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Supply Chain Management

Operations Management-104

Debabrata Ghosh

What is a supply chain?

Flow of Material

C1

C2
Flow of Information

C3

C4
Flow of Information

C5

C6
VENDORS

INBOUND
TRANSPORTATION

PLANTS

INTERFACILITY
TRANSPORTATION

Source: Supply Chain Management: Text and Cases Janat Shah, Pearson Education India, 2009

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DISTRBUTION
OUTBOUND
DISTRIBUTION
CENTRES
TRANSPORTATION CUSTOMERS
CENTERS

Flow of Cash

A detergent supply chain stages

Timber
Company

Unilever or
other
manufacturer

Chemical
Manufacturer

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Paper
Manufacturer

Spencers or
Third Part DC

Tenco Packaging

Spencers store

Customer

Plastic Producer

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Globally Dispersed Manufacturing

Product Design
[Hong Kong]

Yarn Spinning
[Korea]

QC & Shipping
[Hong Kong]

Weaving
[Taiwan]

Stitching
[Indonesia]

Zippers+
[Japan+]

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What is supply chain management?

A set of approaches utilized to efficiently integrate suppliers, manufacturers, warehouses and stores
so that merchandize is produced and distributed at the right quantities, to the right locations and at
the right time, in order to minimize system wide costs while satisfying service level requirements.
Challenges
Global Optimization of a complex network leading
to challenges in system wide costs reduction

Maintaining service levels at

every stage of the supply chain

Coordination between supply

chain players to achieve optimal
system performance

Uncertainties of demand and supply

side resulting in getting it right
extremely difficult

Source: Designing and Managing the supply chain, Simchi-Levi et.al., Mc-Graw Hill, 3rd Ed., 2008

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Sources of SCM uncertainties

Supply side Uncertainty:
Manufacturing yields
Transportation Times
Component availability
Natural and Man-made disasters

Demand side Uncertainty:

Forecasts are only reliable to an extent
Changing consumer behaviour

In September 1999, a massive earthquake devastated Taiwan. Companies like Hewlett-Packard and
Dell which sourced a variety of components were severely affected.
2012 and subsequent devastating fires in the apparel manufacturing factories of global retail
players not only indicated a severe gap in safety standards of the workers in those factories but also
brought global brands under pressure for quality audits and maintenance of safety standards of
supplier facilities.
2013 report of fall in demand (post Diwali) for automobiles led to an inventory pile up of over Rs.
20,000 crore forcing several automakers like Maruti and GM in India to either plan a production cut
or periodic plant shutdowns.

Stiff competition
General slowdown in the PC

Intel reported a 38 percent

decline in quarterly profit in 2006

market
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Why Supply Chain Management ?

By 1990s companies discovered that new manufacturing technologies and strategies that allowed
them to reduce costs and better compete in the markets such as Just-in-Time , Kanban, Lean
Manufacturing Techniques, Quality Management etc. had outlasted the needs of the present times.
Vast amount of resources and investments were made on these methods and further reduction
of costs and improvement in quality were only possible through a different outlook.
While MRP, ERP and the advancement of computing techniques had helped production facilities,
the need was to look beyond the boundaries of the firm.

The need to understand and improve operations beyond the boundaries of the firm
while dynamically focussing on various components of the chain, has led to growth of
supply chain management studies and practice.

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Progression of Logistics Costs

Logistics costs share of the U.S. economy

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Composition of Logistics Costs

Total U.S. logistics costs between 1984 and 2005

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Complexity

U.S. companies spent more than $1 trillion in supply-related activities (1015% of Gross Domestic Product)
Transportation 58%
Inventory 38%
Management 4%

The grocery industry could save $30 billion by using effective logistics
strategies
A typical box of cereal spends 104 days getting from factory to
supermarket.
A typical new car spends 15 days traveling from the factory to the
dealership.

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Process views of a supply chain

Customer

Customer Order
Cycle

Retailer

Replenishment
Cycle
Distributor

Manufacturing
Cycle
Manufacturer

Procurement Cycle
Supplier
Source: Supply Chain Management, Sunil Chopra, Pearson Education India, 3rd Ed., 2008

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Cyclic view of a supply chain

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Process views of a supply chain

Source

Customer Order

Make components

Assembly

Delivery

MTS

Customer Order

Source

Make components

Assembly

Delivery

MTO

Customer Order

Source

Make components

Assembly

Delivery

CTO

Push -Pull view of a supply chain

Source: Supply Chain Management: Text and Cases Janat Shah, Pearson Education India, 2009

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Dells Supply Chain

Customer places an order with Dell

Launched by Michael Dell in 1983

Developed an unprecedented model of
direct distribution in the PC Industry

Collaboration with suppliers for planning

Dell processes orders and performs credit checking and

configuration evaluation
Usual time frame: 2 to 3 days

and execution, share information about

component forecasts, seasonality, market
movements etc.

Dell sends an orders to a manufacturing plant

Evaluated suppliers on inventoryvelocity, e-business collaboration, low-cost

manufacturing and technology leadership.
Inventory Management: Removed

Dell builds, tests and packages the products

Usual Time Frame: 8 hours

warehouses, carried only a few days of

inventory throughout supply chain
enabled through real time monitoring of

inventory and orders across suppliers.

