For A-Plus Writer Only

222

Supply Chain Management

Chapter outline

10.1 Supply chain and supply chain management

10.2 Purchasing and logistics

10.3 Measuring supply chain performance

10.4 Supply chain dynamics-the bullwhip effect r

10.5 Improving supply chain performance

10.6 Supply chain structural improvements

10.7 Supply chain infrastructural improvements

10.8 Technology and supply chain management

10.9 Supply chain risk and resilience

10.10 Key points and terms

In March 2011, the worst earthquake, tsunami, and nuclear disaster in history hit Japan. Toyota's supply chain was devastated by this disaster. Lean manufacturing pioneered by Toyota was based on relative certainty of supply and demand together with minimal inventories. Automobile parts in high d emand and short supply reached 500 parts after the disaster, only to be reduced to 30 parts four months later when Toyota production finally was restored to 90 percent of its capacity. In 2011, Toyota sales dropped 21 percent over the previous year.

However, some manufacturing firms in Japan had more resilient supply chains. Apple's iPad2, which had just been launched, suffered little production loss be- cause Apple had diversified its supply chain inside Japan and to other countries. Fujitsu had major semiconductor factories near the heart of the earthquake zone, yet recovered more quickly than other semiconductor suppliers. While the March 2011 disaster was extreme, it raises the question of how much supply chain resil- ience should be planned. There must be a balance between efficiency, low inventories, and supply chain resilience for unexpected events.

In this chapter, we introduce the subject of supply chain management, which has generated a great deal of interest recently in industry and academia. There are several reason s for this sudden interest. First, the total time for materials to travel through the entire supply chain can be six months to a year or more. Since the

Chapter 10 Supply Chain Management 223

materials spend so much time waiting in inventory, there is a great opportunity to reduce the total supply chain cycle time, leading to a corresponding reduction in inventory, increased flexibility, reduced costs, and better deliveries. Also, many companies have improved their internal operations dramatically and now find it necessary to consider relations with external customers and suppliers in the supply chain to gain further improvements in operations. Finally, supply chain thinking is an application of systems thinking and provides a basis for under- standing processes that cut across a company's internal departments and processes that extend outside the company as well.

0.1 SUPPLY CHAIN AND SUPPLY CHAIN MANAGEMENT

RGURE 10.1 typical supply

dlain.

Supply chain management is an essential aspect of business today. To understand what supply chain management entails, we first need to provide a formal definition of a supply chain. Figure 10.1 depicts a typical supply chain, showing several suppli- ers, manufacturing plants, warehouses, and retail sites. These facilities may be under the control of a single firm, but more likely several firms control them. A supply chain therefore is the set of entities and relationships that cumulatively define materials and information flows both downstream toward the customer and upstream toward the very first supplier. Materials and requisite information (usage instructions, inven- tory levels, invoices, etc.) flow downstream or forward from suppliers to customers, with materials being transformed by the various entities into units of the final prod- uct sold to the customers. Return materials (e.g., defective units, recyclables, cus- tomer returns), requisite information (e.g., demand, forecasts), and monetary payments also flow upstream or backward from customers to suppliers, with infor- mation facilitating capacity and inventory planning within the supply chain.

Although a supply chain generally can be depicted without specifying a vantage point (as in Fig-ure 10.1), it is often more useful to show a supply chain from the perspective of a firm, a factory, a service delivery unit for a firm, a product family (e.g., automobiles), or even a type of service (e.g., outpatient surgeries). Figure 10.2, for example, shows the entire supply chain for an organization called Z. The orga- nization Z, in this case, can be the entire firm or a specific factory or hotel property. The various nodes or ovals represent other facilities through which materials and requisite information flow for the product that Z sells to end customers.

Suppliers Suppliers Factories Warehouses Retail

224 Part Four Capacity and Scheduling

FIGURE 10.2 A typical supply chain from the per- spective of entity Z.

Upstream or Backward Materials and Information Flow

2nd-Tier 1st-Tier Distribution Suppliers 1 Suppliers 1

I I Centers and 1 RetaiJt. Warehouses

T

I

With respect to Z, the flow of materials from upstream nodes into Z generally referred to as physical supply and the flow of materials from Z through dow. stream nodes toward the end customers is referred to as physical distributi«a. Distribution channel, a term frequently used in marketing, is a specific route frolll a producer (in this case, Z) forward through the various nodes (e.g., distributoal and wholesalers) to the end customer and is therefore only part of the sup~ chain for Z. Notice also that the physical supply for Z can be segmented furt:hll!lr into tiers such that 1st-tier suppliers have a direct linkage (represented by an ar- row) to Z, 2nd-tier suppliers have a linkage to Z through 1st-tier suppliers, and _ on. Similarly, Z has linkages to downstream entities (distributors and wholesalem as part of its physical distribution. Each entity in Figure 10.2 ideally plays a valueJ added role in transforming materials into the desired final product for the cus- tomer while passing along relevant information. The Operations Leader box titled "Apple's iPhone" describes the integrative roles that different players assume in bringing forth today's increasingly complex products.

A large company will have several supply chains. In a multidivisional company with many product groups there can be many different supply chains. For exam- ple, large companies such as Procter & Gamble and General Electric may use 50 to 100 different supply chains to bring their products to market. Some of these supply chains u se distribution through company-owned warehouses, some use direct dis- tribution, some use outside manufacturing, and some use in-house manufacturin§ sites. The elements in a supply chain can be arranged in many different ways.

A company can identify its supply chains by first selecting a particular produd: group or product family. Then it should trace the flow of materials and informa- tion from the final customer (end user) backward through the distribution system to the manufacturer and then to the suppliers and the sources of raw materials.

Chapter 10 Supply Chain Management 225

-

Operations Leader Apple's iPhone - -

Many high-tech consumer products are not manu- factured by the companies whose brands they carry, but instead are manufactured by a host of other companies that act as 1st-tier, 2nd-tier, and 3rd-tier suppliers. The iPhone design, software development, chip design, and marketing are done in the United States by Apple. The manufacturing is outsourced to Taiwan, China, Korea, Japan, and Singapore. The iPhone is being assembled by the millions of units in China by FoxConn, a huge Taiwan-based electronics company. Samsung, a South Korean manufacturer, provides Apple's custom-designed chip-the most important hardware component of the phone. The digital camera modules, internal circuitry, Bluetooth chipsets, screen controllers, and other components are provided by 2nd- and 3rd-tier suppliers. This il- lustrates the complex and global supply chain used by Apple.

Sources: http://9to5mac.com/2011/1 0!11/iphone-4s -manufacturing-born-analysis/; http://www.shmula.com/ the-apple-iphone-supply-chain/304/ and http://www . nytimes.com/20 1 0/07/06/technology/06i phone .htm I

This entire chaiu of activities and processes constitutes the supply chain for that product group.

Armed with this understanding of a supply chain, a useful definition of supply chain management (SCM) taken from the Institute for Supply Management (http://www.ism.ws/) is as follows:

Supply chain management is the design and management of seamless, value-added processes across organizational boundaries to meet the real needs of the end customer.

SCM, by this definition, involves a sequence of value-added processes that not only cut across organizational boundaries but also must be tightly integrated. To be inte- grated, the processes must be appropriately designed and systematically managed to allow information to flow and be deployed within and across them. The design and management of these processes therefore require that decisions be made to implement strategies and solve problems to ensure an effective and efficient flow of materials and requisite information across the entire supply chain. These strategies and problem resolutions are intended to reduce uncertainty across the entire sup- · ply chain- uncertainty that each node creates and that affects other upstream and downstream nodes. Taking a .systems perspective is therefore paramount so that strategies and problem resolutions to reduce uncertainty at one node do not end up increasing the uncertainty created at another node. In Section 10.4, we demonstrate more clearly the system dynamics inherent in supply chains and explain why sup- ply chains and their management must be viewed in a holistic fashion.

Besides defining SCM from a process or decision-making orientation, many scholars and managers define SCM as the integration of three traditionally separate

226 Part Fou r Capacity and Scheduling

Operations Leader SCOR Model

The SCOR, or "Supply Cha in Operations Reference, " model represents a cross-industry process framew ork and standard for defining what SCM entails. In this

~. I I

I

Suppliers' • Sup plier ~

Internal or External

- -- -

services to meet planned or actual demand. Make re- fers to processes that t ransform materials into a fin- ished product. The Deliver process is the set of activities

Internal or External r

.~ I I

I

1 Customer 's ~ Customer

Your Company

respect, it seeks to play the same role t hat ISO 9000 or the Baldrige Award plays with respect to total quality management.

SCOR was introduced in November 1996 by the Supply-Chain Council. At that t ime the Supply-Chain Council included 69 voluntary members represent ing a cross section of industry leaders (e.g ., Dow Chem ical, Texas Instruments, Federal Express) . The 69 m ember firms worked for six months to define common supply cha in management processes, best practices for those processes,. and benchmark performance data.

