SUPPLY CHAIN MANAGEMENT

Manimay Ghosh, Ph.D.

Understanding Supply Chain
Chapter 1
 What is a Supply Chain?
• A supply chain is the network of all parties involved,
directly or indirectly, in fulfilling a customer request

• Includes manufacturers, suppliers, transporters,

warehouse owners, retailers, and even customers

• Within each company, the supply chain includes all

functions involved in fulfilling a customer request
(product development, marketing, operations,
distribution, finance, customer service)
THE SUPPLY CHAIN / SUPPLY WEB / SUPPLY NETWORK
 AMAZON SUPPLY CHAIN
• When a customer makes a purchase online
the supply network includes, among others,
– Customers
– Amazon’s website -- provides info on price,
variety, product availability etc.
– Amazon warehouse
– Carrier who delivers packages to customers
– Amazon’s suppliers and their suppliers
Stages in Automotive Supply
Chain
 The Supply Chain
Suppliers Manufacturers Warehouses & Customers
Distribution Centers

Transportation Transportation
Costs Costs
Material Costs Transportation
Manufacturing Costs Inventory Costs Costs
 Historical Perspective
• Supply Chain Management, as we
understand today, is a fusion of at least three
main streams of knowledge
1. Sourcing and procurement
2. Materials Management
a. Material cost – 60% of product cost
3. Logistics and Distribution
a. Transport cost – 50% of logistics cost
 Flows in a Supply Chain

Information

Product
Supplier Customer
Funds
 Supply Chain Management
• Supply Chain Management is primarily
concerned with the efficient integration of
suppliers, factories, warehouses and stores
so that merchandise is produced and
distributed in the right quantities to the right
locations and at the right time, to minimize
total system cost subject to satisfying service
requirements

Simchi-Levi
 The Objective of a Supply Chain

• Maximize overall value (or supply chain surplus or supply

chain profitability) created

Supply chain surplus = Final product’s worth to customer –

Supply chain cost

• (Final Sales Price to customer) – (Costs supply chain incurs in

filling the customer’s request)

• Costs: Costs of conveying information + production cost of

components (say) + Storing costs + Transport costs+ Funds
transfer cost
 The Objective of a Supply Chain

• Example: A customer purchases a wireless router from

Best Buy for $60 (revenue).

• Supply chain incurs costs (information, storage,

transportation, components, assembly, etc.).

• Difference between $60 and the sum of all of these costs

is the supply chain profit.

• Supply chain profitability is total profit to be shared

across all stages of the supply chain.
 The Objective of a Supply Chain

• Success should be measured by total supply chain

profitability, not by profits at an individual stage.

• Customer is the only source of revenue.

• Effective supply chain management is the management

of flows between and among supply chain stages to
maximize total supply chain surplus.
 Logistics Management
• Part of supply chain management that
plans, implements, and controls the
efficient, effective forward and reverse flow
and storage of goods, services, and
related information between the point of
origin and the point of consumption in
order to meet customers’ requirements.

Source: Council of Logistics Management

 Why is SCM Important?
• Drives strategy
– SCM offers opportunity for differentiation
• Product differentiation (Dell) – Before 2007
• Cost reduction (Big Bazaar or Walmart)
• Profitability and growth (7-Eleven Japan)
• At the firm level, SCM impacts
– COST (for many products, 20-40% of the total product costs
are controllable logistics costs)

– SERVICE (for many products, availability of inventory, speed

of delivery are critical to customer satisfaction)
 Why is SCM Difficult?
• Uncertainty is inherent to every supply chain
– Travel times of goods
– Breakdowns of machines and vehicles
– Poor quality of products
– Raw material price fluctuations
– Sustainability issues (green supply chain), E-vehicles
– Weather, natural catastrophe (Tsunami, floods), war
– Local politics, labor strikes, border issues
– Environmental conditions
• Price increase of petrol leads to low sales for petrol cars
• Country’s economy (recession)
– Pandemics such as COVID 19
– Govt. regulations: National Green Tribunal in 2015 ordered
banning of petrol cars that are more than 15 years in NCR/Delhi
 Decision Phases of a Supply Chain

• Supply chain design

• Supply chain planning
• Supply chain operation
 Decision Phases in a Supply Chain
• Supply chain design
– Time Frame: Several Years
• Chain’s configuration
• Resource allocation (manpower, technology, funds)
• Processes at each stage
– In-house production or outsourcing
• Sourcing of components
• Products to be manufactured or stored at various
locations
• Location and capacities of factories and warehouses
• Modes of transportation to be used
• Type of information system to be used (Push vs.
Pull)
Decision Phases in a Supply Chain
• Supply Chain Planning
– Time Frame: Quarter to a Year
• Forecast for demand for next year quarter-wise
• Which factory will serve which markets
• Sub-contracting of manufacturing
• Inventory policies (P, Q or other models)
• Marketing promotions
• Uncertainty of demand
• Exchange rate fluctuations
• Competition
Decision Phases in a Supply Chain
• Supply Chain Operation
– Time frame: Hourly, daily, or weekly

• Attend specific orders in best possible manner on

daily or weekly basis

• Allocate resources (manpower, machinery, set

dates for shipping, decide shipping mode and so
on)
 Process Views of a Supply Chain
• A supply chain is a sequence of processes
within the stage and between stages and
combine to fill a customer need for a
product
• Two different ways to view processes
performed in a supply chain
– Cycle View
– Push/Pull view
 Cycle View of SC Processes
• A supply chain is a sequence of processes
that takes place between different stages
to fill a customer need
• A supply chain can be broken down into
four process cycles
– Customer Order Cycle
– Replenishment Cycle
– Manufacturing Cycle
– Procurement Cycle
Cycle View of Supply Chains
Customer
Customer Order Cycle
Retailer
Replenishment Cycle
Distributor

Manufacturing Cycle
Manufacturer

Procurement Cycle

Supplier
 Push vs. Pull View of Supply Chain

Designing the Supply Chain

• A push system produces goods in advance of customer
demand using a forecast of sales (anticipated orders)
and moves them through supply chain to points of sale
where they are stored as finished goods inventory.
• Push system is speculative

• A pull system is initiated by the customer order. It

reacts to customer demand.
• Pull system is reactive
Pull Systems
L. L. Bean – A Clothing Retail
Company
 Ethan Allen – Two Cycles
(Customized Furniture Maker)
Arrival of customer order triggers
production
 Green Supply Chain
• Green Supply Chain (incorporating environmental
thinking in supply chain practices)

– Green sourcing and procurement

• Defined as integrating environmental concerns and
problems into procurement process
– Using environmentally friendly parts in products
– Select environmentally conscious suppliers
– Adopting a strategic and collaborative understanding with
suppliers
– Assess whether the supplier meets environmental criteria
 Green Supply Chain
– Green product design
• Defined as systematic consideration of design
performance with respect to environmental health,
safety, and sustainability objectives over the product
life cycle
– Designing products with reusability and recyclability
– Less impact on people and environment
– Less packaging materials
– Less toxicity
– Minimum material wastage
• Examples: Mazda reducing hazardous materials in
product design; Nissan’s and other’s zero emission
vehicles such as electric cars
 Green Supply Chain
– Green manufacturing
• Operational activities using less energy
• Using eco-friendly energy (solar and wind)
• Use of less water,
• Minimize waste
• Minimize pollution
• Using eco-friendly technological equipment
• Producing product with reusability and recyclability
features
 Green Supply Chain
– Green packaging
• Eliminate excessive packaging
• Use of paper wrappings
• Reduced quantity of polystyrene

