about this phenomenon.
In an interview with Steven Johnson I posed six questions and asked him to share his insights on a range of topics. These topics range from what gives a system emergent characteristics to how could companies organize their supply chains so as to encourage and benefit from emergent behavior.
1 What is an “emergent system”? How is an emergent system different from an assembly line?
The catchphrase that I sometimes use is that an emergent system is “smarter” than the sum of its parts. They tend to be systems made up of many interacting agents, each of which is following relatively simple rules governing its encounters with other agents. Somehow, out of all these local interactions, a higher-level, global intelligence “emerges.” The extraordi- nary thing about these systems is that there’s no master planner or executive branch—the overall group creates the intelligence and adaptability; it’s not something passed down from the leadership. An ant colony is a great example of this:
EXECUTIVE INSIGHT
(Continued)
316 ESSENTIALS of Supply Chain Management
colonies manage to pull off extraordinary feats of resource management and engineering and task allocation, all by fol- lowing remarkably simple rules of interaction, using a simple chemical language to communicate. There’s a queen ant in the colony, but she’s only called that because she’s the chief reproductive engine for the colony—she doesn’t have any actually command authority. The ordinary ants just do the thinking collectively, without a leader.
A key difference between an emergent system and an assem- bly line lies in the fluidity of the emergent system: random- ness is a key component of the way an ant colony will explore a given environment—take the random element out, and the colony gets much less interesting, much less capable of stum- bling across new ideas. Assembly lines are all about setting fixed patterns, and eliminating randomness; emergence is all about stumbling across new patterns that work better than the old ones.
2 You say that such systems are “bottom up systems, not top- down.” These systems solve problems by drawing on masses of simple elements instead of relying on a single, intelligent “executive branch.” What does this mean for people who are trying to design and build emergent systems?
One of the central lessons, I think, is that emergent systems are always slightly out of control. Their unpredictability is part of their charm, and their power, but it can be threatening to engineers and planners who have been trained to eliminate unpredictability at every turn. Some of the systems that I’ve looked at combine emergent properties and evolutionary ones: the emergent system generates lots of new configura- tions and ideas, and then there’s a kind of natural selection that weeds out the bad ideas and encourages the good ones. That’s largely what a designer of emergent systems should think about doing: it’s closer to growing a garden than it is building a factory.
EXECUTIVE INSIGHT (CONTINUED)
The Promise of the Real-Time Supply Chain 317
3 What does it mean when you say that emergent systems dis- play complex adaptive behavior?
The complexity refers to the number of interacting parts, like the thousands of ants in a colony, or the pedestrians on a street in a busy city. Adaptive behavior is what happens when all those component parts create useful higher-level structures or patterns of behavior with their group interactions, when they create something—usually unwittingly—that benefits the members of the group. When an ant colony determines the shortest route to a new source of food and quickly assembles a line of ants to transport the food back to the nest; when thousands of urbanites create a neighborhood with a distinct personality that helps organize and give shape to an otherwise overwhelming city—these are examples of adaptive behavior.
4 What is negative feedback as opposed to positive feedback? What role does negative feedback play in the ability of a system to exhibit adaptive behavior?
Negative feedback is crucial, and it’s not at all negative in a value-judgment sense. Positive feedback is what we generally mean when we talk about feedback, as in the guitar effect that we first started to hear as music in the 60s: music is played through a speaker, which is picked up by a microphone, which then broadcasts it out though the speaker, creating a sound that the microphone picks up, and so on until you get a howling noise that sounds nothing like the original music. So positive feedback is a kind of self-perpetuating, additive effect: plug output A into input B which is plugged into input A. Negative feedback is what you use when you need to dampen down a chain like this, when there’s a danger of a kind of runaway effect, or when you’re trying to home in on a specific target. Think of a thermostat trying to reach a preset temperature: it samples the air, and if the air’s too cold, it turns the heat on, then samples it again. Without negative feedback, the room would just keep getting hotter, but the thermostat has been
(Continued)
EXECUTIVE INSIGHT (CONTINUED)
318 ESSENTIALS of Supply Chain Management
designed to turn the heat off when the air reaches the target temperature. Ants use a comparable technique to achieve the right balance of task allocation throughout the colony: an indi- vidual ant who happens to be on foraging duty will sample the number of ants also on foraging duty that she stumbles across over the course of an hour—if she encounters a certain num- ber, she’ll switch over to another task (nest building, say) in order to keep the colony from becoming overrun with foragers.