The current version of the SCOR model is repre- sented as a four-level pyramid, with Level 1 (Top Level) defining SCM to encompass management of five dis- t inct processes-Plan, Source, Make, Deliver, and Re- turn. The Plan process refers to the development of a course of action (i.e., strategy) for bala ncing dema nd and supply while meeting the requirements of sourcing, production, and delivery. The Source process refers to the set of activities involved in procuring materials and

involved in order entry, mat erials handling, and trans- porting of goods and services to meet demand. TheRe- t urn process is the set of activities for handling returns of goods. Level 1 of the SCOR model also establishes performance objectives and targets for performance.

Level 2 (Configu ration Level) estab li shes 26 co re supply chain process categories that can be deployed to configure the actual or an idea l operat ional struc- t ure of a fi rm's supply chain. Level 3 (Process Element Level) provides information at the process level (e.g., inputs/out p uts, process metrics) to help f i rms com- pet e in t he marketplace. Finally, Level 4 (Implemen- tation Level) helps firms identify and implement specific supply chain management practices.

A major advanta ge of the SCOR model is that it provides a common framework and lexicon for inter- o rganizational communication and efforts aimed at improving performance of the entire supply cha in.

Source: Adapted from Supply-Chain Council, www.supply -chain.org.

functions: purchasin g, operations, and logistics. This integration is best captured by a cross-industry standard known as the SCOR model, w hich is d escribed in the Operations Leader box. With respect to our examp le, Z, p urch asing would be the function that deals with the p hysical supp ly to en sure the flow of materials an d information into Z, operations wou ld be the function that strives to guarantee the flow of materials and requisite inform ation from Z downstream to other

Chapter 10 Supply Chain Management 227

entities in the physical distribution, and logistics would be the function that · designs and manages the physical transportation of materials both inbound into Z and outbound from Z and from the forward-flow and reverse-flow directions.

What has to be emphasized is that in recent years the three functions of pur- chasing, operations, and logistics have evolved and taken on responsibilities for materials flow. As a result, there has been a blurring of what duties, decisions, and problems belong to purchasing or operations or logistics. For example, what used to be known as the Council of Logistics Management has been renamed the Coun- cil of Supply Chain Management Professionals (http://www.cscmp.org/ ) tore- flect a broadened definition of logistics management that is identical to that of SCM. Similarly, the National Association of Purchasing Managers has changed its name to the Institute for Supply Management (ISM).

Contributing to the confusion in terminology is demand management, which often is discussed as the flip side of supply management and essentially refers to decisions that are taken to affect the quantities demanded of one or more products that are served by a supply chain. These decisions typically are undertaken by marketing and include mechanisms such as what products and product features to offer, what the pricing should be, how products should be promoted, and through what distribution channels products should be sold. Whereas SCM tries to match supply to demand, demand management focuses on creating and man- aging the quantities of one or more products that can be served by a supply chain, giving rise to yet another term, demand chain management.

0.2 PURCHASING AND LOGISTICS

-GURE 10.3 purchasing

de.

The purchasing and the logistic functions are integral to the efficient and effective performance of supply chains. These two functions coordinate and collaborate with the operations function within firms to deliver products and services to cus- tomers while meeting cost, quality, delivery, and flexibility objectives.

The purchasing function sources inputs into the transformation process of the firm from other for-profit and nonprofit organizations. These inputs range from tangible products (e.g., raw materials, parts, and capital equipment) to services (e.g., employee travel, health care, and consulting). In sourcing inputs, the pur- chasing function has the responsibility for many tasks. Those tasks typically are depicted as the purchasing cycle shown in Figure 10.3. As shown, the purchasing function receives information from a user (i.e., a p erson or a department) about a

Purchasing Cycle

Competitive Bidding or Negotiation

228 Part Four Capacity and Scheduling

need. That need, which can be a product or a service, must be clearly specified in terms of product or service characteristics. For example, if the need is for training the specifications ideally should include information about the topics of training (e.g., lean), the timing and duration, the level, and so forth. Once the specificaJ tions have been ascertained, the question of whether it is necessary to source it from a vendor must be answered. Sometimes the need can be satisfied internalJ:}L Perhaps there is expertise about lean training inside the firm. When a need can- not be satisfied internally, purchasing begins the process of identifying and eval- uating potential suppliers, selecting a supplier, agreeing to contract and order details with the selected supplier, and monitoring and managing the relation ship with that supplier.

Firms increasingly engage in global sourcing: the practice of procuring needed goods and services without being constrained to geographic regions. The specific tasks of sourcing do not change. What changes is that the set of potential suppliers no longer consists of those who reside in the same country. By going beyond coun- try borders, firms avail themselves of a large set of potential suppliers and can take advantage of cost and expertise differences from one country to another.

Global sourcing, however, has its challenges. Sourcing from China, for exam- ple, has recently led to newsworthy concerns about product quality and safety (e.g., Mattei and toy recalls, inferior wallboards in residential construction in Florida). Fluctuations in exchange rates •can also threaten the cost savings of sourcing from a lower-cost country. For example, if the U.S. dollar were to de- value 50 percent against the Mexican peso, payments that had been negotiated in pesos and owed to Mexican suppliers would be twice as expensive in terms of dollars. Global sourcing therefore presents both benefits and risks. Careful evalu- ation of both the advantages and the disadvantages must be conducted for global sourcing opportunities.

The logistics function is typically responsible for the actual movement and stor- age of goods across organizations in a supply chain. This movement ideally is oriented downstream toward the customer. However, with increased focus on sus- tainability, the logistics function today also has to be concerned with reverse logis- tics: the movement, storage, and disposal of goods that are returned by the customer. These returns may be due to defects or may occur because the products are no longer usable and have to be recycled. Dell, for example, provides conve- nient ways to recycle an old computer. It can be taken to Goodwill or FedEx will pick it up at your home when you purchase a new Dell computer.

Three key decisions typify the responsibilities of the logistics function: choice of transportation, packaging and materials handling, and the location and man- agement of storage points. Transportation choice is concerned with the mode of transportation: how to transport goods physically between locations in a supply chain. In other words, are goods to be shipped by rail, by truck, by air, or by combinations of these modes? The locations in a supply chain, by the way, can be organizational units of the same firm (e.g., between the warehouse and a plant of the same firm) or organizational units of different firms (e.g., a suppli- er's distribution center and the warehouse of the buying firm) . From the per- spective of a focal firm, transportation choice also can be differentiated in terms of outbound versus inbound transportation. Whereas outbound transportation pertains to the movement of goods from the focal firm to its customers, in- bound transportation pertains to the movement of goods from suppliers to the focal firm. ·

Chapter 10 Supply Chain Management 229

Operations Leader Unpackaged: The Eco~Friendly London Grocery Store

Unpackaged is not your typical grocery store. An organic grocery store founded in 2006 by its propri- etor, Catherine Conway, Unpackaged tells its cus- tomers to bring their own containers when they shop. Customers have obeyed, bringing with them bottles, glass jars, paper bags, plastic bags, and old boxes to carry their produce home. Inside this London store, organic grocery items are stored in barrels, buckets and bins, and matte bla~k tubs. Cus- tomers scoop their purchases into the containers they bring. The store has been profiled in videos on their website www.beunpackaged.com .

Asked to describe the store's philosophy, Conway responded as follows:

We source Fair Trade products where possible; we don't sell products that are shipped by air; we give preference to suppliers who are part of coopera- tives; and we apply the same three basic principles of the "waste hierarchy" : reduce, reuse and recycle. Unnecessary packaging increases the price of the goods because you're effectively being charged twice: First, when you buy overpackaged goods, and then through your taxes, which are spent get- ting rid of the leftover rubbish. Packaging is usually disposed of either in a landfill or by incineration, both of which are major pollutants. Of course, some packaging can be recycled, but only some. Despite our best efforts, most of what we bring into the home ends up in a landfill. (from C. Dowdy, "On the Loose," Hemisphere, May 2009, p. 92)

When the store turned one year old on Novem- ber 7, 2007, it commissioned an environmental im- pact report in which Unpackaged was compared with a conventional grocery store. According to the report, Unpackaged generates 1.5 fewer tons of greenhouse gas annually than a conventional gro- cery store in which shoppers are given the choice of paper or plastic at checkout.

Source: Adapted from C. Dowdy, "On the Loose," Hemisphere, May 2009, pp. 90-92; http://beunpackaged .com/.