– Green distribution
Monitoring all activities to reduce environmental
damages
• Fuel consumed
• Frequency of transport
• Distance to customers
Achieving Strategic Fit in a
Supply Chain
Chapter 2
 Competitive Strategy
• A competitive strategy defines, relate to its competitors,
the set of customer needs it seeks to satisfy through its
products and services
• Competitive strategy is defined based on how the
customer prioritizes product cost, delivery time, variety,
and quality.
• For example, Walmart customer places greater
emphasis on cost
• McMaster-Carr customers puts greater emphasis on
product variety and response time
• IKEA customer focuses on reasonable variety at low cost
 Value Chain for an Organization

NPD – focuses on portfolio of new products. Also dictates whether development

effort will be made internally or outsourced

Marketing and sales – How the market will be segmented, and how the product will
be positioned, priced, and promoted.

Supply chain strategy determines the nature of procurement of raw materials, its
transportation to and from company, manufacture of product, distribution of the
product to customer along with follow-up service, and whether these processes will be
in-house or outsourced.
 Achieving Strategic Fit
• Strategic fit requires the goals of supply chain strategies to
be aligned with the goals of competitive strategies

• For a company to achieve strategic fit, it must accomplish the

following:
– The competitive strategy and all functional strategies must
fit together to form a coordinated overall strategy
– The functional dept. must structure their processes to
execute these strategies
– The design of the overall supply chain and the role of each
stage must be aligned to support the supply chain strategy
 IKEA
• Ikea’s overall strategy: Low variety stylish
furniture, low or reasonably priced
– Design strategy ?
– Production strategy ?
– Distribution strategy ?
– Retail strategy ?
 Example – IKEA
(Swedish Furniture Retailer)
• Ikea’s overall strategy: Low variety stylish
furniture at a reasonable cost
– Design strategy: In-house design focused on cost of
manufacturing, modular products, common
components, limited variety, rapid assembly
– Production: High volume production machines – low
cost (plants located in low-cost countries & focusing on
efficiency), 100% sourcing from long-term suppliers
– Distribution: Shipping large quantities, high density,
unassembled modules at low cost. Densely packed
components lower transport cost
 Example – IKEA
(Swedish Furniture Retailer)
– Retail:
• Components stored in large stores, not finished
products
• Self-selection by customers, limited sales staffing
• Customers responsible for assembly and transport
• Limited customer service

• OBSERVATION: The strategy at every stage

and function of the IKEA supply chain is aligned
with competitive strategy
Ikea
 How is Strategic Fit Achieved?
1. Three basic steps to achieve strategic fit

A. Understanding the customer and supply

chain uncertainty

B. Understanding the supply chain capabilities

C. Achieving strategic fit

 Step 1: Understanding the Demand
Uncertainty
• Customer demand varies along several
attributes
– Quantity of units needed in each lot
– The response time customers are willing to tolerate
or lead time
– The variety of products needed
– The desired rate of innovation in the product
– The service level
One key measure to combine these attributes: Implied demand uncertainty

Implied demand uncertainty is demand uncertainty imposed on the

supply chain because of the customer needs it seeks to satisfy
 Impact of Customer Needs on
Implied Demand Uncertainty
Customer Need Causes Implied Demand Uncertainty to …

Range of quantity required Increase because a wider range of the quantity required implies
increases greater variance in demand

Lead time decreases Increase because there is less time in which to react to orders

Variety of products required Increase because demand per product becomes less
increases predictable

Required service level increases Increase because the firm now has to handle unusual surges in
demand

Rate of innovation increases Increase because new products tend to have more uncertain
demand

Number of channels through which Increase because the total customer demand per channel
product may be acquired increases becomes less predictable
 Impact of Supply Source Capability on
Supply Uncertainty
Supply Source Capability Causes Supply Uncertainty
to
Frequent breakdowns Increase

Unpredictable and low yields Increase

Poor quality Increase

Limited supply capacity Increase

Inflexible supply capacity Increase

Evolving production process Increase

 Strategic Fit
• Creating a supply chain that best meets
the demand a company has targetted
given the uncertainty it faces
 Step 2: Understanding the Supply
Chain Capabilities
• Supply Chain Responsiveness
– A supply chain’s responsiveness includes the
supply chain’s ability to do the following:
• Respond to wide range of quantities demanded
• Meet short lead times
• Handle a large variety of products
• Build highly innovative products
• Meet a high service level
• Handle supply uncertainty
Step 2: Understanding Supply Chain Capabilities
• How does the firm best meet demand in
that uncertain environment?
• Creating strategic fit is all about designing
a supply chain whose responsiveness
aligns with the implied uncertainty it faces
 The Demand and Supply
Uncertainty Spectrum
Predictable Predictable supply and uncertain Highly uncertain
supply and demand or uncertain supply and supply and demand
demand predictable demand or somewhat
uncertain supply and demand

Salt at a An existing A new

supermarket automobile communication
model device

Figure 2.2: The Implied Uncertainty (Demand and Supply)

Spectrum
 Understanding Supply Chain
Capabilities – Two Characteristics

1. Responsiveness

2. Efficiency
 Responsiveness
• Responsiveness is the ability of the supply
chain to
– Respond to wide range of quantities
demanded
– Meet short lead times
– Handle large variety of products
– Meet a high service level
– Meet supply uncertainty
 Efficiency
• Responsiveness comes at a cost
– For example, to respond to wide range of
quantities demanded, capacity is increased,
which increases cost
• Increase in cost leads to second
characteristics of Supply Chain – Efficiency
• Efficiency is the inverse of the cost of making
a product and delivering to customer.
Increase in cost lowers efficiency.
 Responsiveness vs. Efficiency
• Responsiveness
– Ability of the supply chain to respond
purposefully and within a time scale to
customer’s requirements of change in
marketplace
• Efficiency
– Focus on cost reduction and no resource is
wasted on non-value added activities
Understanding the Supply Chain: Cost-
Responsiveness Efficient Frontier
Responsiveness

High Shows the lowest possible cost for a

given level of responsiveness

Low
Cost
High Low
 Responsiveness Spectrum

Highly Somewhat Highly

efficient responsive responsive

Most
Integrated Dell
automotive
steel mill
production

Supply chains range from those that focus solely on being

responsive to those that focus on a goal of producing and
supplying at lowest possible cost
 Step 3: Achieving Strategic Fit
• Goal
– High responsiveness for a supply chain with
high demand uncertainty
OR
– Efficient supply chain for a low demand
uncertainty
 Step 3: Achieving Strategic Fit
• Dell (Customized PCs delivered within days at
reasonable price): High demand uncertainty
• Responsive supply chain
• Zara delivering trendy items (unpredictable
demand) in Europe with plants in Europe
• Responsive supply chain
• Zara selling basic T-shirts (predictable demand)
with plants in Asia
• Efficient supply chain
• Nestle’s Maggi Noodles: Reliable and stable
customer demand: low demand uncertainty
• Efficient supply chain
 Achieving Strategic Fit Shown on the
Uncertainty/Responsiveness Map
Responsive
supply chain
NP iPhone 12,
autonomous
vehicles, electric
vehicles
Responsiveness
spectrum

Commodity – Salt, Sugar, Toothpaste, steel

Efficient
supply chain

Certain Uncertainty Uncertain

demand spectrum demand
 Learning
• The key to strategic fit and strong financial
performance across the supply chain is to
structure the supply chain drivers appropriately to
provide the desired level of responsiveness at the
lowest possible cost.