5 In your book you mention a designer who has proposed build- ing a learning network of traffic lights that will find an opti- mal solution to continually changing traffic conditions. You observe that, “You can conquer gridlock by making the grid itself smart.” What is it that would make the grid smart? Is this grid an example of an emergent system?
The idea proposed in the traffic model is not to take the tra- ditional engineering, top-down approach and say: “let’s look at the entire city and figure out where all the problems are, and try to design the roads and the light system to eliminate the problems.” The smart grid approach is to give each light a local perspective with a little bit of information, and give it the goal of minimizing delays at its own little corner. So the light would be able to register the number of cars stacked up at the intersection, and it would be able to experiment with different rhythms of red and green, with some feedback from its near neighbors. When it stumbles across a pattern that reduces delays, it sticks to that pattern; if the delays start pil- ing up again, it starts experimenting again. The problem with this sort of approach is that on Day One it’s a terrible, terrible system, because it doesn’t yet know anything about traffic flows. (You’d have to teach it quite a bit before you could actu- ally implement it.) But it would learn very quickly, and most importantly, it would be capable of responding to changing conditions, in a way that the traditionally engineered approach would not. That’s a hallmark of adaptability.
EXECUTIVE INSIGHT (CONTINUED)
The Promise of the Real-Time Supply Chain 319
6 Consider a system composed of many different companies whose goal is to provide a market with the highest levels of responsiveness at the lowest cost to themselves. High levels of responsiveness require that these companies work together to design, make, and deliver the right products at the right price at the right time in the right amounts. What are some of the things that these companies could do to organize themselves into an emergent system?
There’s a telltale term in supple chain systems, which may well be unavoidable—the term “chain” itself. Almost all emer- gent systems are networks or grids; they tend to be flatter and more horizontal, with interaction possible between all the vari- ous agents. The problem that supply chains have with positive feedback revolves around the distance between the consumer and those suppliers further down the chain—because the information has to pass through so many intermediaries, you get distortion in the message. Most emergent systems that I’ve looked at have a great diversity of potential routes that information can follow; the more chain-like they become, they less adaptive they are. The other key here is experimentation: letting the system evolve new patterns of interaction on its own, since these can often be more useful and efficient than the pre-planned ones. Of course, you don’t want to waste a few economic quarters experimenting with different supply chains, most of which are a disaster. But that’s where some of the wonderful new modeling systems for complex behavior can be very handy: you can do the experimenting on the computer, and then pick the best solutions to implement in real life.
Emergent Behavior in Supply Chains In the workings of a system such as a free market, we witness emergent
behavior. This behavior is what the great British economist Adam Smith
referred to as the “invisible hand” of the market. This invisible hand
EXECUTIVE INSIGHT (CONTINUED)
320 ESSENTIALS of Supply Chain Management
emerges to set product prices so as to best allocate available supplies
to meet market demands. Local interactions between large numbers of
agents, governed by simple rules of mutual feedback, produce a macro
effect for the system as a whole that results in what we call emergent
behavior.
As we begin to practice supply chain management as a game be-
tween companies and people who are motivated to achieve certain
performance targets, we will see emergent behavior in supply chains.
Good players in the supply chains of particular markets will seek each
other out, because by playing together they can create more effi cient
supply chains and generate better profi ts.