Second, packaging and materials handling focus on finding ways to protect goods that are in transit from one location to another or that need to be stored tem- porarily before they are used. Wrong packaging and incorrect materials handling can have damaging effects on products in transit. For example, in shipping perish- able goods (e.g., meat, fruits, and vegetables) across long distances, refrigeration is required; otherwise, the goods will spoil and will not be safe to consume when they reach their final destination. Packaging in fact can also be an important marketing tool for branding purpose and for inducing changes in consumer behavior. Read the Operations Leader box titled "Unpackaged: The Eco-Friendly London Grocery Store" about packaging for branding and environmental sustainability.

Third, management of storage points focuses on how many storage facilities (or warehouses) to have in a supply chain, where to locate storage facilities in the sup- ply chain, and how to manage them. The number, size, and location of storage fa- cilities affect how responsive a supply chain is. These storage facilities can belong to the entity that is shipping goods downstream, to the entities receiving goods from upstream, or, as increasingly is the case, to third-party independent entities providing the transportation mode.

230 Part Four Capacity and Scheduling

TABLE 10.1 Exemplary Issues and Decisions for the Purchasing and Logistics Functions

Purchasing Function

• Make-or-buy • Supplier management strategies for

sou reed items • Supplier qualification and selection • Ongoing supplie r evaluation and

relationship s • Strategic partnerships w ith suppliers • Supplier involvement in desi gn • Sourcing strategy

Logistics Function

• Transportation mode • Materials handling and warehousi ng

• Packaging • Storage locations within a supply cha-

• Shipping policies • Third-party logistics providers

Table 10.1 highlights the key issues and decisions that typify the responsibilii:Ht of the purchasing and logistics functions . Because these issues and decisions are covered in courses on purchasing management and logistics management, only a brief discussion is presented here.

10.3 MEASURING SUPPLY CHAIN PERFORMANCE

While it is useful to think of a supply chain when one is considering the set of ac- tivities needed to manufacture a product or deliver a service, measuring its perf<Jl"i mance cannot be done in isolation from the various entities that make up the supply chain for a particular product or service. Measuring the performance of a supply chain therefore must be done one company at a time from each company'd individual perspective, along with a few measures that are applicable to the entire supply chain. From the standpoint of supply chain measurement, each company can derive its own performance measures, which in turn are affected by its supply chain partners. Finally, the performance of a company within a supply chain can affect the performance of the other companies as well.

For example suppose a manufacturing company has three kinds of inventory: raw materials, work in process, and finished goods. The level of raw-materials inventory is a function of the suppliers' lead times and the safety stock needed to handle variance in lead times and demand. Therefore, raw-materials inventory depends on the suppliers in the supply chain. Similarly, finished-goods inventory is a function of the logistics lead time in shipping the product to the customer, the producer's lead time in refilling inventory, and the customer's variance in de- mand. Both the company and the customer influence the level of finished-goods inventory. Work-in-process inventory, however, is the most controllable compo- nent of inventory by the manufacturing company itself and is a function of the company's throughput time to convert raw materials into finished goods. There- fore, in measuring supply chain performance, we must remember that each mem- ber of the supply chain should measure its own performance but that performance is highly influenced by other supply chain members.

While there are many metrics for measuring supply chain performance, they gen- erally correspond to the delivery, quality, flexibility, and cost measures discussed in Chapter 2. Examples of specific measures of performance include the following:

1. Delivery. Delivery actually has three distinct measures: on-time delivery, fill rate, and lead time. In make-to-order situations, on-time delivery is the percent- age of orders delivered complete and on the date requested by the customer. Note that orders are not counted as delivered when only part of an order is

Chapter 10 Supply Chain Management 231

filled or when the customer does not get the delivery on the requested date. Thls is a stringent definition, but it measur~s performance in getting the entire order to the customer when it is wanted.

In make-to-stock situations, the fill rate is measured as the percentage of or- ders filled completely from inventory. Suppliers affect on-time delivery and fill rates: If they do not provide the components needed on time, the inventory can- not be maintained or the order delivered on time. On-time delivery depends on the logistics system for shipping the order to the customer on time and, of course, on the producer for delivering on schedule.

The third measure of delivery is replenishment lead time, which is the time it takes from when the order is taken to when it is delivered to the customer. For a make-to-order process lead time depends on a number of things, including the time from order placement to the start of the work plus the throughput time of the producer plus the delivery time to the customer. For a make-to-stock pro- cess the lead time can be shortened by carrying inventory at the producer or the suppliers.

2. Quality. Quality can be measured in a number of ways, including the perfor- mance of the product or service, conformance to specifications, and customer satisfaction. Quality is influenced by the expectations of the customer, the sup- pliers' ability to deliver a quality product or service, and the producer's pro- cess of quality planning, control, and improvement.

3. Flexibility. Flexibility is the ability to rapidly change operations and the supply chain. Two common measures of flexibility are volume flexibility and mix flex- ibility. Volume flexibility is the time it takes to increase or decrease output by a fixed amount (say, time to increase volume by 120 percent). Mix flexibility is the time it takes to change the mix of products or services delivered. These mea- sures are influenced by the producer's and suppliers' levels of inventory, avail- able capacity, and lead times.

4. Time. Time can be measured not only for an individual company but also for the entire supply chain. The total supply chain throughput time is just the sum of the throughput times (also called cycle times) of each of the entities in the supply chain. For example, if the throughput time of the supplier is 5 weeks, the throughput time of the producer is 10 weeks, and the delivery time to the customer is 2 weeks, the total supply chain throughput time is 17 weeks. As we noted in Chapter 6, if there is a constant usage rate from inven- tory, the throughput time is the inventory level divided by the usage rate (an application of Little's Law). For example, if the inventory level is $10 million and we sell (or withdraw) $100,000 per day, we have 100 days of throughput time. The throughput time in each part of the supply chain (supplier, manu- facturer, wholesaler, and retailer) is added to get the total supply chain throughput time.

However, it is also important to consider the time it takes to get paid for the product once it is sold. It is not enough to reduce inventories; the company must also get the cash from sales so that it can use the money to make and sell more products. Cash-to-cash cycle time is a frequently used measure to gauge how quickly a firm is paid by its customers relative to how quickly it has to pay . its suppliers. Cash-to-cash cycle time can be computed as follows:

Cash-to-cash cycle time = Days in inventory + Days in accounts receivable - Days in accounts payable

232 Part Four Capacity and Scheduling

Research has shown that decreasing the cash-to-cash cycle time can impiUII firm's profitability. In 2011, Dell Computer reported a negative cash-to-cash time of -33 days (days in inventory= 9, days in accounts receivable= 40, -- in accounts payable = 82). In essence, Dell gets its money before it has to pay suppliers. This is one of the fastest cash-to-cash cycles in industry due to very inventories and accounts receivable, coupled with relatively high accounts .r able. It is made possible by Dell's very effective management of its supply chail

5. Cost. Cost, from an operations point of view, generally refers to the unit cost the product or service. Unit cost is defined as the total manufacturing cost.. eluding materials, labor, and overhead, divided by the number of units prod~ Additional costs are also incurred in distribution, inventory carrying, and - counts receivable, to name a few. Suppliers heavily influence the unit cost, siid often more than 50 percent of costs are accounted for by purchased materials.

Cost is a measure that also can be analyzed for the supply chain as a w~ Each entity adds cost as the product is moved along the supply chain. There :!~. costs of materials and components from suppliers. The producer adds a certaill amount of cost to fabricate and assemble the product. Cost is added by logistilt to ship materials and work-in-progress between firms in the supply chain a~ ship the finished-goods inventory to the customer. The sum of all of these cosiS is the total supply chain cost.

It is important for a company to set goals for the five separate measurement areas with respect to its own performance. A company should also meet with its supplielll and customers to set supply chain goals as a group. It is important that the whole supply chain be improved, not just one portion. Also, improvement in the compa-" ny's part of the supply chain could work to the detriment of other parts and needs to be coordinated for overall system benefit. For example, if a company unilaterallY cuts its finished-goods inventory, it could reduce its cost but increase stockouts, af- fecting its ability to supply its customers. Alternatively, a company could reduce its inventory by reducing its throughput time and also working with suppliers and lo- gistics to reduce their throughput times. This could benefit the entire supply chain.

10.4 SUPPLY CHAIN DYNAMICS-THE BULLWHIP EFFECT

The entities in a supply chain are interrelated by the very fact that they send mate- rials and information up and down the supply chain. The decisions they make and the actions they take can have a substantial impact on each other. These interrela- tionships define the dynamics that we often observe in any supply chain, with one specific manifestation of supply chain dynamics being the bullwhip effect.

The bullwhip effect describes the increasing variability in orders that are re- ceived by entities upstream in a supply chain, which in tum affects the amount of inventory that those entities hold. The bullwhip effect has been observed in nu- merous industries ranging from consumer products to pharmaceuticals to elec- tronics. The bullwhip effect takes its name from Procter & Gamble executives who first saw the effect on ordering baby diapers, a relatively fixed-demand item. Yet, orders at the factories, wholesale, and retail levels exhibited much more variance than final consUJ;ner demand . Hewlett-Packard also observed an upstream increase in variance of orders and inventories for printers.