• Providing a high degree of responsiveness at a

given cost and the same level of responsiveness
at a lower cost are both desirable routes to gaining
competitive advantage
 Comparison of Efficient and
Responsive Supply Chains
Efficient supply chain Responsive supply
chain
Primary goal Lowest cost Quick response

Product design strategy Min product cost Modularity to allow

postponement
Pricing strategy Lower margins Higher margins
Mfg strategy High utilization Capacity flexibility

Inventory strategy Minimize inventory Buffer inventory

Lead time strategy Reduce but not at Aggressively reduce even

expense of greater cost if costs are significant
Supplier selection Cost and low quality Speed, flexibility,
strategy reliability, and quality
Transportation strategy Greater reliance on low Greater reliance on
cost modes responsive (fast) modes
 Tailoring the Supply Chain for
Strategic Fit - Options
• Multi-product environment (Responsiveness vs. Efficiency)
– Option 1
• Products requiring high responsiveness – flexible
process
• Products with low responsiveness – Efficient process

– Option 2
• Products with high level of responsiveness – faster
modes of transportation, example FEDEX
• Products with low level of responsiveness – slower
modes of transportation (water, rail)
 Tailoring the Supply Chain for
Strategic Fit
• Option 3
– Require high responsiveness (items that are fast
moving and low demand uncertainty) – inventory kept
in regional warehouses close to customer
– Require high efficiency (slow moving items with high
implied demand uncertainty)-- Centralized warehouse
far from the customer
• Option 4
– High demand uncertainty: source to vendors close for
high responsiveness
– Less demand uncertainty: Source production to low-
cost countries
 Learning
• When supplying multiple customer
segment with a wide variety of products
through several channels, a firm must
tailor its supply chain to achieve strategic
fit
Tailoring to Achieve Strategic Fit
• The concept of tailoring to achieve strategic fit is important
in industries such as high tech or pharmaceuticals.

• Product Introduction (say, iPhone 12, driverless vehicles,

Corona Vaccine)
– Demand is uncertain and supply unpredictable
• Requires capacity that is flexible, more expensive but
responsive
– Margins are high, and time is crucial to gaining sales
– Product availability is crucial to capturing market
– Cost is secondary

New Products: RESPONSIVE SUPPLY CHAIN

 Achieving Strategic Fit
• As product matures as a commodity later in its
life cycle
– Demand becomes more certain and supply is predictable

– Margins are low due to increased competition

– Price becomes a significant factor in customer choice

– Handles low level of uncertainty and achieves economies of

scale

Mature Products: EFFICIENT SUPPLY CHAIN

 Challenges to Achieving Strategic
Fit
1. Increase product variety and shrinking life cycles
– Limiting existing products to those that add value and
discontinuing old products
– Continually introduce new products
– Design product platforms with common components
and a tailored supply chain for achieving
responsiveness to handle new products and low
volume products
– Low-cost solution to handle high volume products
(mass production)
 Challenges to Achieving
Strategic Fit
2. Globalization and Increasing uncertainty
– Fluctuations in exchange rate, oil prices, government
directives can affect demand of many products
• Flexible plants can handle varieties of products that have
demand, in place of a dedicated plant for a single product
that may gradually start losing market

3. Fragmentation of supply chain ownership

– Firms shedding non-core functions to other firms
– Difficulty in coordination with other firms
• Reduced overall supply chain profitability
 Challenges to Achieving
Strategic Fit
4. Changing technology and business
environment
– Till 2004 Dell focused on customization (sold
personalized PCs directly to customers)

– By 2005, demand for PCs dropped and

demand for Laptops increased
• Dell changed strategy and focused on selling
through retail outlets since 2007
 Challenges to Achieving
Strategic Fit
5. Environment and Sustainability
– Example: National Green Tribunal issued an interim
order dated 11 December, 2015 on no registration
of new-diesel run vehicles or no renewal of diesel
vehicles more than 10-year old to curb
environmental pollution of NCT Delhi-NCR
– Sourcing guidelines today are geared towards
producing products that met environmental and
social performance criteria.
• Electric vehicles, green products that are environment
friendly
 Article
• What is the right supply chain for your
product, HBR, Mar-Apr 1997, 83-93
Supply Chain Drivers and
Metrics
Chapter 3
 Objectives of Supply Chain
• Responsiveness
– Ability of the supply chain to respond
purposefully and within a time scale to
customer’s requirements of change in
marketplace
• Efficiency
– Focus on cost reduction and no resource is
wasted on non-valueadded activities
 Drivers (or Factors) of Supply
Chain Performance
• Six drivers have significant influence on a firm’s
financial performance

• Facilities
– places where inventory is stored, assembled, or
fabricated
– production sites and storage sites
• Inventory
– raw materials, WIP, finished goods within a supply chain
– inventory policies
• Transportation
– moving inventory from point to point in a supply chain
– combinations of transportation modes and routes
 Drivers (or Factors) of Supply
Chain Performance
• Information
– data and analysis regarding inventory, transportation,
facilities throughout the supply chain
– potentially the biggest driver of supply chain
performance
• Sourcing
– functions a firm performs and functions that are
outsourced
• Pricing
– Price associated with goods and services provided by
a firm to the supply chain
Components of Facilities Decisions
• Role
– A
• Flexible
• Dedicated
• Combination of both
– B
• Product focused (single product)
• Functional focused (many products)
• Location
– Centralize: To gain economies of scale
– Decentralize: More responsive by being closer to customer

• Capacity
– Excess capacity: allows flexibility to respond to wide swings in
demand but it costs money, decreases efficiency
– Less capacity: High utilization, efficient, but less responsive to
demands

Tradeoff: responsiveness vs. efficiency

 Facility Related Metrics
• Capacity (max output under steady condition)
• Utilization (Hours worked / Hours available)
• Theoretical flow time of production (no delays)
• Actual average flow time (with delays)
• Product variety
• Volume contribution of top 20% SKUs (80/20)
• Processing / Set up / Down Time / Idle time
• Average production batch size
• Production service level (fraction of orders
completed on time and in full)
 In Sum - Facilities
• Multiple plants, flexible plants: More
responsiveness

• Single plant, dedicated plant: Higher

efficiency, lower responsiveness
 Inventory
• Exists in the supply chain because of
mismatch between supply and demand
 Inventory
• Held in the supply chain in the form of
– Raw materials
– WIP
– Finished goods
– Maintenance Repair and operating supplies
(MROs)
 Inventory: Role in Competitive
Strategy
• If responsiveness is a strategic competitive
priority, a firm can locate larger amounts of
inventory closer to customers

