Operation and Management Assignment 3
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lec_06_online.pptxOperations and Supply Chain Management
Lecture 06
Outline – Supply Chain Mgt.
Supply Chain Management (SCM)
What is SCM
Outsourcing concepts
Supply Chain Strategies
Issues and Opportunities in a Supply Chain
Measuring the performance of a Supply Chain
A Supply Chain
This supply chain includes all the interactions among suppliers, manufacturers, distributors, and customers.
S2
S3
S2
S1
Manufacturer
Distributor(s)
Customers
Retailer(s)
Tier 3
Suppliers
Tier 2
Suppliers
Tier 1
Suppliers
Supply Chain Management
Definitions of Supply Chain Management
Supply Chain Management is the integration of the activities that procure materials and services, transform them into intermediate good and final products, and deliver them to customers.
Supply Chain Management deals with the management of materials, information, and financial flows in a network consisting of suppliers, manufacturers, distributors, and customers. -- Prof. Hau Lee, Stanford Supply Chain Forum
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Outsourcing Concepts
They can be confusing…
Outsourcing: Procuring from external sources services or products that are normally part of an organization.
Offshoring: Moving a business process to a foreign country but retaining control of it.
Backsourcing: The return of business activity to the client firm. A client firm is an organization that outsources from outsource provider.
Nearshoring: Choosing an outsource provider in the home country or in a nearby country.
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Examples
Electronic Data Systems (EDS) provides information technology for Delphi Automotive and Nextel. This is Outsourcing.
If a firm owns two production facilities, one in the home country and the other in a foreign country, and later decides to shift production from the first to the second, this is not Outsourcing, but Offshoring.
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Examples
Dell believed it could save cost by moving some of its technical support for corporate customers to Bangalore, India. But faced with complaints from customers, it shifted some of help desk service phone calls back to Tennessee and Texas. This is Backsourcing.
If a US-based company outsources from Canada or Mexico, this practice is called Nearshoring.
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Why Outsourcing?
| Strategic Reasons | Tactical Reasons |
| Improve business focus | Reduce or control operating costs |
| Gain access to world class capabilities | Make capital funds available |
| Accelerate re-engineering benefits | Create cash infusion |
| Share risks | Compensate for lack of internal resources |
| Free resources for other purposes | Improve management of difficult or out-of-control functions |
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Supply Chain Strategies
The number of suppliers, their locations, and their sizes are important considerations in deciding the type of SC strategy to use.
Six typical Supply Chain strategies:
Many Suppliers
Few Suppliers
Vertical Integration
Joint Venture
Keiretsu Network
Virtual Companies
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1. Many Suppliers
A common strategy when products are commodities.
Suppliers respond to demands and specifications of a “request for quotation”. Order goes to the low bidder.
Suppliers are responsible for maintaining the necessary technology, expertise, cost, and quality competences.
Long-term “partnering” relationships are not the goal.
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2. Few Suppliers
Rather than focusing solely on low cost, a buyer can benefit from forming a long-term relationship with a few dedicated suppliers.
Suppliers in this relationship are expected to participate in the Just-In-Time system and provide design innovations and technological expertise.
Example: The strategy has resulted in suppliers that develop new products, winning customers for Marks & Spencer, a British retailer.
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3. Vertical Integration
Vertical integration can take the form of forward or backward integration.
Backward integration: a company buys its suppliers, such as Ford Motor when it decided to produce its own car radio.
Forward integration: a manufacturer of components make the finished product.
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3. Vertical Integration – Cont.
Benefits?
Cost reduction in purchasing components/raw materials
Quality adherence
Timely delivery
Inventory reduction
Requirements?
Enough capital
Large management talent
Required technology
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4. Joint Venture
Formal collaboration
Enhance skills
Secure supply
Reduce costs
Cooperation without diluting brand or conceding competitive advantage
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5. Keiretsu Networks
Keiretsu is somewhere between few suppliers and vertical integration.
First appeared in Japan following World War II.
In Keiretsu, manufacturers become financial supporters of suppliers through ownership or loans. Suppliers’ suppliers can also be made as part of the coalition.
It features long-term “partnering” relationship. Technical expertise and quality production are expected from the suppliers.
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6. Virtual companies
Virtual companies rely on a variety of supplier relationships to provide services on demand.
The relationship may be short- or long-term and my include true partners, collaborators, or simply able suppliers and subcontractors.
This form offers specialized management expertise, low capital investment, flexibility, and speed.
In apparel business, the designers of clothes seldom manufacturer. They license manufacturers. They are able to keep low overhead and respond quickly to market change.
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Issues in an Integrated SC
Local optimization - Members of a Supply Chain are inclined to focus on maximizing local profit or minimizing immediate costs based on their limited knowledge.
Incentives (sales incentives, quantity discounts, quotas, and promotions) - push merchandise prior to sale
Large lots - low unit cost but do not reflect sales
Bullwhip effect - Fluctuation in orders increases as orders move through the supply chain.