To illustrate the bullwhip effect, consider the four-tier supply chain shown in Figure 10.4. The retailer, which is closest to the market demand, observes the

FIGURE 10.4 The bullwhip effect. Source: Ad apted from J, Nienhaus, A. Ziegenbein, ..c! P. Schoensleben, " How Human Behaviour Amplifies lhe Bullwhip Effect. A Study Based on the Beer Distribu- lion Game Online," Produc- lion Planning and Contro/17, 1111. 6 (2006), pp. 547-557.

Chapter 10 Supp!y Chain Management 233

Order Pattern Inventory Levels

80 50 70

60 50

40 40 30

30 20

Retailer 10

0 20

-10 -20

10 -30 -40 -50 -60

5 10 15 20 Time -70 Time

50 80 70 60

40 50 40

30 30 20

1st-Tier 10 Supplier

20 0 -10

10 -20 -30 -40 -so

5 10 15 20 Time

-60 -70 Time

50 80 70 60

40 50 40

30 30 20

2nd-Tier 10 Supplier 20 0

-10

10 -20 -30 -40 -50

10 15 20 Time

-60 -70 Time

80 50 70

60

40 50 40 30

30 20 3rd-Tier 10 Supplier 20 0 -10

- 20 10 - 30

-40 -50 -60

10 15 20 Time - 70

demand and places orders to its 1st-tier supplier. The retailer orders correspond to the demand for the 1st-tier supplier. The 1st-tier supplier in turn orders from the 2nd-tier supplier, and so on. At the same time, because there is the replenish- ment lead time involved in producing and delivering products, each entity in this four-tier supply chain also holds inventory. By doing so, each entity is aim- ing to fulfill demand quickly (i.e., the orders an entity receives) from inventory and can also reduce its replenishment lead time since orders do not have to wait to be produced.

234 Part Four Capacity and Scheduling

When we review the graphs of the order patterns among the four entities in this supply chain, three observations can be drawn. First, we see that there is variabilil11 in the orders received by each entity from period to period. Without order variabil- ity, the same order quantity would be received again and again up the supply chain. Second, when we compare the magnitude of the variability of the orders received by the retailer with that received by the 1st-tier supplier, with that received by the 2nd- tier supplier, and with that received by the 3rd-tier supplier, an interesting patte.- emerges. As we move farther and farther back from the market or up the suppiJ chain, the variability of orders received by upstream entities becomes m agnifiedl The farther away a supply chain entity is, the greater is the variability of orders it receives. Third, the same pattern of upstream magnification of order variability also describes inventory levels across the four entities in this supply chain. Because the entities in the supply chain are not synchronized to match the market demand ob- served by the retailer, the varying order sizes received by the various entities resuJt in an accumulation of inventory at times and in shortages and delivery delays at other times. The bullwhip effect thus affects not only the performance of the indi- vidual entities in a supply chain but also that of the supply chain in its entirety.

Why is the bullwhip effect so common across industries? One reason is that supply chain entities farther upstream may not have or be granted access to actual market demand. Instead, they use forecasts to guide their initial decisions and ac- tions and use actual orders received to make adjustments to those decisions and actions. When forecasts are inaccurate, the initial decisions and actions do not match actual market demand, creating situations of feast or famine. Another rea- son is the replenishment lead time (i.e., the time between when an order is placed and when an order is received) that each entity faces. When a supply chain entity faces substantial replenishment lead time, it may have no choice but to hold safety stock as a buffer against unexpected large orders. A third reason is the delay in sharing information up and down the supply chain. The retailer in Figure 10.4 may be very willing to share market demand data up the supply chain. Unfortu- nately, this will not solve the problem as long as there are lead times in filling or- ders. When demand increases at the retailer, for example, the 1st-tier supplier not only must fill the larger order but also must replenish its inventory, leading to larger orders passed on to the 2nd-tier supplier and so on up the supply chain. This explains the order amplification seen upstream in the supply chain.

To summarize, the supply chain example depicted in Figure 10.4 illustrates four key points about supply chain dynamics:

1. The supply chain is a highly interactive system. Decisions in each part of the supply chain affect the other parts. Changing parts of the system (e.g., replacing a supplier) without changing the rules that govern the interactions in the sys- tem may not lead to improvements.

2. A bullwhip (or accelerator) effect often is observed in supply chains. Upstream en- tities in the supply chain (e.g., warehouses and the factory) react to inflated orders from downstream entities that are closer to the market by placing even larger or- ders upstream and carrying inventory. These inflated orders distort the true de- mand information (quantity change, timing of change, etc.) observed in the market

3. Even with perfect information available to all levels, the bullwhip effect can be observed in a supply chain because of long replenishment lead times between the entities in the supply chain and long lags in sharing information up and down the supply chain.

Chapter 10 Supply Chain Management 235

4. The best way improve the supply chain is to reduce the total replenishment lead time and feed back actual demand information to all levels as quickly as possible. The physical and information time lags in the supply chain only serve to create fluctuations in orders and inventories.

Research results by Nienhaus et al. (2006) of simulations studies with over 4000 participants shows how human behavior amplifies the bullwhip effect. Managers tend to over compensate due to changing orders and inventory. Two human strat- egies caused amplification in the supply chain.

1. Safe harbor: Managers order more than necessary to increase safety stocks be- cause they are afraid of running out of inventory. This forces suppliers to also order more inventory and may cause upstream stockouts temporarily. Thus, a safe harbor causes increased orders and inventory magnification upstream on the whole supply chain.

2. Inventory panic: Managers reduce inventories thinking they are too high and costly. When downstream demand increases, the effect is to order more due to low safety stock. AB a result, upstream tiers often run out of inventory and are unable to fill. orders for some days. This also magnifies the effect of demand changes.

As noted above, there are several ways to reduce the bullwhip effect b y sharing information or reducing replenishment lead times. By doing this the bullwhip will be reduced but not eliminated, since managerial behavior for a safe harbor or in- ventory panic is still present. The role of human behavior in causing the bullwhip · must also be considered.

10.5 IMPROVING SUPPLY CHAIN PERFORMANCE

To improve supply chain performance, greater coordination must be attained not only within firms but also across firms. The typical firm is organized into func- tional silos, with different departments managing different aspects of the supply chain. For example, purchasing takes care of the suppliers and raw-materials in- ventory, operations takes care of manufacturing and work-in-progress inventory, and marketing manages demand and finished-goods inventory. When these de- partments lack coordination, as they often do, there are dramatic effects on the supply chain within the firm as well as beyond the firm.

Within-fum and across-fum coordination can be increased by changing and im- proving either the structure or the infrastructure of supply chains. Changes in supply chain structure relate to the products and services offered; the types and locations of facilities, process technology and layouts, and vertical integration. Changes in sup- ply chain infrastructure relate to the roles and responsibilities of employees, who the suppliers are and how they are managed, and systems, including information sys- tems, production and inventory control, and quality control systems.

Whether the intended improvement is in supply chain structure or supply chain infrastructure, the goal of any improv ement initiative should be to facilitate increased coordination to r-educe either uncertainty or total replenishment lead time and the total cost of supplying the market. Only when uncertainty in demand or in supply times can be reduced along the chain is the need for inventory also reduced. For example, in the extreme case in which demand uncertainty is zero and resupply is completely reliable, no inventory is needed except for that in tran- sit. The material can be scheduled to arrive just as it is needed b y the customer.

236 Part Four Capacity and ScheduUng

Likewise, when the total replenishment lead time in the supply chain is reduced, the supply chain as whole can react more flexibly and rapidly to real demand changes, again reducing the investment that the supply chain needs to make in inventory.

10.6 SUPPLY CHAIN STRUCTURAL IMPROVEMENTS

Changes in supply chain structure rearrange the elements of the supply chain, usu- ally in a major and dramatic way. These changes are frequently long-range in nature and require considerable capital. Changing and improving supply chain structure can be accomplished in a number of different ways, including the following:

1. Engaging in forward and backward integration 2. Pursuing major process simplification 3. Changing the configuration of factories, warehouses, or retail locations 4. Pursuing major product redesign 5. Working with third-party logistics providers

Forward integration and backward integration refer to ownership within the supply chain. If a manufacturer, for example, decides to buy a wholesale firm and distribute its products only through that wholesaler, the integration is forward toward the market. If the manufacturer buys a supplier company, the integration is backward in the supply chain. If one firm owns the entire supply chain, there is total vertical integration.