Supply chains will form like sports teams and these teams will com-
pete with each other for market share. Just as the game of basketball or
soccer evolves over time, so too will the game of supply chain manage-
ment. New tactics, techniques, and technology will come about. Market
demands and the desire for competitive advantage will drive compa-
nies to collaborate and innovate with each other to win at the game of
supply chain management.
Computers are best used to automate the rote, repetitious activities
that humans fi nd to be dull and boring. These are all the ongoing and
routine activities of recording and monitoring supply chain operations.
Computers do these tasks very well. They do not fall asleep, they do not
miss details, and they can handle enormous volumes of data without
complaint.
People are best used to do the creative and problem-solving ac-
tivities. These are the activities that do not have clear right or wrong
answers. These are the activities that call for people to collaborate with
other people and share information and try out different approaches to
see which ones work best. People are good at these activities and they
like doing them so they learn and keep getting better.
At a macro level, this will give rise to supply chains that, in
effect, learn and grow smarter. Computers will listen to the hum
The Promise of the Real-Time Supply Chain 321
and crackle of data fl owing through the real-time, always-on sup-
ply chain. They will employ pattern recognition algorithms to spot
exceptions and events that need to be brought to the attention of
human beings. Like good pilots and navigators, people will learn to
respond effectively to these developments as they happen. People will
learn to keep steering the supply chain on a course toward its desired
performance targets.
Adaptive Networks and Economic Cycles As we learn to recognize and effectively respond to developments in our
supply chains, it will tend to lengthen the periods of market growth and
stability. Any industry or market where there is a boom-to-bust cycle
is an opportunity for us to apply the self-adjusting feedback loop to
smooth out the economic ups and downs. The boom-to-bust cycle is
caused by the same dynamic that results in the Bullwhip effect in indi-
vidual supply chains (see Chapter 6).
In industries ranging from manufacturing to real estate develop-
ment and telecommunications, the boom-to-bust cycle causes eco-
nomic waste and disruption. It also brings with it all the related human
hardships that are caused by the cycle. Examples of this cycle are the
“Dot Com” bubble of 1997 to 2001 and the Real-Estate bubble of 2003
to 2008. The ability to recognize and smooth out excessive swings in
demand, prices, and productive capacity in different areas of the econo-
my will create greater stability and more sustainable prosperity. Through
this stability more wealth will be both generated and preserved. Think of
the wealth that was destroyed by the excessive investments that created
more dot com companies and more real-estate developments than were
really needed. Think of the wealth that disappeared in company closures
and job losses that happened when these companies and their suppliers
fi nally had to face the consequences of too much supply and not enough
demand.
322 ESSENTIALS of Supply Chain Management
Adaptive supply chain networks using real-time information and
feedback loops can effectively dampen excessive market swings. This
ability alone will have a wealth creation effect that is even more pow-
erful than what was created by the effect of the steam engine and the
industrial revolution.
Chapter Summary The “always-on” connection of the Internet and other communication
networks allows us to see ourselves in real-time. We can now see the
supply chain as a continuous moving picture, whereas in the past we
could only see it as a collection of snapshots taken at periodic intervals.
This always-on, moving picture makes it possible to constantly adjust
supply chain operations week to week and day to day to get signifi cant
new effi ciencies.
This self-adjusting feedback loop is harnessed to the supply chain
through the daily actions of the people who carry out supply chain op-
erations. First motivate people by providing them with monetary or psy-
chological rewards for achieving predefi ned performance targets. Then
provide people with real-time information that shows them whether
they are moving toward or away from their targets. People will steer
toward their targets and they will learn to hit these targets more often
than not.
The effect of this dynamic will be to give rise to supply chains that
are both highly responsive and very effi cient. Real-time operating ad-
justments will result in supply chains that can better adapt to business
changes and deliver performance and profi tability that is of a higher level
than anything that has been seen before.