• If cost is more important, inventory can be

reduced to make the firm more efficient by
having a central warehouse
• Trade-off
– Responsiveness: more inventory
– Efficiency: less inventory
 Inventory-Related Metrics
• Cash-to-cash cycle (how quickly a company can convert its
products into cash through sales)
• Average inventory (measured in units or financial Value)
• Inventory turns (COGS / Avg. aggregate inventory value)
• Products with more than a specified number of
days of inventory
• Average replenishment batch size
• Seasonal inventory (Sales – Cycle –Safety Inv)
• Fill Rate (Fraction of orders that were met on time from inventory)
• Fraction of time out of stock
 Little’s Law
• Material flow time (T) is the time that
elapses between the point at which
material enters the supply chain to the
point at which it exits. Throughput (D) is
the rate at which sales occur. If inventory
is represented by I, Then
I=D×T
 Little’s Law
• If the flow time of an auto assembly
process is 10 hours and the throughput is
60 units an hour. Then inventory is 60×10
= 600 units
 Inventory Problems
(Class Exercise)
• What will be the inventory turns if the
annual cost of goods sold is $24 million a
year and the average inventory is $6
million?
 Inventory Problem-Solution

• Inventory Turn = 24,000,000/6,000,000 = 4

 Inventory Problem
(Class Exercise)
• A company has 9000 units on hand and
the annual usage is 48000 units. There
are 240 working days in the year. What is
the days of supply?
 Inventory problem - Solution
• Average daily usage = 48000/240 = 200 units
• Days of supply = inv on hand / daily usage
= 9000/200 = 45 days
 Inventory Related Metrics

Cost of goods sold

Inventory turnover =
Average aggregate inventory value

 Average aggregate inventory value 

Weeks of supply =   52 weeks
 Cost of goods sold 
 In Sum - Inventory
• Higher levels of inventory: Responsiveness

• Lower levels of inventory: Higher efficiency

 Components of Transportation
Decisions
• Design of Transportation Network
– Direct to customer
• Direct shipping or direct shipping using milk runs
– Sending to customer through some intermediaries
• Shipping via DC using milk runs

• Choice of Transportation Mode

– Way material to be moved from one location in the
supply chain network to another
• Air, Truck, Rail, Sea, pipeline
 Transportation-Related Metrics
• Average incoming shipment size (no. of units
in shipment)
• Average inbound transportation cost
(transport cost/unit brought in)
• Average outbound transportation cost (cost
per unit shipped)
• Average outbound shipment size (no. of units
in outbound shipment)
• Average outbound transportation cost per
shipment
• Fraction transported (units or Rs) by each
 In Sum - Transportation
• Faster modes of transportation: Higher
speed, higher transport cost, higher
responsiveness, but lower inventory
holding cost
• Slower modes of transportation: Lower
cost, higher efficiency, lower
responsiveness
Information – Role in Supply Chain
• Connection between various stages of
supply chain

• Crucial to the daily operations of each

stage in supply chain
– Scheduling in factory
– Warehouse management
 Key Components of Information
Decisions
• Push Versus Pull
• Coordination and Information Sharing
• Aggregate Planning
• Enabling Technologies
– EDI, ERP, Internet, RFID
 Information
• Right information can help improve product
availability (responsiveness) and reduce costs
(efficiency – reduction in inventory)

• Airlines routinely uses information to offer right

number of seats at a discounted price(efficiency)
leaving sufficient seats for business customers
who make reservations at the last minute and are
willing to pay higher price (responsiveness)
 Information Related Metrics
• Forecast horizon
• Frequency of update of forecast
• Forecast Error (Actual Demand – Forecasted Demand)
• Seasonal Factors (avg demand in a season
exceeds average demand for the year)
• Variance from Plan for Production or Inventory
and Actual Values – indicates shortages or
surpluses
 In Sum - Information
• Investing in information vastly improves
the supply chain’s performance on both
dimensions
– Responsiveness and efficiency
 Sourcing
• Business processes required to purchase
goods and services
• Sourcing
– In-House or Outsource to a third party
• Outsource fully or outsource the responsive products

• For example Zara (fast fashion Spanish apparel retailer)

outsources trendy fashionable apparel (responsive item) by
having production facility in Europe (Portugal and Spain),
and basic apparel (efficient/standard items) in Asia.

• Driven by the impact on the total supply chain surplus

 Sourcing
• Sourcing decisions are important because
they affect
– Efficiency
• Third parties can achieve better economies of scale
due to their lower cost structure
– Responsiveness
• Outsource if parent company lack capabilities or too
costly to develop (Third party logistics: Outsourcing to
package delivery firms such as DHL, Fedex, UPS etc.
for quick delivery)
 Key Components of Sourcing
Decisions
• Supplier Selection
– Single or multiple suppliers
– Role of each supplier
– Identify the criteria for supplier selection and measuring
performance
– How suppliers should be selected
• Direct negotiations
• Auctions
– Developing contracts to define role of each supplier so as to
improve supply chain performance

• Procurement
 Sourcing Related Metrics
• Days Payable Outstanding (# days between when a supplier
formed a supply chain task and when it was paid)
• Average Purchase Price (avg. price at which goods were
purchased during that year)
• Range of Purchase Price (fluctuation in purchase price)
• Average Purchase Quantity (avg. amount purchased per
order)
• Supply Lead Time: Time between when an order is placed and
when the product arrives
• Fraction on-time deliveries: Fraction of deliveries from supplier
that were on time
• Supply Quality: Quality of product supplied
 In Sum - Sourcing
• Third party sourcing is meaningful when
the third party raises supply chain profits
more than the firm can by its own

• In contrast, a firm should keep a supply-

chain function in-house if the third party
cannot increase supply chain profits or if
the risk associated with sourcing is
significant
 Pricing: Role in
the Supply Chain
• Pricing determines the amount to charge
customers in a supply chain
• Pricing strategies can be used to match
demand and supply
 Key Components of Pricing
Decisions
• Pricing and Economies of Scale

• Everyday Low Pricing (EDLP) OR High-Low Pricing

– Costco charges low fixed price (EDLP) → stable
demand
– Other supermarkets change prices (offer discounts)→
demand changes accordingly

• Fixed Pricing OR Menu Pricing

– Menu Pricing that changes with some attributes (response time
or location of delivery)
• Amazon (shipping rates changes based on time required for
delivery)

• Overall Trade-off: Increase firm’s profit

 Pricing Related Metrics
• Profit Margin (profit as a % of revenue)
• Days Sale Outstanding (avg time between a sale is made and
cash collected)
• Incremental Fixed Cost per Order (incremental costs
independent of order size)
• Incremental Variable Cost per unit (incremental cost that vary
with size of order)
• Average Sales Price
• Average Order Size
• Range of Sale Price
• Range of Periodic Sale
 In Sum - Pricing
• Differential pricing – Highly responsive
• Everyday low pricing – More efficient
Supply Chain Performance
Additional Metrics
 Supply Chain Performance
Measures
• Total Length of chain
 Terms Directly Obtained from
Financial Statements
Terms from the income Symbol Terms from Balance Symbol
and expenditure sheet
statement

Cost of raw materials CRM Inventories (inclusive of INV

RM, WIP and FG)

Cost of production CP Raw materials inventory RM

Cost of distribution DC Semi-finished goods SFG

inventory

Cost of sales CS Finished good inventory FG

Net Sales NS Accounts Receivables AR

(excluding loans and
advances)