Zara is a Spanish-based clothing retail chain that has en- gaged aggressively and successfully in vertical integration in support of its more than 1800 clothing stores in over 80 coun- tries. By integrating across design, production, distribution.. and retailing, Zara is a rebel in an industry in which the norm is to outsource all production activities to countries with the lowest labor costs. By owning its own production facilities, Zara is able to dictate 85 percent of what to make while in- season, often with small batch runs. Because that is coupled with IT investments in capturing and transmitting demand information across its supply chain, Zara can respond quickly

Zara vertically integrates to respond quickly to changing market trends, with the design-to-store-delivery to changing market needs. cycle time being as fast as just two weeks.

In addition to the substantial time-to-market benefits, vertical integration reaps the profits of suppliers or distributors provided that there is an attractive return on investment. Vertical integration also has drawbacks, however, such as . loss of flexibility to changing technology and possible loss of economies of scale. Nevertheless, forward and backward integration decisions can be evaluated like any other investment choice of the firm and may be the key to improving supply chain performance.

Major process simplification is used to improve supply chains when the pro- cesses are so complex or out of date that a major change is required. In this case, a dean-slate approach is used in which the processes are designed from scratch without regard for the existing processes. This could include major conceptual changes in how business is conducted and major changes in information systems. For example, consider the changes 3M made in its Post-it Notes supply chain. The

LE 10.2 -Cost of

~hip for lkhoring

Chapter 10 Supply C hain Management 237

plant implemented a pull system driven by customer demand, which utilized quick changeovers, daily replenishment of branch stock, and responsive produc- tion scheduling based on daily customer demand. 1 This resulted in a 99 percent fill rate, work-in-process inventory of less than one day, a reduction in machine changeovers from two hours to 13 minutes, and a reduction in new-product intro- ductions from 80 days to less than 30 days.

The third way to restructure supply chains is to change the number and con- figuration of suppliers, factories, warehouses, or retail sites. Sometimes the distri- bution system is no longer configured in the right way. For example, many companies have determined that they have too many suppliers and are reducing the number of suppliers by one-half or more (supply base reduction). This is be- ing done to partner with the best suppliers to ensure JIT deliveries and certified sources of material. Another structural change of this type is occurring in Europe as it becomes a more unified market. As a result, companies are finding that they need fewer plants and warehouses in different locations. A complete reconfigura- tion of the production and distribution facilities is under way at many companies.

Changing the configuration of a supply chain often involves practices such as outsourcing and off-shoring. Off-shoring occurs when a firm moves work per- formed internally to another facility belonging to the same firm but in another country. Outsourcing occurs when work that traditionally has been performed in- ternally is delegated to another firm, whether that firm is in the same country or in another country. When an activity is transferred from a domestic facility to the fa- cility of another firm in another country, the label "off-shore outsourcing" is most appropriate.2 U.S. manufacturers today are increasingly engaged in off-shore out- sourcing, with major subsystems of complex products being designed and manu- factured by a global cadre of firms . While labor cost is a major motivating factor, it is by no means the only reason firms outsource. See the Operations Leader box titled "Boeing 787 Dreamliner" for Boeing' s approach to developing and manufac- turing the 787 aircraft.

A part of evaluating off-shore production is to compute the total cost of own- ership in both the home and foreign country. This cost must include the purchase price of the product and various costs associated with importing. These include, for example, shipping, import duties, inventory carrying costs, w arranty, and other costs. See Table 10.2 for a complete list of the total cost of ownership. But,

Unit price at o rig in Foreign import duties Shipping cost s (including airfreight if needed) Carrying cost of invento ry in t ransit Quality, rew ork, and wa rranty costs Airfre ig ht to overcome delivery o r qua lity problems Pre-eva luati on and regulatory compliance Foreign trips for auditing, negotiations, and product support Wage inf lation over time Currency appreciation over t ime Potent ial costs associated with po lit ical and economic instability as a percent of price Costs associated w ith loss of intellect ual property as a percent of price

1 Actually, this involved changes in both st ruct ure and inf rastruct ure. 2 When a firm pursues off-shore o utsourcing, th e fi rm essentially is engaging in global sou rcing.

238 Part Four Capacity and Scheduling

Operations Leader Boeing 787 Dreamliner

The 787 Dreamliner is Boeing's new super-efficient commercial airplane. The 787 Dreamliner has two models-the 787-8 and the 787-9 (larger). After three years of delays, the aircraft finally started flying cus- tomers in December 2011.

There are several aspects that make the Boeing 787 Dreamliner impressive besides its fuel-efficient perfor- mance. For one, the airplane will be manufactured us- ing 50 percent composite material. By comparison the 777 uses only 10 to 12 percent. The product develop- ment process and the eventual global supply chain also make this Boeing 787 Dreamliner unique in that

the design of the airplane involved cooperation from an international cast of top-tier strategic sup- ply partners who will also end up supplying approxi- mately 85 percent of the parts making up the airplane. In fact, the only major part of the 787 to be built by Boeing at its Everett, Washington, manufac- turing facility is the vertical fin, with the remaining 85 percent being transported to this plant by road. rail, sea, and plane for final assembly.

The list of offshore outsourcing companies and associated parts includes such venerable partners as Messier-Bugatti (France) for electric brakes, Rolls- Royce (United Kingdom) for engines, Alenia Aero- nautica (Italy) for the horizontal stabilizers, Mit- subishi Heavy Industries (Japan) for the wing box. and Chengdu Aircraft Group (China) for the rudder. The decision to involve these strategic partners was motivated not so much by design and produc- tion cost as by technological expertise and the promise of new business from airlines in the respec- tive countries of these major suppliers. Air Nippon Airways has already taken delivery of the Boeing 787, with at least another 800 airplane orders having been received from 60 other airlines around the world.

Source: Adapted from aerospaceweb.org/aircraft! jetliner/b787.

off-shoring should not only consider the costs, but a possible loss of resiliency and control of the supply chain. Furthermore, many companies are concerned about protection of their intellectual property and will not outsource or off-shore prod- ucts that are part of their core technology. Since costs and risks change over time. some U.S. companies are bringing back products they previously off-shored.

Major product redesign is often another initiative needed to make improvements in the supply chain. Some companies have found that they have too many different product variations and types, some with extremely low sales. As a result, product lines are trimmed and redesigned to be more modular in nature. For example, Hewlett-Packard found that it had to make many different models of laser printers because of the different power requirements in different countries. To get around the problem, the company decided to have a laser printer design with a swappable power supply module that could be inserted at the last minute to configure the printer for the particular country where it would be used. Except for the swap- pable power supply module, all other parts of the laser printer remained common across countries. This postponement strategy saved the company millions of dollars.

Other global firms have followed in Hewlett-Packard's footsteps by incor- porating tp.odularity into the designs of their products. Modular product

Chapter 10 Supply Chain Management 239

FIGURE 10.5 Component swapping modularity and the supply chain. Source: From F. Salvador, C. Forza, and M. Rungtusanatham, "How to Mass Customize: Product Architectures, Sourcing Configurations," Business Horizon 45, D). 4 (2002), pp. 61--ti9.

SWAPP ABLE COMPONENT SUPPLIER(S):

~ • • Easily controllable . . . . "' . :

• Located in close proximity to the firm

BASIC PRODUCT BODY COMPONENT

SUPPLIERS:

• High volume, reliable processes

• Long term purchasing agreement

Product body-component #1 ..., _ _..,...,._~ --.\7

Product body-component #2

C::J ... v Product body-component #3

-+-~+c;u ... v Product body-component #4

-+---~-~~ [] ... v

Final product variants

~,~,15 ~1, ...

, ________________ (1)_C:~I?..l2.:t!~iy:_~~;::_~~ _r:!i!l_!:>}~ -~:l!~~~.r. Final assembly lead time and cost low if

----- __ . ________ . _. _. -· ____ . _. _. _. __ . _. _. _ .5~2 ~~~t.~~~Y:!"Y.-.- ••• -·... conditions (1) and (2) hold

~EX-Logistics and Customer

Service," Vol. XV

designs have catalyzed the pursuit of mass customization and allowed those firms to realize many operational benefits, including simpler process flows , less process complexity, lower inventory investments, and lower unit cost. In addition, these firms have been able to reconfigure their supply chains since the type of modularity incorporated has implications for the selection of sup- pliers, the way they are managed, the contracts to pursue with suppliers, and their proximity.

Figure 10.5 shows, for example, the supply chain implications of incorporating component swapping modularity into product redesign (essentially what Hewlett-Packard did). Suppliers of common parts are managed with long-term purchasing agreements, with a focus on pricing and reliable delivery. These sup- pliers produce in high volumes and have reliable transformation processes. Swap- pable component suppliers, by contrast, are selected on the basis of proximity and ability to deliver quickly. These suppliers are managed closely and often come under strong control by the buying firm.