About the Author
Michael H. Hugos is an author, speaker and principle at Center for
Systems Innovation. He works with clients to fi nd elegant solutions to
complex problems with focus in supply chains, business intelligence and
new business ventures. Earlier, he spend six years as chief information
offi cer (CIO) of a national distribution organization in North America
where he developed a suite of supply chain and e-business systems that
transformed the company’s operations and revenue model. For this work
he won the CIO 100 Award for resourcefulness, the InformationWeek
500 Award for innovation, and the Computerworld Premier 100 Award
for career achievement.
Hugos earned his undergraduate degree in urban planning and de-
sign from the University of Cincinnati and his MBA from Northwestern
University’s Kellogg School of Management. He has spoken at confer-
ences and taught seminars in Asia, Africa, Europe and North America.
Hugos is also author of several other books including Business Agility:
Sustainable Prosperity in a Relentlessly Competitive World and Business in the
Cloud: What Every Business Needs to Know about Cloud Computing.
He can be reached via his website at www.MichaelHugos.com.
Essentials of Supply Chain Management, Third Edition by Michael Hugos
Copyright © 2011 John Wiley & Sons
Index
325
3i Infotech, 96 7-Eleven, 28
A
ABC. See activity-based costing activities, coordinating, 16 activity-based costing, 190 adaptive networks, 321–322 aggregate forecast, 46 aggregate planning, 46–49 agility, 216–217 airplanes, 15 Alexander the Great, 7–9 Alexander the Great and the Logistics of
the Macedonian Army, 8 alliances, strengthening, 313–315 American Production and Inventory
Control Society. See Association for Operations Management
antiretroviral drugs, 96 APICS. See Association for Operations
Management Apple, 35–37 The Art of War, 203–207 ARV. See antiretroviral drugs Association for Operations
Management, 207–209 availability, 57
B
backlog, 48–49 Basics of Supply Chain Management, 191
behavior, emergent, 319–321 benefits, 266
defining, 263–270 BI. See business intelligence big box store, 19 Booz & Company, 95–96 bottlenecks, 192 BPM. See business process
management brainstorming, 245–247 broadband, 111 BTO. See build-to-order BTS. See build-to-stock budget
creating, 259–262 estimating, 263
buffer, 13 build-to-order, 154, 156, 160 build-to-stock, 154–155, 160 bullwhip effect, 184–187, 229 business analysis, 278 business cycle, 184 business goal, 276 business intelligence, 130–131, 168 business models, 144 business operations
company performance and, 167 improving, 246
business opportunity, identifying, 243–244
business process flows, 250 business process management,
129–130
Essentials of Supply Chain Management, Third Edition by Michael Hugos
Copyright © 2011 John Wiley & Sons
326 Index
business strategy, 276–279 aligning, 34 supply chain and, 27–33
Butterfly Effect, 218–219
C
capabilities, developing, 31–33 capacity, 10–11 capacity allocation, 81–82 case study, 274–303 cash-to-cash cycle time, 158 causal methods, 44 Center for Value Chain Research,
100–106 Chaos Theory, 218–219 Charlie Supply Inc., 274–303 Chopra, Sunil, 3, 7, 10, 29, 35–37 cloud computing, 133–145 Cohen, Shoshanah, 161–165 collaboration, 102–105 collaborative operations, support,
226–227 collaborative planning, forecasting, and
replenishment, 199–202 collections, 67–69 collections practices, implementing,
68–69 company performance, business
operations and, 167 competitive advantage
strategic alliances for, 298–303 supply chain as, 242–243