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Dell ships and delivers the products

Usual time frame: no later than 5 days after receipt of
orders

Source: Designing and Managing the supply chain, Simchi-Levi et.al., Mc-Graw Hill, 3rd Ed., 2008

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DELL Inc. - TIMELINE

1983--

Michael Dell starts business of pre-formatting IBM PC HDs on

weekends

1985-1986--

$6 million sales, upgrading IBM compatibles for local businesses

$70 million sales; focus on assembling own line of PCs

1990--

$500 million sales; with an extensive line of products

1996-1997--

Dell goes online; $1 million per day in online sales; $5.3B in annual sales
Dell online sales at $3 million per day; 50% growth rate for 3rd
consecutive year, $7.8B in total annual sales.

2005--

$49.2B in sales

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Measuring Supply Chain Performance

The following two performance measures can be calculated using financial data:
Inventory Turns = (Cost of Goods sold/Average aggregate value of inventory)
Average aggregate value of inventory includes total value of all items at cost including raw materials, work-inprocess inventory and finished goods = (average inventory for item i * unit value of item i)
Inventory Days of Supply = (Average aggregate value of inventory/ Cost of Goods sold ) * 365 days

Dell Computers financial data 1996-2003:

1996

1997

1998

1999

2000

2001

2002

2003

Revenue
(billion $)

5.3

7.8

12.3

18.2

25.3

31.9

31.2

35.4

Cost of
goods sold
(billion $)

4.2

6.1

9.6

14.1

20.1

25.5

25.7

29.1

Total
Inventory
(million $)

356.7

217.3

184.1

231.8

330.4

349.3

307

306

Source: Operations Management, James R Evans & David A collier, Thomson, 2007

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Supply Chain Evolution

First Revolution.: Ford Motor Co. 1910-1920.

Single Product.
Vertical Integration

Second Revolution: Toyota Motor Co. 1960-1970.

Wide Variety
Long term relationship with suppliers.

Third Revolution. 1990s- 2000s.

Dell Computers
Customization.
Medium term relationship with suppliers
Suppliers have to maintain technology and cost leadership.

Bharti-Airtel
Strategic Outsourcing : Network Management with Nokia & Ericsson & IT
Management with IBM

Source: Supply Chain Management: Text and Cases Janat Shah, Pearson Education India, 2009

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The Gartner Supply Chain Top 10

Inventory Turns

2009

1. Apple

1. Apple

74.1

1. Apple

2. McDonalds

2. Amazon

10.0

2. Dell

3. Amazon

3. McDonald's

142.4

3. P&G

4. Unilever

4. Dell

35.6

4.IBM

5. Intel

5. P&G

5.5

5. CISCO

6.P&G

6. Coca-Cola

5.8

6.Nokia

7. CISCO

7.Intel

5.0

7.Wal-Mart

8. Samsung

8. Cisco Systems

11.0

8.Samsung

9. Coca-Cola

9. Wal-Mart Stores

8.3

9. PepsiCo

6.0

10. Toyota

10. Colgate-Palmolive 10. Unilever

Source: Supply Chain Management Review, Sep-Oct 2012

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Bullwhip Effect in the US PC supply chain

Changes in
demand
80%

60%
Semiconductor
Equipment

40%

20%

PC

0%

-20%

Semiconductor

-40%
1995

1996

1997

1998

1999

2000

2001

Annual percentage changes in demand (in $s) at three levels of the semiconductor
supply chain: personal computers, semiconductors and semiconductor manufacturing
equipment.
Source: Matching Supply with Demand, Cachon and Terwiesch, McGraw-Hill, 2012

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Causes of the Bullwhip Effect

Buyer Practices

Supplier Practices
Incentives offered to buy-in-bulk
Price Promotions
Sales force incentive
Supplier behaviour uncertainty
Shortage Handling
Price Fluctuations
Supplier Inefficiency

Order

Forecasting of future trends in demand

Updating of future demand based on
recent demand
Promotion plans
Order Batching considering economies of
scale of production
Large production runs
Buying in large batches

Order

Source: Supply Chain Management: Text and Cases Janat Shah, Pearson Education India, 2009

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Impact of Bullwhip Effect

Increase in manufacturing cost and significant rise in inventories.
Increase in replenishment lead times.
Increase in stock outs.
Increase in Labour costs.

Ways to combat the Bullwhip Effect

Information sharing:
Collaborative Planning, Forecasting and Replenishment (CPFR)

Vendor Managed Inventory (VMI): delegation of stocking decisions

Continuous Replenishment

Efficient Promotions

Alignment of Incentives Contracts benefitting supply chain partners

Source: Supply Chain Management, Sunil Chopra, Pearson Education India, 3rd Ed., 2008

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Re-visiting Newsvendor Problem

For a product under the newsboy settings:

c: cost
p: selling price
s: salvage value
Cu = Underage cost
Co = Overage cost

Cu
F (Q*)
Cu Co

Expected overstock from an order for Normally distributed demand with mean and s.d.