Some companies have made a strategic decision to assign performance of in- ventory management, distribution, and logistics to firms known as third-party logistics providers. These providers become new nodes in the supply chain and, thus, change the structure of an existing supply chain. For example, National Semi- conductor concentrates on making semiconductors. When the product is pro- duced, it is given to Federal Express for inventory or distribution. Federal Express then warehouses the product, takes incoming orders, and ships the product to the customer. In the past, Federal Express would hav e been responsible only for the shipping portion of the typical supply chain. By becoming a third-party logistics provider, Federal Express distribution centers become new nodes in a firm's supply chain.

240 Part Four Capacity and Scheduling

10.7 SUPPLY CHAIN INFRASTRUCTURAL IMPROVEMENTS

Changes to improve supply chain infrastructure are made within a specific si:rur!- ture or configuration of the supply chain. These changes often are considered be on the "soft" side of the supply chain. They involve changing the way the sup- ply chain operates within the specific structural arrangements. This means ilia decisions about issues such as vertical integration, the number and type of faclo4 ries and warehouses, and major product and/ or process designs have alrea~ been made.

This, however, does not mean that initiatives to improve supply chain infra- structure cannot have a major impact. The objective of supply chain infrasi:rur!- tural improvement initiatives is the same: to remove sources of uncertainty, timf! and cost from the supply chain. Improvements in the supply chain infrastructunl can be just as dramatic and just as important as improvements that effect suppt chain structural change. While numerous initiatives to improve supply chain in- frastructure are available, we focus on the following five:

1. Cross-functional teams

2. Partnerships

3. Setup time reduction

4. Information systems

5. Cross-docking

The use of cross-functional teams is pervasive in many businesses today. Their purpose is to provide coordination that is lacking across the various d epartmenlll and functions of a business. For example, a cross-functional team often is used to plan and control the master schedule for manufacturing. The team consists of rep- resentatives from marketing / sales, production, human resources, and account- ing/ finance . The team develops a forecast of future expected orders, plans the capacity of manufacturing, and schedules customer orders. Everyone then agrees to work toward executing this plan. Without a cross-functional team of this type marketing makes a forecast, production uses a different forecast to plan produc-l tion, and the capital is not made available to provide the capacity needed. Without a cross-functional team, the functional silos are very effective in destroying any semblance of a master schedule that everyone can implement.

Partnerships with suppliers and customers provide coordination across busi- nesses the same way cross-functional teams provide coordination within the busi- ness. Partnerships start with a commitment by both firms to establish a long-tena business relationship that will be mutually beneficial. The partners must develop trust in each other to make this work. Also, the partners probably will establish · teams of employees from the two different firms to work together on important improvement projects. For example, a new product was developed over several months by a team of engineers from an appliance company and its key customer's site. This team worked very effectively and made a final presentation to the senior executives from both firms. One executive turned to the other and said, "Which employees are yours and which ones are ours?" The team had become so inte- grated that it was difficult to tell the members apart.

Another example comes from the grocery industry. Demand at the retailer level typically varies by about 5 percent from week to week, yet demand at the wholesale

Chapter 10 Supply Chain Management 241

1 Operations Leader Efficient Consumer Response Europe

In 1994, a joint trade and industry body, ECR Europe, was launched within the grocery industry in Europe. The formation of this organizing body was driven in large

part by the chang- ing business envi-

ECR ronment at that p ~ime. Sop_histicated • . . ~ mformat1on tech-

Effi<"Jeut Consumer Response 1

. . no ogy, tncreasmg global competition,

and cutthroat margins, along with an increasing con- sumer focus on wider choices, shopping convenience, superior service, and increased product quality and freshness, led to the realization that the traditional sep- aration of manufacturer and retailer and the absence of real coordination and cooperation between those enti- ties could not work. The intent in forming ECR Europe was to find ways to make the grocery supply chain more responsive to changes in consumer demand while reduc- ing the costs of meeting consumer demand .

Headquartered in Brussels, Belgium, ECR Europe has influenced the formation of similar bodies within European countries, in other geographic re- gions (e.g., ECR Asia and ECR Australasia), and in countries outside Europe (e.g ., ECR Brazil). Today, ECR Europe works closely with those national and international bodies to promote, facilitate, and sup- port projects aimed at exploring new collaborative in itiatives that allow consumer wishes to be fulfilled "better, faster and at less cost" (ECR Europe's mis- sion statement). Examples of current projects include how to reduce shrinkage in the supply chain, how to measure and implement optimal shelf availability for products, and how to package to meet sustain- ability requirements . Project results are shared widely through publications, at annual conferences of ECR Europe, and through the International Com- merce Institute (www.ecr-institute.org), the knowl- edge arm of ECR Europe.

and supplier levels varies by factors of two to four times that amount. This again reflects the bullWhip effect. To combat the bullwhip effect, the grocery industry has formed a partnership of retailers, wholesalers, and manufacturers to imple- ment what is called efficient consumer response (ECR). The basic elements of ECR are aimed at managing both demand and the supply chain to serve custom- ers efficiently. Read the Operations Leader box titled "Efficient Consumer Response Europe" to learn more about this supply chain partnership initiative and its global influence.

In supply chain improvement it is often necessary to deploy lean tenets and techniques to pursue setup time reduction across entities within the supply chain. A 2009 McKinsey report in fact identified lean as one of six key manage- ment practices that differentiate firms w ith good supply chain performance from those with poor supply chain performance. Setup time reduction can take m an y days out of the supply chain, reducing the total replenishment lead time and the total supply chain throughput time. In addition, reduced setup times allow smaller lots of materials and the product to be produced and transferred across the supply chain economically. Once lot sizes are reduced, inventory in the sup- ply chain would also be reduced; the inventory would turn over more quickly, more closely meeting the market need. Reducing setup time requires imagina- tion and can be done for any piece of production equipment simply by getting ready for the changeover before the machine is stopped and then making changes quickly once the machine no longer is running so that it can be put back into production as soon as possible.

242 Part Four Capacity and Scheduling

Changes to information systems are important in supply chains. One of changes occurring in industry is obtaining sales data from the final customer =.- feeding that information back through the supply chain. Suppliers no longer get orders from their customers; they know the sales and inventory positionl the customers as well. This gives the supplier a basis for better (i.e., more ac~ and more timely) forecasting of future orders and planning capacity. Sharing :. kind of information is easy once partnerships across the supply chain have hem established. However, capturing and sharing the downstream demand inforDIIII- tion across the supply chain will require improved information systems and Del decision rules for capacity planning. These elements can be integrated into a vised information system.

Cross-docking is an innovation in transportation that has been attributed Walmart. The basic idea is that a supplier's shipments are taken from variallo docks at the warehouse when they arrive and transferred directly to a Wal.mall truck at another dock. The items do not spend time in the warehouse's invent0111 they simply are moved from one dock to another. This provides the benefit of truckload shipments (i.e., economies of scale) while drastically reducing ware- house inventory. Cross-docking is being used wherever there is sufficient vollllllll to make it possible.

10.8 TECHNOLOGY AND SUPPLY CHAIN MANAGEMENT

Structural and infrastructure improvements in the supply chain can help red"ld cost, uncertainty, and time. These improvements often take advantage of advance4 technology to facilitate increased coordination among supply chain entities.

The Internet and the World Wide Web, for example, are disruptive technolol gies that are changing not only how business transactions occur among firms 01" between firms and customers but also how the supply chain can be made more efficient. Because of the Internet, electronic commerce (e-commerce) is thriving B2B (business-to-business) connections in forms such as e-procurement, order entry, and Internet auctions are facilitating interfirm exchanges of goods and ser vices. Similarly, B2C (business-to-consumer) connections are allowing tradi- tional brick-and-mortar firms to create an alternative distribution channel to of- fer merchandise and services for sale. Examples include BarnesandNoble.co~ Target.com, United.com, and even automobile manufacturers such as Ford. BMW, and Honda.

At the same time, new types of businesses have emerged to serve as intermedi- aries and to help traditional brick-and-mortar firms sell their goods and services over the Internet; eBay.com (auction), eBags.com (luggage), and Expedia.cOJ .. (travel) are all examples of this new type of business.

In terms of the supply chain, the Internet is rapidly allowing businesses to be connected to each other and to the end consumer. These interconnections are pro- viding integration and facilitating more rapid and accurate information exchange across the supply chain, resulting in better coordination between companies. In- formation that was once not readily available can now be made visible to many layers of the supply chain. The Internet, as a result, is enabling companies to speed up their supply chains and reduce costs at the same time. See the Operations Lead- ers box titled "The Cisco Story" to see how Cisco is using the Internet to manage its supply chain.