Accounts payables AP
 Supply Chain Performance Measures
(Length of Chain)
• Days of Raw Material (DRM) = RM (Rs) × 365 / Cost of
RM per year (Rs)

• Days of WIP (DWIP) = Semi Finished Goods (Rs) *365 / CP (Rs)

Where CP = Cost of production

• Days of finished goods (DFG) = FG (Rs) × 365 / Sales

(Rs)

• Minimum total length of chain ► Best performance

 Other Financial Ratios
Net Income
• ROE = ----------------------------------------
Average Shareholder Equity
 Financial Ratios
Net Income + Interest Exp (1-Tax rate)
• ROA = ---------------------------------------------
Average Total Assets

By adding interest back to net income, we derive a figure that shows

earnings before any distributions have been made to either
creditors or stock holders. Thus, we eliminate the matter of how the
assets were financed from influencing the measurement of how
well the assets have been employed.
 Return on Financial Leverage
(ROFL)
• ROFL = ROE – ROA

• ROFL captures the amount of ROE that

can be attributed to financial leverage
(such as accounts payable and debt)
 Other Financial Ratios

Accounts Payable Turnover (APT)

Costs of goods sold

• APT = ------------------------------
Accounts Payable
 Other Financial Ratios
• Accounts Receivables Turnover (ART)

Sales Revenue
• ART = ------------------------------
Accounts Receivables
 Other Financial Ratios
• Inventory Turnover (INVT)

Costs of goods sold

• INVT = ----------------------------
Inventories
 Other Financial Ratios
• Property Plant and Equipment (PPET)

Sales Revenue
• PPET = -----------------------
PP & E

• Cash-To-Cash Cycle = Weeks in Inventory + Weeks

Receivables – Weeks payable

Cash-to-cash cycle measures the average amount of time from

when a cash enter the process as cost to when it returns as
collected revenue
 Class Exercise
• As a supply chain management consultant, you
have been asked to evaluate a furniture
manufacturer's cash-to-cash conversion cycle in
weeks under the following assumptions: Sales of
$23.5 million, Cost of Goods Sold of $20.8
million, 50 operating weeks a year, total average
on hand inventory of $2,150,000, accounts
receivable equal to $2,455,000, and accounts
payable of $3,695,000. What do you conclude?
What recommendations can you make to
improve performance?
 Cash-to-Cash Cycle
• Inventory Turnover = COGS / Inventory
=20.8×1000000 /2150000 = 9.67
Thus inventory sat for = 50 / 9.67 = 5.17 weeks

• APT = COGS / Accounts Payable

= 20.8×1000000 / 3695000 = 5.62
Thus manufacturer financed its own operation with
supplier’s money for 50/5.62 = 8.89 weeks
 Cash-to-Cash Cycle
• ART = Revenue / Accounts Receivables
= 23.5×1000000 / 2455000 = 9.57
Manufacturer collected its money from sales in 50/9.57 =
5.22 weeks
• Cash-to-Cash Cycle (C2C)
C2C = wks in Inv + wks in Receivables – wks in Payable
C2C = 5.17+ 5.22 - 8.89 = 1.5 weeks

Conclusions: Furniture manufacturer’s operating capital is locked up for

1.5 weeks before it becomes available. Thus performance is less
speedy and needs improvement.
 Supply Chain Design

Cash-to-Cash Cycle

Days cash is locked in Inventory + Days cash is locked in

receivables – days cash is free because the business has
not paid bills
 Dell’s Supply Chain Cash-to-Cash Conversion Cycle

• In 2003, Dell's cash-to-cash conversion cycle is C2C = 3.8

days + 26.8 days – 61.8 days = - 31.2 days.

The negative value means that Dell receives customers’

payments (accounts receivable) 31.2 days, on average, before
Dell pays its suppliers (accounts payable).

• This means that Dell's value chain is a self-funding cash

model!
 C2C for Titan Watches
• Titan Watches reduced its C2C days by
reducing the inventory of finished goods
lying at various points in the company’s
supply chain.

Source: Business Standard, March 2020

 C2C for BigBasket
• Bigbasket, a grocery e-commerce leader
has a negative C2C cycle
• Inventory days: 11-12
• Account Payables days: 14-15
• Accounts receivables days: 0 (customers
pay upfront or on delivery)
• Therefore, C2C = - 3 days

Source: Business Standard, March 2020

 HUL Working Capital
Performance

From 2001 till 2005, HUL was collecting its money from the sale of products more than
6 days, 9 days and 5 days respectively before it had to pay its suppliers
SUPPLY CHAIN COST
THE STRATEGIC PROFIT MODEL
 Financial Statement Analysis

• Walmart and Macy’s

– Compare and contrast with respect to following:
• ROE
• ROA
• ROFL
• APT
• ART
• INVT
• PPET
– Comment
 Article
• “The hierarchy of supply chain metrics,”
Supply Chain Management Review, 2004
 Enhancing Supply Chain
Performance (Cost Service Map)
 Enhancing Supply Chain
Performance
• Supply Chain Optimization
– Improve on forecasting, location, transportation, and
inventory management to improve on cost and
service fronts
• Supply Chain Integration
– Better intra- and inter-firm integration of supply chains
help reduce waste in the system and improve overall
efficiency which results in downward movement of the
efficiency frontier
– Change in organizational processes and performance
measures
 Enhancing Supply Chain
Performance
• Supply Chain Restructuring
– Making significant changes in the supply
chain structure help firm move the efficiency
frontier in the downward direction
• Moving from the Make-to-stock (MTS) to the
Configure-to-order (CTO) model
• Reduce the number of stock points in distribution
• Differentiating between fast-moving and slow-
moving items of material flow in chain
• Product and process design
Network Design and Operations
in Supply Chain

Chapter 5
THE SUPPLY CHAIN
 Network
• A supply chain is a network consisting of
nodes and linkages
– Nodes: Conversion, or storage, or demand
points

– Linkages: Transportation activities through

which material flow takes place in the chain
 Network Design
• Supply chain network decisions include number, locations,
size and role of the manufacturing plants, storage facilities,
and allocation of capacity and markets to each facility (ex:
assignment of retail outlets to warehouses)
• Supply chain network decisions are classified as follows:
– Number of facilities
– Facility role (flexible or dedicated)
– Facility location
– Capacity allocation (how much capacity allocated to each
facility?)
– Market and supply allocation (which markets to serve?
Which supply sources should feed each facility?)
 Importance of Facilities
• Facilities
– Capacity location decision
• Expensive to create and then shut down
• Expensive to move to a new facility
– Example: Tata Motors Singur plant
– Capacity allocation decision
• Too much capacity – poor utilization, higher costs
• Too little capacity – poor responsiveness, high cost
if demand is filled from a distant facility
 Importance of Facilities
• The allocation of supply sources and markets to facilities
has a significant impact because it affects total
production costs, inventory holding costs, transportation
costs, facility costs incurred by the supply chain to satisfy
customer demand. Thus, network design is strategic
decision and has a long lasting effect on the firm.