= (Q*-)Fs[(Q*- )/]+ fs [(Q*- )/]

= (Q*-)NORMDIST[(Q*- )/,0,1,1]+ NORMDIST[(Q*- )/],0,1,0]
Expected understock from an order for Normally distributed demand with mean and
s.d.
= ( - Q*)[1-Fs{(Q*- )/}]+ fs [(Q*- )/]
= ( - Q*)[ 1-NORMDIST{(Q*- )/,0,1,1}]+ NORMDIST[(Q*- )/,0,1,0]

Source: Supply Chain Management, Sunil Chopra, Pearson Education India, 3rd Ed., 2008

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Re-visiting Newsvendor Problem

Expected Profit from an order for Normally distributed demand with mean and s.d.
= (p-s)Fs {(Q*- )/} (p-s) fs {(Q*- )/} - Q*(c-s)F(Q*,,) + Q*(p-c)[1- F(Q*,,) ]
= (p-s) NORMDIST[{Q*- )/} 0,1,1] (p-s) NORMDIST [{Q*- )/} 0,1,0]
- Q*(c-s)NORMDIST(Q*,,) + Q*(p-c)[1- NORMDIST(Q*,,) ]

Source: Supply Chain Management, Sunil Chopra, Pearson Education India, 3rd Ed., 2008

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Supply Chain Contracting at Umbra Visage (UV)

Example:
Zamatia makes sunglass at a cost of $35 and sells them to UV for $75.
UV sells them for $115 and salvages left over inventory for $25 per unit.
Demand is normal with mean 250 and standard deviation 125.
UV faces a newsvendor problem.
UV:
Cu = 115 - 75 = 40, Co =75 - 25 = 50, Critical ratio = 40 / 90 = 0.44
Q = + Z* = 250 + (-0.13)*125 = 234
Expected Profit of UV= $5580
Profit of Zamatia = 40*234 = $9360
Total supply chain profit = $14940

What is the order quantity if a single firm made the decision for the supply chain?
Supply chain:
Cu = 115 - 35 = 80, Co =35 - 25 = 10, Critical ratio = 80 / 90 = 0.89
Supply chains critical ratio is much higher than UVs critical ratio!
Q = + Z* = 250 + (1.23)*125 = 404
Expected Profit = $ 17830
Source: Matching Supply with Demand, Cachon and Terwiesch, McGraw-Hill, 2012

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Supply Chain Contracting at Umbra Visage (UV)

Source: Matching Supply with Demand, Cachon and Terwiesch, McGraw-Hill, 2012

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Supply Chain Contracting at Umbra Visage (UV)

Suboptimal supply chain performance occurs because

Each firm makes decisions based on their own margin, not the supply chains margin.
This is called double marginalization.

Buy-Back Contracts

Let Zamatia offer Umbra to buy back the leftover sunglasses at the end of the season at a
price of $75
UV incurs a cost of $1.50 per pair for shipping leftover inventory to Zamatia
Zamatias salvages these sunglasses for $26.50
Cu = 115 - 75 = 40, Co =1.50, Critical ratio = 40 / 41.5 = 0.9639
Q = 475
UVs expected profit = $9580
Expected Leftover Inventory = 227
Zamatias expected profit = (475*75) (475*35) (227*75) + (227* 26.5) = $7991
Total supply chain profit = $9580 + $ 7991 = $17571

Source: Matching Supply with Demand, Cachon and Terwiesch, McGraw-Hill, 2012

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Buy-Back Contracts

Let Zamatia offer Umbra to buy back the leftover sunglasses at the end of the season at a
price of $65
UV incurs a cost of $1.50 per pair for shipping leftover inventory to Zamatia
Zamatias salvages these sunglasses for $26.50
Cu = 115 - 75 = 40, Co =1.50 + 75-65 = 11.50, Critical ratio = 0.7767
Q = 346
UVs expected profit = $8072
Expected Leftover Inventory = 112
Zamatias expected profit = 9528
Total supply chain profit = $17600

There is a wholesale/buy back price combination that makes both firms better off!

Source: Matching Supply with Demand, Cachon and Terwiesch, McGraw-Hill, 2012

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Buy-Back Contracts

Suppose Zamatia offers to buy-back unsold sunglasses at b per unit:

Choose b to make UVs critical ratio equal the supply chains critical ratio:

Buy back price Shipping cost Price

Price Salvage value
Price - Wholesale price

Price Cost

$115 $25
Buy back price $1.5 $115 $115 $75
$71.5
$115 $35

Buy Back Contracts Summary:

What are they?

How do they improve supply chain performance?

Administrative costs plus additional shipping and handling costs.

Where are they used?

The retailers overage cost is reduced, so the retailer stocks more.

Allows for the redistribution of inventory risk across the supply chain.
Could protect the suppliers brand image by avoiding markdowns.

What are the costs of buy-backs?

Retailer is allowed to return to the supplier goods left over at the end of the selling season.

books, cosmetics, music CDs, agricultural chemicals, electronics

Other Contracts: Revenue Sharing, Quantity Flexibility

Source: Matching Supply with Demand, Cachon and Terwiesch, McGraw-Hill, 2012

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