Chapter 1 0 Supply Chain Management 243

Operations Leader The Cisco Story

Cisco Systems, Inc., is the worldwide leader in network- ing for the Internet. Cisco's Internet Protocol-based (IP) networking solutions are the foundation of the In-

ternet and most corporate, educa- CISCO SYSTEMS tion, and government networks

around the world; Cisco employs 67,000 people worldwide.

Cisco has set the standard for business transformation by using Internet technol- ogy to integrate its core processes and culture. The results have been phenomenal:

• 90 percent of orders taken online.

• Monthly online sales exceed $3.5 billion.

• 82 percent of support calls now resolved over the Internet.

• Customer satisfaction has increased significantly.

Cisco's CEO, John Chambers, says, "Cisco's success and our increased productivity gains are due largely to the implementation of Internet applications to run our business. The ability to harness the power of the Internet to create a New World business model is driving survival and competition in today's fast- paced economy."

Source: Cisco website: www.cisco.com, 2002, 2012.

In all supply chains, two fundamental processes are being affected dramatically by the Internet:

1. Order placement

2. Order fulfillment

The process of order placement includes not only the actual entry of an order from the cust9mer but also information supplied before the order is entered. For example, a customer might like to know before ordering a particular item whether it is in stock, where it is located, and how long it will take to be delivered. When this information is available on the supplier' s website, the customer can access it quickly.

The Internet can facilitate faster order placement and increased accuracy of an order. As the order is taken online, it can be checked for missing information, and selection menus can be provided to ensure that the customer makes correct choices. When the customer makes a special order, the specifications can be pro- vided to the supplier and then checked for consistency when the order is filled. After the order is entered, the Internet can provide the customer with manufactur- ing and shipment status. With the Internet, the order placement process can be streamlined and made more efficient and less error-prone .

In the same way, the Internet can enhance order fulfillment. Today, advance- ments in planning technologies allow orders taken by the producer to be shared seamlessly within a firm to schedule production of the order or replenishment of inventory. Such orders can also be transmitted seamlessly to control internal man- ufacturing of supporting pp.rts and external procurement of m aterials as needed. These advanced planning technologies even allow placement of procurement or- ders directly to suppliers, with suppliers having visibility of current as well as fu- ture planned orders. In this way the entire supply chain is linked electronically.

£-procurement plays an important role in the process of both order placement and order fulfillment. It allows a company to interact electronically w ith its sup- pliers through B2B com1ections. Several processes are included in e-procurement,

244 Part Four Capacity and ScheduUng

FIGURE 10.6 Processes for e-procurement. Source: Adapted from E. A. Ageshln, "E-Procure- men! at Work: A Case Study," Production and Inven- to1y Management Journal, 1st Quarter, 2001, pp. 48-53.

Request Requirement _. Selection _. Requisition _. Approval

Buy Requisition _.Source _. Negotiate _.Contract

Supply Confirm _.Process _.Ship _.Invoice

Order

Payment Receive _.Deliver _.Match _.Pay

as is shown in Figure 10.6. Each of these processes can be done electronically on the Internet.

There are generally three types of e-procurement services:

1. Online catalogs listing products, prices, specifications, sales, and delivery terms. 2. Third-party auctions for buyers and sellers. 3. Private exchanges conducted by major corporations.

Many large and small suppliers have put their catalogs online so that customers can easily purchase standard parts and J:Omponents. This has simplified order placement greatly. However, order fulfillment still must be done physically by making and shipping the product with electronic assistance for order confirma- tion, billing, and payment.

An example of third-party auctions in the auto industry is Covisint, sponsored by GM, Ford, Chrysler, and others. This reverse auction site provides easy access to suppliers who w ish to bid on parts and component contracts. Covisint has now expanded to health care, government, and financial services.

Numerous companies have formed their own private exchanges for e-procurement, including Dell Computer, Siemens, GE, Herman-Miller, IBM, and Procter & Gamble. For example, IBM has 15,000 suppliers connected via the Inter- net, and all procurement transactions at IBM are Web-based. Read the Operations Leader box titled "IBM and E-Procurement" to get answers to questions about how IBM used the World Wide Web to manage its supply chain.

E-procurement and B2B marketplaces have been growing rapidly. In 2009 e-procurement transactions reached $3 .0 trj.llion, with over 20,000 B2B market- places. This huge growth, however, has created significant problems:

• Too much focus has been placed on technology without adequate attention to process redesign and process coordination issues.

• Joint value propositions have not been developed carefully so that both part- ners benefit from the B2B exchange.

• There have been too many fragmented efforts ·across divisions within the same company and fragmented approaches across companies.

• Multitudes of record accuracy and data issues have plagued the process.

Despite these problems, progress has been made in integrating supply chains, and the promise for the future is bright. E-procurement is rapidly becoming a standard practice in industry.

Chapter 1 0 Supply Chain Management 245

Operations Leader IBM and E~Procuremcnt

This is a portion of an interview with IBM Vice Presi- dent and Chief Procurement Officer John M. Paterson about how the Web has changed the way IBM does business.

--------- ------------ ...:..====~= ®

Q. A manufacturer of IBM's size must have a complex supply chain. About how many outside suppliers does IBM use?

A. We probably have a total of a couple of hun- dred thousand suppliers across all our manufacturing lines. Of those, a few hundred are key suppliers. We may place hundreds of millions of dollars in orders with a key supplier in a year.

Q. Supply chain management has become an in- dustry buzzword and concern in manufacturing in the last year. How important is improving external supply chain management for manufacturers today?

A. For IBM, it's life or death. Fifteen years ago we were the primary designers of the technologies in all our products. Today, the speed of technological change has forced us to become integrators of other people's technology for many products.

Q. A number of Web-based tools and services have appeared in the last year in the supply chain arena. What types of Web services are valuable for manufacturers, and which should they be cautious of using?

A. Too many Web services have a heavy bias to- ward the buy side of the supply chain. Web services only work when they benefit both the buy side and the sell side. When a service promises buyers they will save 15 percent, and that is coming out of sup- pliers' margins, you can imagine how suppliers feel.

The real value of Web services is in the integration of the supply chain rather than in being able to plug suppliers in and out based on price. Web-based ser- vices that tout spot buying and options are of little value to large manufacturers. We want to develop continuity, quality, assured levels of supply from our OEMs [original equipment manufacturers] ....

According to Paterson, purchasing's role in finding suppliers of new technology is an important one if IBM is to continue to be successful in the marketplace.

"We as a procurement community need to be pro- actively bringing supplier capabilities to the table," Paterson said. The mission of procurement is "not to wait for someone to ask for something and then source it. If IBM buyers do that, they will not deliver the value to IBM that IBM needs to compete," said Paterson.

Sources: Adapted from G. B. Latamore, "Get Personal, " APICS-The Performance Advantage, October 2000, pp. 30-35; http://www.digikey.com/purchasingpro/us/en/ articles/supply-chain/ibm-depends-on-suppliers-for -technology-value/1123, December 2011 .

10. 9 SUPPLY CHAIN RISK AND RESILIENCE

Modem supply chains span across multiple countries and have numerous suppliers and customers. As a result of this complexity, they are subject to higher risk from sup- ply and demand disruptions that are unexpected. There has been a tendency to re- duce the cost and inventories in supply chains by a variety of approaches. As a result, supply chains tend to be less resilient to disruptions and have higher risk exposure. We define supply chain resilience as the ability to quickly respond to unexpected disruptions in supply or demand than can be either natural or manmade.

In 2001, Cisco's supply chain broke from too much inventory. The world's larg- est network equipment maker shocked the stock market by announcing that it would write off $2.5 billion in inventories, and its stock price subsequently dropped by 6 percent. What happened is Cisco relied too much on outside suppli- ers and gave them incentives to overproduce in the face of a recession, with the resulting product ending up in Cisco's warehouses. Similar stories are repeated for the opposite situation, when supply chains have too little inventory and pro- duction is limited. When Apple launched its Power Book, the market received the product beyond expectations and Apple had $1 billion in unfulfilled orders. In this case, they had too little inventory and capacity.

246 Part Four Capacity and Scheduling

FIGURE 10.7 Supply chain mitigation framework. Source: APICS Magazine 22, no. 1 (January /February 2012), reprinted with permission.

There are many factors that lead to unexpected disruptions in supply chains. These include strikes, recessions, pricing changes, natural disasters, manufactur-1 ing failures, and unexpected demands. All of these must be considered when planning for supply chain resiliency. Ensuring that a supply chain is resilient helps to bring a supply chain back up to normal operational capabilities once disrupti~ events occur. Even then it is impossible to plan for all possible disruptive eventsr especially those that are unavoidable acts of nature (force majeure). So the ques- tion is what level of resilience is needed to ensure supply chain durability?