• Decision to allocate markets and supply sources to be

reconsidered on regular basis
– Provided facilities are flexible enough to serve
different markets and receive supply sources from
different sources
 Trade-offs in SC
• Increasing number of warehouses yields:
– Improvement in service level
– Increase in inventory costs due to safety stock
– Increase in overhead cost
– A reduction in outbound transportation cost
– Increase in inbound transportation cost
In essence, the firm must balance the cost of opening new
warehouses with the advantage of being close to the
customer
 Factors Influencing Network Design
• Strategic factors
• Technological factors
• Macroeconomic factors
• Political factors
• Infrastructure factors
• Socioeconomic factors
• Positive externalities between firms
• Operational Factors
 Strategic Factors
• A firm’s competitive strategy has a
significant impact on network design
– Low cost
Locate lowest cost location for their facilities even if
that means locating far from markets, they serve

– High responsiveness
• Locate facilities closer to the market and may select
a high-cost location
 Technological Factors
• If production technology displays significant
economies of scale
– Few high-capacity facilities
• Example: Manufacturer of computer chips
• Intel has 10 wafer fabrication plants worldwide
• Low fixed costs
– Many local facilities to reduce transport costs
• Example: 50+ Bottling plants for Coca-Cola in India
 Macroeconomic Factors
• Tariffs or customs duty
– High tariffs
• More production locations with each facility having a lower
allocated capacity
– Low tariffs
• Decrease in # facilities and increase in capacity of each firm

• Tax incentives
– Encourages firms to locate facilities in specific areas

• Example: Baddi in Himachal Pradesh.

• https://economictimes.indiatimes.com/news/company/corporate-
trends/baddi-investors-tax-holiday-cut-short-by-3-
years/articleshow/59364209.cms?from=mdr

• India has developed 14 Special Economic Zones SEZs in (Santa

Cruz, Cochin, Falta, Indore, Jaipur…)
– 5 years corporate tax holiday
– Duty free import of capital goods, RM, Consumables
 Macroeconomic Factors
• Exchange rate
– Affects profitability of the firm
– Japanese have built factories worldwide to
avoid exchange risk fluctuations
– Build excess capacity to cater to different
markets
 Political Factors
• Political Factors
– Locate facilities in politically stable countries
 Infrastructure Factors
• Infrastructure Factors
– Good infrastructure is a pre-requisite to locate
facilities
• Availability of sites
• Labour availability
• Proximity to sea and airports
• Proximity to highways and railway terminals
 Socioeconomic Factors
• Socioeconomic Factors
– Promoting industrial development of
industrially backward areas
• India
– Northeastern region
– Jammu and Kashmir
– Himachal Pradesh
– Uttaranchal
 Positive Externalities Between
Firms
• Collocation (grouping together) of multiple firms
benefits all of them.
• Firms locating close to each other
– Gas stations and retail stores located close to
each other
– Competing retail stores locate close to each
other in a mall to have access to huge
customers visiting
– Automotive companies locating close to each
other to enjoy common supplier base
 Operational Factor
• Firms must consider the following costs
– Inventory costs
– Facility costs
– Transportation costs

• If # of facilities increase
– Inventory costs increase
– Facility costs increase
– Transport cost decrease
 Operational Factor
• Transformation
– When there is a significant reduction in
material weight or volume as a result of
processing, it is better to locate facilities
closer to the supply source rather than the
customer
• Example: Locating steel plants closer to iron ore
mines
Service and Number of Facilities
Number of
Facilities

Response Time
 Inventory Costs and Number
of Facilities
Inventory
Costs

Number of facilities
 Transportation Costs and
Number of Facilities
Transportation
Costs

Number of facilities
 Facility Costs and Number
of Facilities
Facility
Costs

Number of facilities
 Total Costs Related to
Number of Facilities
Total Costs
Total Costs

Facilities
Inventory
Transportation

Number of Facilities
Total logistics Cost = Inventory costs + Transport Cost + Facility Costs
Framework for Network Design
• Phase 1: Define a supply chain
strategy/design

• Phase II: Define the regional

(north/south/east or west) configuration
– Approximate # facilities, regions where
facilities will be set up, whether facility will
produce all products for a given market or a
few products for all markets
Framework for Network Design
• Phase III: Select a set of desirable
potential sites in each region (city) based
on hard infrastructure and soft
infrastructure requirements

• Phase IV: Deciding precise location

(specific place within a city) and capacity
allocation for each facility and how
markets are allocated to each facility
Relevant Costs in Decision Making
• Fixed facility costs
– Costs that are fixed and independent of the
volume of production and storage
• Variable production cost
• Transportation costs
 Network Operations
• Focus on identifying the optimal linkages
between plants and markets
 Two Ways to Model and Solve
Design and Operations Problems
• Cost minimization
• Profit maximization
 Network Operations Optimization
• Focus on identifying the optimal linkages
between plants and markets
• Firm has to link various entities in the chain and
decide the appropriate levels at each plant
• Objective: Minimizing cost or maximizing profit
 Network Design Optimization
• Focuses on the location of nodes for plants and
storage points for given customer nodes, i.e., where
to locate facilities
• Objective: Minimizing cost or maximizing profit
• Tool: Linear programming
– Constraints
• Demand
• Supply
• Binary variable
– Facility open – 1
– Facility closed - 0
 Network Operations Optimization
• Problems
Network Optimization Model: Cost
Minimization
Network Design Model: Cost
Minimization
Network Optimization Model: Profit
Maximization
Network Design Model: Profit
Maximization
Locating Plants and Warehouses
Simultaneously
Locating Plants and Warehouses
Simultaneously
Locating Plants and Warehouses
Simultaneously
Locating Plants and Warehouses
Simultaneously
Locating Plants and Warehouses
Simultaneously
 Role of IT in Network Design
• A good network design IT system makes
the
– modeling of network design easy
– Provides faster solution to large problems
– Allows “what if” scenarios
– Structured to interface with other planning and
operational software
• Two Giants in network design
– SAP and Oracle, Opiant, Smartops
 Making Networking Decisions in
Practice – Final Thoughts
• Do not underestimate the life span of
facilities
• Do not gloss over the cultural implications
• Do not ignore quality of life
• Focus on tariffs and tax incentives when
locating facility
Demand Forecasting in SC

Chapter 10
 Characteristics / Rules of
Forecasts
• 1st Law: Forecasts are always wrong

• 2nd Law: The longer the forecast horizon,

the worse the forecast

• 3rd Law: Detailed forecasts are worse than

aggregate forecasts
 Forecasting in Supply Chains
• Why forecasting is important in supply
chains?
 Forecasting in Supply Chain
• Every company in a supply chain does product
forecasting for its
– Production scheduling
– Capacity planning
– Inventory control
– Material requirements planning
– Workforce planning, hiring, firing

• Forecasting is often based on order history from

the company’s immediate customers
 Article
• “The Bullwhip Effect in Supply Chains”,
Sloan Management Review, 1997
 Supply Chain Management and
Uncertainty
• Inventory levels fluctuate considerably across the supply chain even when
customer demand doesn’t vary
• The variability worsens as we travel “up” the supply chain
• Studies show that total supply chain (leaving manufacturer and arriving
retailer has more than 100 days of inventory supply
Multi-tier Wholesale
Suppliers Manufacturer Distributors Retailers Consumers