competitive environment, 43–44 constraints, 192 consumption management, 64 contract management, 66–67 contract negotiation, 65–66 coordination, work–flow, 144 core competencies, defining, 30–31 Correll, Sean, 70–73 cost, 14 cost avoidance benefits, 266 cost structure, 51
pricing and, 49–50
cost/benefit analysis, 267–270 costs, 265–266
defining, 263–270 CPFR. See collaborative planning,
forecasting, and replenishment credit, 67–69 credit policy, setting, 67–68 credit practices, implementing, 68–69 credit risk, managing, 69 CRM. See customer relationship
management cross-functional product design teams,
77–78 crossdocking, 12 Crown Agents, 95 culture, negotiation, 58–63 customer relationship management, 88,
117–118 customer service, 5, 78–80, 151
metrics, 153–156 customers, 25 cycle inventory, 12–13, 52–53, 57 cycles, economic, 321–322
D
dashboard, 173, 175 data delivery system, 257 data warehouse, 170–171, 257 data
capture, 110–119 connections, 227–233 manipulation and reporting,
114–115 sharing, 178–181 storage and retrieval, 113–114 strategy and, 228–233
DC. See distribution centers decision making, support, 226–227 decisions, making, 16 degree of error, 46 deliver, 42 delivery scheduling, 90–93 delivery sources, 92–93 Dell, 35–37
Index 327
demand, 43 distortion, 186 flexibility, 152, 160 flexibility metrics, 158–159 fluctuations, 10–11 forecasting, 42–49, 187–188 planning, 117 uncertainty, 57
developing market, 148, 150 differentiation, 281 digital subscriber line, 111 direct benefits, 266 direct deliveries, 90 distribution centers, 19, 93 distribution decisions, 47 distributors, 24–25 DSL. See digital subscriber line
E
e-business, 143 e-business integration, supply chain
and, 135–145 e-business systems infrastructure, 256 EAN. See European Article Number economic cycles, 321–322 economic lot size, 79–80 economic order quantity, 57, 188
calculating, 53–54 understanding, 55
economic value added, 83–84 EDI. See electronic data interchange efficiency, 28
internal, 151–152, 160 internal metrics, 156–158 order management, 88–89 pursuit of, 214–216 responsiveness vs., 12, 17–18,
227–228 efficient supply chain, 229 electronic data interchange, 19,
111–112 Electronic Product Code, 126 electronic transport, 15 Ellram, Lisa M., 3
Emergence: The Connected Lives of Ants, Brains, Cities, and Software, 315–319
emergent behavior, 319–321 Emptoris, 70–73 Engels, Donald, 8 enterprise resource planning,
115–116, 164 EOQ. See economic order quantity EPC. See Electronic Product Code ERP. See enterprise resource planning Esciki, Huseyin, 58–63 European Article Number, 126 EVA. See economic value added EVE-Online, 218 EverQuest, 218 evolution, of supply chains, 2–7 extensible markup language, 112–113 extranet, 257
F
facilities, cost, 14 facility management, 81–82 feedback loop, 309–311 feedback, real-time, 237–239 The Fifth Discipline, 185 flexibility, 158–160 fluctuations, demand, 10–11 Ford Motor Company, 22 Ford, Henry, 22 forecast, 46 forecasting, 16–17
methods, 44, 47 variables, 47 collaborative, 200 demand, 187–188
Fredenhall, Lawrence, 191 functional focus, 11
G
Ganeshan, Ram, 3 generalized assignment, 91–92 geographical site, 14
328 Index
Ghana, 96 global data synchronization network,
196–198 Global Trade Item Number, 126 goal, defining, 243–244 The Goal, 7, 191–194 Goldratt, Eliyahu, 7, 10, 191–194 The Great Game of Business, 311–312 growth, 302–303 growth market, 148–150
indentifying new, 289–298 opportunities, 297–298
GS1, 197 GTIN. See Global Trade Item Number
H
Harrison, Terry P., 3 Hill, Ed, 191
I
ICCL. See inter-company communications link