The level of resilience is determined by the ability to plan for disruptions, detect them early, and act quickly. This is illustrated in Figure 10.7, where company B is more resilient than company A. Company A has no risk mitigation system and subsequently incurs more loss of revenue, profitability, and market share than company B, whidt mitigated supply chain risk and is continuously monitoring possible disruptions. At point Tin Figure 10.7 the disruption occurs. Company B discovers the problem more quickly at point B1, while company A discovers it at point A1. Also, company B acts more quickly to respond to the crisis than company A. When a disruption occurs. rapid actions to maintain business continuity are needed. The business continuity plan needs to be implemented and risk mitigation actions taken immediately.

There are three stages to risk mitigation. In Stage 1, a proactive plan is needed before disruption occurs. Stage 2 is oriented to minimize damage to the supply chain during disruption. Then, Stage 3 is cpncemed with post-disruption recovery.. The actions that should be taken in each of these stages are shown in Table 10.3, at both the strategic and operational levels.

The important point is that supply chains can be made more resilient by advance planning, early detection, and speedy action during disruptions. Since additional capacity, alternative sources of supply, or more inventories can be re- quired, this may reduce the efficiency of the supply chain. Supply chains can be too fat or too lean; either condition should be avoided.

] Stage 1: ..c: Business as usual~ "' ~ s Resilience-

Proactive supply chain risk mitigation

Stage2: Recovering from a supply chain disruplio!'l

Agility- Early detection and quick response to minimize damage

Sl:.1ge3:

B"u«ines~ as usual

Recovery- Damage control through last line of defense: insurance cover

T Discovery Bl Discovery A l Recovery B2 Recovery A2

Time--.

- Impact of supply chain disruption on organization A, which has no risk mitigation system - Impact on organization B, which has mitigated supply chain risk and is continuously

monitoring for disruptions

10.10

Chapter 10 Supply Chain Management 247

TABlE 10.3 Framework for Building a Resilient Supply Chain

Source: APICS Magazine 22, no. 1 Ganuary /February 2012), reprinted with permission.

Proactive: plan for disruption

• Conduct enterprise- level supply chain risk assessment

• Make risk adjustments to total cost of sourcing equations

• Design actionable busi- ness continuity plans covering all failure

Reactive: minimize damage

• Paradigm shift with less emphasis on efficiency and more emphasis on business continuity

• Sanction supplies from reliable alternative sources and employ alternate transport nodes and manufactur-

scenarios ing facilities in case the • Identify authorities for preferred options fail

decision making during (risks associated with disruptions the alternate sources

• Invest in improving should be divorced from capacity and inventory those borne by primary visibility , sources) :

Post-recovery

• Reevaluation of the supply chain to assess the following parameters:

o effectiveness of the business continuity plan

o effectiveness of early disruption detection syst ems

a validity of total cost of ownership/sourcing equations

o resilience of the supply chain t o future disruptions

____ ., _____ ., ________________________ -:--:- ---- ---- ------------------- ~,. ________________________ .. ___ _ • Supplier selection

based on o risk-adjusted total

cost to source o supplier's business con-

tinuity plan strength • Identify alternate suppliers

with different operating conditions A

• Maintain higher buffer lev- els for critical components

• Continuous monitor- ing of supply chain for disruptions

• Backup of information systems

Before the disruption

KEY POINTS AND TERMS

• Diagnose all the impacts to the supply chain once a disruption has been identified

• Invoke the business con- tinuity plan to ensure safety of employees and continuity of operations

• Take swif t action to em- ploy available capacities within the organization and supplier network

• Constantly monitor the situation

During the disruption

' ' '

• Prepare a disruption report that covers f ailure points as a result of disruption, cause and effect analy- sis, and comparative analysis of disruption performance through industry peers

• Systematic loss report- ing to mitigate issues through insurance coverage as a last line of defense

After the disruption

Every firm must manage one or more supply chains. An understanding of supply chain management is essential to improving performance in all parts of the supply chain. This chapter's key points include the following:

• A supply chain is the set of entities and relationships that cumulatively define the way materials and information flow downstream and upstream from the customer. The downstream flow facilitates transformation of materials into units of the final product sold to consumers and information related to the product. The upstream flow facilitates return of defective units, recyclables, and information for planning purposes.

248 Part Four Capacity and Scheduling

Key Terms

• Supply chain management is concerned with the design and management of value-added processes that not only cut across organizational boundaries but must be tightly integrated to allow information and materials to flow and be deployed within and across them.

• The purchasing function performs tasks in the purchasing cycle to p rocure goods and services to meet the needs of the firm. The logistics function is con- cerned with the movement and storage of goods within a supply chain.

• Measurement of supply chain performance should be made in five areas: deliv- ery, quality, flexibility, cost, and time.

• The bullwhip, or accelerator, effect entails market demand being magnified through orders placed to upstream supply chain entities, such that the farther upstream an entity is, the greater is the variability in the orders received. Infor- mation time lags, human behavior, and replenishment lead time lags largely account for the dynamics observed.

• Structural improvements in supply chains can be achieved by vertical integra- tion; major process simplification; changing warehouse, factory, and retail con- figurations; major product redesign; and the outsourcing of logistics to a third party.

• The supply chain practices of outsourcing and off-shoring change a firm' s sup- ply chain configuration by allocating work performed internally to other firms within the supply chain either domestically or in other countries.

• When considering off-shoring a product or component, the total cost of owner- ship should be considered along with supply chain risks and protection of core technologies.

• lnfrastructural improvements in supply chains can be accomplished by cross- functional teams, setup time reduction, partnerships, information systems, an d cross-docking.

• The Internet is creating new types of businesses that facilitate transactions be- tween firms (B2B) or between a firm and its customers (B2C). The Internet is also improving supply chain performance b y speeding up and reducing costs in order placement and order fulfillment processes.

• There are three types of e-procurement services: online catalogs, third-party auctions, and private exchanges. These e-procurement services use the Internet to connect buyers w ith suppliers.

• Supply chain resiliency is need ed to respond to unexpected events and disrup - tions. Resiliency is achieved by advanced planning, early detection, and swift actions.

Supply chain 223 Physical supply 224 Physical distribution 224 Supply chain

managem ent 225 SCOR mod el 226 Demand management 227 Purchasing cycle 227 Global sourcing 228 Reverse logistics 228

Total supply chain throughput time 231

Cash-to-cash cycle time 231 Bullwhip effect 232 Supply chain structure 235 Supply chain

infrastructure 235 Forward integration 236 Backw ard integration 236 Process simp lification 236

Supply base reduction 237

Outsourcin g 237 Off-shoring 237 Total cost of

own ership 237 Postponement

strategy 238 Componen t swapping

modularity 239

Third-party logistics providers 239

Partnerships 240 Cross-docking 242

1. Federal Express

Chapter 10 Supply C hain Management 249

B2B 242 B2C 242 £-procurement 243 Third-party auctions 244

Private exchanges 244 Supply chain resilience 245

STUDENT INTERNET EXERCISES

http://www.fedex.com.Jus/supplychain/services

From this website, find what supply chain management services FedEx offers. Under what circumstances might a company want to use these services?

2. Supply Chain Council http://supply-chain.org/about/scor

Access this site to study the SCOR (Supply Chain Operations Reference) model. Come to class prepared to discuss how the model works and how it can be used.

3. PriceWaterhouseCoopers http://www.pwc.com/

Do a qukk search of the PriceWaterhouseCoopers home page, using the words supply chain to find some of the latest ideas this consulting firm is u sing.

4. Covisint http://www.covisint.com.J

Read about Covisint solutions offered to suppliers and customers in the auto in- dustry. Come to class prepared to discuss your findings.

Discussion Questions

1. What is the difference between supply chain man- agement and demand management?

2. Define the supply chains for the following prod- ucts from the first source of raw m aterials to the final customer:

a. BigMac

b. Gasoline

c. Automobile repair d . A textbook

3. Why is supply chain managem ent an important area to study? How do the functions of purchas- ing and logistics contribute to supply chain performance?

4. How do lead times and forecast errors affect sup- ply chain performance?

5. Why is increased coordination n eeded to manage supply chains? Give three examples.

6. How can coordination be increased both internally within the firm and externally with customers and suppliers?

7. A supply chain has the following information:

Supplier Factory Wholesale Retailer

Inventory in days* 30

Accounts receivable in days 20

Accounts payable in days 30

Purchasing un it cost $ 5

A dded unit cost $ 1 0 Sales unit price $20 On-time

delivery (%) 85

90

45

45

$20 $25 $55

95

* This is also the throughput time in days.

40

30

60

$55 $ 10 $70

75

20

40

37

$ 70 $ 30 $110

95

a. Compute the total supply chain throughput time for all the entities from beginning to end.

b. Comp ute the cash-to-cash cycle time for each of the four entities separately. Based on this calcu- lation, who is benefiting the most?