Sales

Sales
Sales

Sales

Time Time Time

Time

Bullwhip Effect
BULLWHIP EFFECT or WHIPLASH EFFECT or WHIPSAW EFFECT

As we move up from retailers to wholesalers and to manufacturers, each stage in the

chain distorts demand and variability in demand keeps increasing as we move up
the supply chain
 WHIPLASH Effect
• Orders to the upstream member in the
supply chain exhibit greater variance than
actual orders at the point of retail sale, and
• The variance of orders increases as one
moves upstream (variance propagation)
Bullwhip Effect
 Result of Bullwhip Effect
• Excessive inventory
• Poor customer service
• Lost revenues
• Misguided capacity plans
• Missed/unstable production schedules
– Expensive capacity change adjustments such as
overtime, subcontracting, extra inventory, backorders,
hiring and laying off workers, equipment additions,
underutilization, obsolescence of over-produced items
• Aggravated problems with demand forecasting
 Major Causes for Bull Whip Effect
• Demand forecast updating
– Forecasting based on orders and not customer demand
• Large order batching (large, infrequent orders)
a. To avoid significant cost associated with placing,
receiving or transporting orders. Instead of ordering
frequently, orders may be placed weekly, bi-weekly, or
even monthly – spike in demand during the month
followed by no demands for rest of the month
b. To achieve economies of scale in transportation
c. Push ordering by salespeople – a hockey stick effect

If all customers’ order cycles were spread out evenly

throughout the week, bullwhip would be minimal
 Major Causes for Bull Whip
Effect
• Price fluctuations
– Forward buying or buying in advance (customers move up
future purchases to the present due to low prices, price
discounts, quantity discounts etc. offered by suppliers)
• Thus, customers buy in quantities that do not reflect their immediate
needs; they buy in bigger quantities and stock up for the future
• Customer’s buying pattern does not reflect its consumption pattern –
the bullwhip effect
• Rationing and shortage gaming
– When product demand exceeds supply, a manufacturer
often rations its product to customers. Knowing that
manufacturer will ration, customers exaggerate their real
demand and later cancel orders
 Counteracting Bullwhip Effect
• Demand forecast updating
– Use CPFR
– Use Electronic Data Interchange (EDI)
– Collect sell-through data on withdrawn stocks from retailers
– Institute vendor managed inventory
• Large order batching
– Reducing high cost of ordering by using e-procurement

– Small batches lead to high cost of transportation. To reduce high cost,

assortment of different products from the same manufacturer instead of
a full load for the same product

– Use of 3PL
• Consolidating load from multiple suppliers, a firm can realize full
truck load economies without the batches coming from the same
supplier
 Counteracting Bullwhip Effect
• Price fluctuations
– Reduce frequency and magnitude of price
discounting
– Use everyday low price (EDLP)
• Shortage gaming
– Instead of allocating products based on
orders, it can allocate in proportion to past
sales record
– Stringent penalties on order cancellations by
customers
 Bullwhip Effect Measure

Variance of orders
• Bullwhip = ----------------------------------
Variance of demand
Variance amplification is present if bullwhip measure is greater than 1.
This means that the size of the company’s orders fluctuates more than
the size of its incoming demand.
If measure = 1, no amplification is present
If measure < 1, smoothing or dampening as orders move up the SC
If measure > 1, variance amplification (i.e., bullwhip effect is present
means size of company’s orders fluctuate more than the size of
its incoming demand
 Bullwhip Example
Chieh Lee Metals, Inc. orders sheet metal and transforms it into 50 formed table tops
that are sold to furniture manufacturers. The table shows the weekly variance of
demand and orders for each major company in this supply chain. Each firm has one
supplier and one customer, so the order variation for one firm will equal the demand
variance for its supplier

This chain exhibits a classic bullwhip effect. Despite what might be a very stable
Demand pattern at the retail level, order sizes to suppliers vary significantly.
 Problem
• Over the past 8 weeks, demand for gears
at Michael’s Metals has been 140, 230,
100, 175, 165, 220, 200, and 178. Michael
placed weekly orders of 140, 250, 90, 190,
140, 240, 190, and 168 units. Calculate
the bullwhip measure for Michael’s Metals
over the 10-week period.
 CPFR
• Collaborative Planning Forecasting and
Replenishment (CPFR)
– A web-based tool
– Applied in food, apparel, and general merchandise
– Sharing of forecasts led to
• Improved forecast accuracy
• Reduced inventory
• Reduced lead time
• Improved service levels (reduce out-of-stock)
• Increased sales
• Improved efficiency across the supply chain
Managing Inventories in
Supply Chain
Chapter 11
Inventory
 What is Cycle Inventory
• Cycle Inventory is the average inventory in a
supply chain due to either production or
purchases in lot sizes that are larger than those
demanded by the customer
– For example, a retailer may sell 5 laptops per day
but when it orders the manufacturer it orders
laptops in lots of 50. In essence it holds the
inventory till the next replenishment lot arrives.
• Cycle Inventory = Q /2, where Q = Lot size
 Q-Model

Inventory on hand
Q Demand Rate

Avg. Inventory
(Q/2)
R
Reorder Pt.

L
Time L = Lead Time Time
Order Placed
Order Receipt R = Reorder Point
 Aggregating Multiple Products
in a Single Order
• To reduce lot size is the reduction of fixed cost incurred
per lot. One major source of fixed cost is the fixed
transportation cost. In several companies, the array of
product sold is divided into groups, with each group
managed independently by a separate product manager.
This results in separate orders and deliveries for each
product thus increasing overall cycle inventory.
Aggregating orders and deliveries across product is an
effective mechanism to lower cycle inventories. This
allows fixed cost to be spread across multiple suppliers
(single delivery coming from multiple suppliers) or fixed
cost spread across multiple retailers (single truck
delivering to multiple retailers)
 Aggregating Multiple Products in a
Single Order
• To reduce lot size → reduce fixed costs
– Fixed cost:
o Fixed transport cost to transport order
o administrative costs to place order
o labor cost to receive order)

• Two options
– Single delivery coming from multiple sources

– Single truck delivering to multiple retailers

Lot Sizing With Multiple Products or
Customers
1. No aggregation: Each product manager orders
his model independently

2. Complete Aggregation: The product managers

jointly orders every product in each lot

3. Tailored Aggregation: The product managers

order jointly but not every order contains every
product; i.e., each lot contains a selected
subset of the products
 Lot Sizing with Multiple Products or
Customers
• Multiple products
– Independent orders
• No aggregation: Each product ordered separately
1 2 3

– Joint order of all products

• Complete aggregation: All products delivered on each
1 2 3 1 2 3 1 2 3
truck

– Joint order of a subset of products

• Tailored aggregation: Selected subsets of products on
1 2 3
each truck 1 2
1
 Lots are Ordered and Delivered
Independently for Each Product (EOQ)
Annual demand = D
Number of orders per year = D/Q
Annual material cost = CD
Annual order cost = (D/Q)S
Annual holding cost = (Q/2)H = (Q/2)hC
Total annual cost = TC = CD + (D/Q)S + (Q/2)hC