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Why called Bullwhip effect?
Demand variation increases as orders move from the downstream of a Supply Chain to the upstream.
End Customer
(Downstream)
Suppliers
(Upstream)
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Major Causes of Bull-whip Effect
Demand Forecast update
Explanation:
When a downstream player places an order, the upstream manager take it as a signal about future demand.
Many of the forecasting methods place substantial weight on recently observed demand, leading to distortion when there is a sudden peak or drop in orders.
Remedies:
In-time demand sharing among members via Point of Sales (POS), EDI, or Vendor Managed Inventory (VMI).
Some companies convinced their suppliers to locate their production faculties nearby.
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Examples of Remedies - Demand Forecast
JC Penny and Levi Strauss are linked with an EDI that allows Levi Strauss to obtain sales data. These data allow Levi Strauss to better plan the production process as well as better control inventory and delivery. The savings leads to a reduction in costs and prices, benefitting both JC Penny and Levi Strauss.
McKesson developed a close relationship with Johnson & Johnson, one of its major suppliers. Both firms receive data on inventory, POS, and customer information through a joint information system. This enables Johnson & Johnson to provide better services to McKesson, which in turn improves the level of service that McKesson is able to provide to its customers.
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Major Causes of Bullwhip Effect
Order Batching
Explanation: Companies may want to accumulate demand before issuing an order to take advantage of the economies of scale in order placing or transportation.
Remedies:
Use Electronic purchasing to reduce ordering costs and then encourage placing frequent orders
One solution to discourage shipment consolidation can be to outsource the transportation activities. Third-party logistics providers are able to consolidate small quantities from different customers.
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Major Causes of Bullwhip Effect
Price Fluctuation
Explanation: Companies may buy supplies well in advance of demand as a result of special trade deals and consumer promotions, such as discounts and rebates. Price fluctuation might lead to increased demand variation in a supply chain.
Remedies:
To reduce the frequency and magnitude of special trade deals and consumer promotions. Every-Day-Low-Price can be one solution;
Adopt Continuous Replenishment Program (CRP), that is, products are replenished only for the sold amount. There are no specific order points or order sizes. CRP is usually implemented together with VMI to achieve greater efficiency, such as in Wal-Mart.
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Major Causes of Bullwhip Effect
Rationing and Shortage Gaming
Explanation:
When product demand exceeds product supply, manufacturers tend to ration their products to customers by allocating in proportion to the amount ordered.
Buyers may respond to that strategy by over-ordering and cancelling excess orders later. Think about what happened to the automotive industry after the earthquake and tsunami hit Japan.
Remedies:
One possible way is to allocate products in proportion to past sales.
Impose high order cancellation fee.
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Supply Chain Coordination
A classic tension within a supply chain: An increase in one firm’s profit might come at the expense of a decrease in the other firm’s profit.
With respect to the allocation of supply chain profit, firms should care about two things:
The size of a firm’s piece of the “pie”, where the pie refers to the supply chain’s total profit;
The size of the total “pie”.
Buy-back Contracts
What a supply chain needs is a tool that first maximizes the size of the “pie” and then allows them to decide how to divide it between them.
Such a tool can be Buy-Back contracts.
Buy-back contracts introduce new costs into the supply chain since the original buyer will need to ship the leftover inventory back to the original supplier.
Buy-back contracts may also generate new revenue as the supplier may be able to resell the leftover to another buyer, possible at another location.
More Supply Chain Contracts
Three common-type of quantity discount supplier pricing:
Linear Quantity Discount
This quantity discount scheme assumes that a supplier offers a price that decreases in the quantity ordered by a retailer.
Let t be some constant discount rate and be the base price.
Unit price for order quantity Q:
, and
Total cost = , that is, discounted unit price times the corresponding order quantity
Linear Quantity Discount
Interpretation
As we can see from the left figure, the unit cost/price decreases as the order quantity increases. So a buyer can always benefit from the discount schedule.
When the total purchasing cost is concerned, as we can see from the right figure, the total purchasing cost keeps increasing until Q = v/(2t) and decreases since then. What it means is that for order quantities that exceed v/(2t), the more you order, the less you pay in total.
A linear discount scheme usually has the limitation on how much a buyer can order at maximum.
All-unit Quantity Discount
All-unit Quantity Discount
The unit price offered by a supplier declines on a step function basis. Define as a set of alternative unit prices such that
And let be a set of quantities, called break points, such that
Set
Then the all-unit quantity discount can be expressed as
All-Unit Quantity Discount
Unit cost
Interpretation
As we can see from the left figure, the unit cost/price applies to all the units purchased and decreases as the order quantity increases.
The all-unit schedule appears irrational in some respects. For example, as we can see from the right figure, the total cost of ordering units is higher than the total cost of ordering slightly more than units. This is an incentive for buyers to order more.