incremental benefits, 266 Industrial Age, 308 information, 6, 16–18, 33 information integration, 144 information systems, 109–110 infrastructure, 14 innovation rate, 30 intangible benefits, 266 integration, 21, 23
information, 144 inter-company communications link,
275–276 internet, 110–111 inventory, 6, 12–13, 17, 32, 48–49, 193
amount to carry, 47–48 flow, 194 levels, 78, 80 turns, 157 value, 156–157
inventory management, 50–57, 63–67 systems, 118
ISI Research and Training Institute, 95
J
job lot storage, 11–12 Johnson, Steven, 315–319 Just Born Inc., 100–106
K
Kenya, 96
L
labor, cost, 14 Lambert, Douglas M., 3 LAN. See local area network lead times
order, 57 variability, 57
Lee, Hau, 143, 178–179 Leigh University, 100–106 less than truck load, 91 local area network, 111 location, 6, 14, 17, 32 logistics, 4 logistics, strategy vs., 2–3 long-term forecast, short-term vs., 45 Loo, J.W.K., 237 Loo, James, 234–235 LTL. See less than truck load
M
maintenance, repair, and operations, 31, 63
make, 41 Management Sciences for
Health, 95 manufacturing execution systems,
118–119 market allocation, 81–82 market performance categories,
149–152
Index 329
markets migration, 174–177 models, 148–149 supply chains, 148–149 understanding, 29–30
massively multi-player supply chain games, 217–220
mature market, 149–150 Meindl, Peter, 3, 7, 10, 29 Meshew, Robert, 120–123 Microsoft, 120–123 milk run deliveries, 91–92 mindfulness, 233 MMORPG, 217–220 Motorola, 215 MRO. See maintenance, repair and
operations
N
Napoleon, 2 negotiating behaviors, 59–61 negotiating culture, 58–63 Network Services Company, 204–207,
246–250, 255–257 networks, 16
adaptive, 321–322 North-West University (South Africa),
97 Northrop Grumman, 96
O
ODM. See original design manufacturers
OfficeMax, 83–89 operating efficiencies, 5 operations
impact on, 132–133 view, 172
opportunities, 171–174 order
batching, 188–189 entry, 88–89 lead times, 57
routing, 88–89 status, 88–89
order management, 82–89 system, 88–89
original design manufacturers, 162 outside flexibility, 159 outsourcing, supply chain operations,
98–99
P
participants, 23–27 Partnership for Supply Chain
Management, 95–98 PEPFAR. See President’s Emergency
Plan for AIDS Relief performance, 14
enabling, 161–167 performance data, collecting, 168–171 performance incentives, 189–190 performance measurement, 152–153,
160 PFSCM. See Partnership for Supply
Chain Management pipelines, 15 plan, 40 planning, 16–17, 42–49
advanced, 116 collaborative, 200 sales and operations, 207–210
point-of-sale-activated, 121, 124 pool points, 101 POSA. See point-of-sale-activated President’s Emergency Plan for AIDS
Relief, 95–98 price weight, 72–73 pricing, cost structure and, 49–50 problems, 171–174 process flow, 236 procurement, 56–57
systems, 116 producers, 24 product
characteristics, 43 classification, 199
330 Index
product (continued ) data standards, 195–199 demand distortion, 186 focus, 11 pricing, 30, 49–50 promotion, 51 quantity, 29 rationing, 189 variety, 29–30
product design, 75–78 product design teams, cross-functional,
77–78 product development, 152, 160
metrics, 159–161 production, 5, 10–12, 17, 31–32
capacity, 47–48 scheduling, 78–81
productivity, 302–303 project objectives, 282–287, 294–297
defining, 257–259 project plan, creating, 259–262 promotion, price, 49–50 PRTM Management Consulting,
161–165 purchasing, 61–63
Q
qualitative, 44 Quiviger, Thibault, 136–143
R
R-value, 80–81 radio frequency identification, 124–129 rail, 15 Ranganathan, C., 233–237 replenishment, collaborative, 200 request for proposal, 70–73 response time, 29 responsive supply chain, 230 responsiveness, 28
efficiency vs., 12, 17–18, 227–228 retailers, 25 return on investment, estimating, 263
return on sales, 157 return processing, 94 reverse logistics, 94 RFID. See radio frequency
identification RFP. See request for proposal risk, 220–222 River Rouge Plant, 22 route, 16 run-out time, 79–80
S
S & OP. See sales and operations planning
safety inventory, 13, 56–57 Sagar, Nikhil, 83–89 Sales & Operations Planning, 207–208 sales and operations planning, 207–210
cycle, 209 sales force automation, 117–118 Sam’s Club, 28 savings matrix, 91–92 scheduling
advanced, 116 delivery, 90–93
SCMS. See Supply Chain Management System
SCOR. See supply chain operations reference
seasonal inventory, 13, 54–57 self-adjusting feedback loop, 309–310 Senge, Peter, 185 service level, 30 service providers, 26–27 SFA. See sales force automation ship, 15 short-term forecast, long-term vs., 45 simulation
methods, 45 modeling, 131–132 tactical planning, 139–141 warehouse operations, 141
single-product locations, 82 SKU. See stock keeping unit
Index 331
Slone, Reuben, 83–89 social media, 237–239 sources, 40
delivery, 92–93 South Africa, 96 speculative forecast, 46 SQL. See structured query language Stack, Jack, 311–312 steady market, 149–150 stock keeping unit storage, 11 Stock, James R., 3 strategic alliances, 298–303
structuring, 299–302 strategic market view, 172 strategic sourcing technology, 70 strategic supply chain design, 137–139 strategy
creating, 244–247 evolving, 231 logistics vs., 2–3
structure, 20–23, 27 structured query language, 113 Sun Tzu, 203–207 suppliers, proximity to, 14 supply, 42–43 supply allocation, 81–82 supply chain collaboration, 202–207 supply chain coordination, 187–190 Supply Chain Council, 40 Supply Chain Management System,
95–98 supply chain management, defined, 3–4 Supply Chain Management, Second
Edition, 3, 7 supply chain technology, trends,
119–133 supply chain
business strategy and, 27–33 collaboration, 213–217 coordination, 213–217 defined, 2–3 design, 137–139 drivers, 17 e-business integration and, 135–145 old vs. new, 21
operations, 39–42 operations reference, 40, 165 requirements, 5 strategy and projects, 279–288
Sutherland, Joel, 100–106 synchronization, planning, 144 system design
conceptual, 247–251 guidelines, 251–255
system development sequence, 264 system needs, assessing, 135
T
tactical company view, 172 tactical planning, simulation and,
139–141 tariffs, 14 taxes, 14 TCO. See total cost of ownership technology needs, assessing, 135 Teo, T.S.H., 237 theory of constraints, 191–194 time boxes, 261 time series, 45 TL. See truck load Today and Tomorrow, 22 total capacity, 48 total cost of ownership, 70–73 transport mode, choice of, 14 transportation, 6, 14–167, 32–33
planning systems, 117 scheduling systems, 119
trial and error, 220–222 truck load, 90 trucks, 15 Turkey, 58–63
U
Uniform Code Council, 126 Universal Product Code, 126 University of Notre Dame, 83–84 UPC. See Universal Product Code upside flexibility, 159
332 Index
utilization, 47 rates, 78, 80
V
value-added networks, 112 VAN. See value-added networks vendor selection, 64–65 vertical integration, 21, 23 virtual integration, 21, 23
W
W.W. Grainger, 31 Wal-Mart, 12, 18–20, 45 Wallace, Tom, 207–208 Walton, Sam, 18–20 WAN. See wide area network
warehouse management systems, 119 warehouse operations, simulation
and, 141 web-based e-commerce, 257 Whang, Seungjin, 143 wide area network, 111 work-flow, 193
coordination, 144 World of Warcraft, 218
X
XML. See extensible markup language
Y
Yanasik, Tolga, 136–143 YCH Group, 233–237