Incremental Quantity Discount
Incremental Quantity Discount
Under incremental quantity discounts, discounts are only applied to additional units beyond the breakpoints. The unit cost/price for the quantity interval decreases as increases.
The average unit cost/price can be calculated as follows:
,
for
for
The unit discounted price is just the total purchase cost divided by the order quantity.
Example
Suppose a trash bag company charges based on an incremental scheme. Specifically, it charges 30 cents per bag for the first 500 bags, 29 cents for all units beyond.
Then for orders of no more than 500 bags, the average cost is 30 cents.
For orders of less than 1001 bags but more than 500, then the average cost , where Q is the exact order quantity.
Incremental Quantity Discount
Interpretation
As we can see from the left figure, discounts are only applied to the additional units beyond those break points. The average unit cost/price decreases as the order quantity increases due to the discounts.
Different from the all-unit schedule, no irrationality is observed in the right figure. The total purchasing cost increases as the order quantity increases.
Example: Quantity Discount
Suppose a store has been given an all-unit quantity discount schedule for a product. The normal cost for the product is $5. For orders between 1001 and 2000 units, the unit cost drops to $4.8; for orders of 2001 or more units, the unit cost is only $4.75. The store expect the sales for that product in the next month to be 2500. How much does it pay?
Now how much does the store pay if it is offered an incremental quantity discount scheme with the same quantity break points as stated above. The price is $5 for orders no greater than 1000. For the next additional 1000 units, the unit price becomes $4.8. For any additional units above 2000, the price drops to $4.75. What is the purchasing cost?
Example: Quantity Discount
For the all-unit quantity discount scheme,
Total cost = $4.75 * 2500 = $11875
For the incremental quantity discount scheme,
Total cost = $5 * 1000 + $4.8 * 1000 + $4.75 * 500 = $12175
Comments:
Note that the average cost/price per unit with an all-unit schedule will be less than the average cost per unit with the corresponding incremental schedule.
In the previous example, the average cost per unit with the all-unit schedule is $11875/2500, which equals $4.75/unit.
The average cost per unit with the corresponding incremental schedule is $12175/2500 , which equals $4.87/unit/
Notice the irrationality of the all-unit schedule? In the example, 1,000 units would cost $5,000, whereas 1,001 units would only cost $4,804.8. This is an incentive for a buyer to purchase more.
How to evaluate Supply Chain performance
The evaluation of Supply Chain with focuses on procurement and inventory tends to answer two questions:
How well the supply chain is performing; and
How well assets are utilized.
Benchmarking is used to answer the 1st question.
To answer the 2nd question, three measures can be of help.
Percent of assets invested in inventory
Inventory Turnover
Weeks-of-Supply
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Benchmarking
Benchmarking is the process of comparing one’s own business processes to the industry bests or the best practices in other industries.
| Typical Firms | Benchmark Firms | |
| Lead time (in weeks) | 15 | 8 |
| Time spent placing and order | 42 mins | 15 mins |
| Percent of late delivery | 33% | 2% |
| Percent of rejected material | 1.5% | 0.0001% |
| Number of shortages per year | 400 | 4 |
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To start the process, a firm must decide on the process it wishes to evaluate and select the benchmark firms. Relevant data need to be collected to conduct the comparison. The result is usually improved process performance by achieving the targets set during the process.
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How well assets are utilized
Percent of assets invested in inventory
Example: Home Depot had $11.4 billion invested in inventory and total assets of $44.4 billion in 2006.
Then, its Percent of assets invested in inventory = (11.4/44.4)* 100% = 25.7%
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Inventory Turnover
Inventory turnover (computed on an annual basis)
Inventory turnover = Cost of goods sold / Inventory Investment
Cost of goods sold is the cost to produce the goods or services sold for a given period.
The inventory investment can be:
The sum of the beginning and the ending inventory values divided by 2; OR
The sum of the values of different types of inventories being held in the system.
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Example: Inventory Turnover
PepsiCo. Inc provides the following in its 2005 annual report (in $ billion). Determine its inventory turnover.
Inventory Turnover = 14.2/(.74 + .11 + .84) = 8.4
There are 3 types of inventories in this system. The inventory investment is just the sum of the three inventory values.
For inventory turnover, it’s usually the higher the better.
| Net Revenue | $32.5 | |
| Cost of goods sold | $14.2 | |
| Inventory: | ||
| Raw Material inventory | $.74 | |
| WIP inventory | $.11 | |
| Finished good inventory | $.84 |
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Weeks-of-Supply
Weeks-of-supply indicates for how long the average amount of on-hand inventory may last based on the current demand.
Weeks-of-supply = Inventory Investment / (cost of goods sold / 52 weeks)
Using the PepsiCo’s example, the weeks-of-supply for PepsiCo in 2005 = (.74 + .11 + .84) / (14.2 / 52) = 6.19 weeks
This measure may have more meaning in the wholesale and retail portions of the service sector than in manufacturing.
For weeks-of-supply, it is usually the lower the better.
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