Fixed Order Cost = Fixed Administrative cost + Fixed Truck Cost + Fixed Labor Cost
 Lots are Ordered and Delivered
Independently for Each Product (EOQ)
D: Annual demand
S: Setup or Order Cost H = hC
C: Cost per unit
h: Holding cost per year as a fraction 2 DS
of product cost Q* =
H: Holding cost per unit per year H
Q:Lot Size
2S
T: Reorder interval
n* =
Material cost is constant and DH
therefore is not considered in this
model
 Some Inventory Metrics
• Cycle Inventory = Lot size / 2 = Q/2

• Average Flow Time = Average Inv/Flow Rate

– Q / 2D

• Holding Cost per year = hC

– Where h = Fraction of the unit cost of the product (C )
 Role of Cycle Inventory
• Role of cycle inventory is to allow different
stages in the supply chain to purchase
product in lot sizes that minimize the sum
of material, ordering, and holding cost
• If manager considers only hold cost, s/he
will reduce lot size and cycle inventory
• If Manager consider economies of scale in
purchasing, s/he will be motivated to
increase lot size and cycle inventory
 Role of Cycle Inventory
• Manager must make a trade-off that
minimizes total cost across the supply
chain when making lot size decision
Aggregating Multiple Products in a
Single Order
• Key Point
– Aggregating replenishment across products,
retailers, or suppliers in a single order allows
for a reduction in lot size for individual
products because fixed ordering costs are
now spread across multiple products,
retailers, or suppliers.
 Multiple Products Ordered and
Delivered Independently
Demand
DL = 12,000/yr, DM = 1,200/yr, DH = 120/yr

Common order cost

S = $4,000

Product-specific order cost

sL = $1,000, sM = $1,000, sH = $1,000

Holding cost
h = 0.2

Unit cost
CL = $500, CM = $500, CH = $500

Calculate: Annual Hold Cost, Annual Order Cost, Total cost, Order Freq, and
Ag flow time
 Multiple Products Ordered and Delivered
Independently

Litepro Medpro Heavypro

Demand per year 12,000 1,200 120
Fixed cost/order $5,000 $5,000 $5,000
Optimal order size 1,095 346 110
Cycle inventory 548 173 55
Annual holding cost $54,772 $17,321 $5,477
Order frequency 11.0/year 3.5/year 1.1/year
Annual ordering cost $54,772 $17,321 $5,477
Average flow time 2.4 weeks 7.5 weeks 23.7 weeks
Annual cost $109,544 $34,642 $10,954

• Total annual cost = $155,140

 Lots Ordered and Delivered Jointly

S* = S + sL + sM + sH Annual order cost = S * n

DL hC L DM hCM DH hC H
Annual holding cost = + +
2n 2n 2n

DL hC L DM hCM DH hC H
Total annual cost = + + +S*n
2n 2n 2n

å
k
DL hC L + DM hCM + DH hC H Di hCi
n* = n* = i=1

2S * 2S *
 Products Ordered and Delivered Jointly

S* = S + sA + sB + sC = $7,000 per order

12,000 ´100 +1,200 ´100 +120 ´100

n* = = 9.75
2 ´ 7,000

Annual order cost = 9.75 x 7,000 = $68,250

Annual ordering
and holding cost = $61,512 + $6,151 + $615 + $68,250
= $136,528

A decrease of 12%
 Products Ordered and Delivered Jointly

Litepro Medpro Heavypro

Demand per year (D) 12,000 1,200 120

Order frequency (n∗) 9.75/year 9.75/year 9.75/year

Optimal order size (D/n∗) 1,230 123 12.3

Cycle inventory 615 61.5 6.15

Annual holding cost $61,512 $6,151 $615

Average flow time 2.67 weeks 2.67 weeks 2.67 weeks

 Key Learning
• A key to reducing cycle inventory is reducing lot
size. A key to reducing lot size without
increasing cost is to reduce fixed costs. This
may be achieved by reducing fixed costs itself or
by aggregating lots across multiple products,
customers, and suppliers. The fixed ordering
and fixed transportation costs are now spread
over multiple products, retailers, or suppliers.
 Lessons from Aggregation
• Aggregation allows firm to lower lot size
without increasing cost
• Complete aggregation is effective if product
specific fixed cost is a small fraction of joint
fixed cost
• Tailored aggregation is effective if product
specific fixed cost is a large fraction of joint
fixed cost
 Class Exercise
• Page 345
–Problem 11
 Lots are Ordered and Delivered Jointly for
Select Subset of the Products
• Tailored aggregation
– Higher demand products ordered more
frequently, and lower demand products
ordered less frequently

– Appropriate when product-specific ordered

costs are high
 (Lessons from Aggregation)

Scenarios Total Cost % Decrease

Independent Ordering $155,140

(no aggregation)

Lots ordered and $136,528 12%

delivered jointly
(complete
aggregation)

Ordered and delivered $130,767 4.2%

jointly for select
subset (tailored
aggregation)
 Key Learning
• A key to reducing cycle inventory is reduction of
lot size. A key to reducing lot size without
increasing costs is to reduce the fixed costs
associated with each lot
• Reducing fixed costs involves
– Reducing fixed costs itself
– Aggregating lots across multiple products, customers,
or suppliers
– Tailored aggregation is best is product-specific order
costs are large
 Case
• Delivery strategy at MoonChem
– (page 348 - 350)
 Managing Uncertainty in Supply
Chain: Safety Inventory – Chap 12
 Safety Inventory
• Safety inventory is carried to satisfy
demand that exceeds the amount
forecasted for a given period

• Safety inventory is required when demand

and supply are uncertain, and a product
shortage may result if actual demand
exceeds the forecast demand or supply is
later than anticipated
The Role of Safety Inventory
 Safety Inventory
• Raising the safety inventory increases
product availability, but also increases
inventory holding costs
• The issue is particularly significant in
industries in which product life cycles are
short and demand volatile.
– Inventory on hand in such situation becomes
worthless
 Factors Affecting Level of
Safety Inventory
– Measure of product availability (ability to fill order
from available inventory)

• Ability to fill a customer order out of available inventory

– Product fill rate →fraction of product demand that is
satisfied from product in inventory. Measured over
specified amounts of demand rather than over time. For
example, what percentage of smartphones sold from stock
– Order fill rate→ fraction of orders that are filled from
available inventory. Measured over specified number of
orders rather than over time. In a multi-product scenario
an order may constitute two or more products (laptop,
phone and printer)
 Factors Affecting Level of
Safety Inventory
• Difference between product fill rate and order fill
rate is not significant in a single product situation,
but significant in multiple product case.

• As the desired product availability goes up, the

required safety inventory also increases because
the supply chain must now be able to
accommodate uncommonly high demand or
uncommonly low supply.
 Safety Inventory
• In recent years, product variety has grown but
product life cycle has shrunk
– Product that is “hot” today is likely to be become
obsolete tomorrow leading to too much inventory
and associated hold cost
• Key to success in supply chain is to
determine ways to decrease the level of
safety inventory with hurting product
availability
 Safety Inventory

• Safety Inventory – Z × σd × √LT

 Factors Affecting Level of
Safety Inventory
• The level of safety inventory is determined by two
factors
– The uncertainty of demand and supply
• Higher uncertainty in demand leads to higher safety
inventory
– Milk: Low uncertainty → low safety inventory

– Spices: High uncertainty → high safety inventory

• Higher uncertainty in supply leads to higher safety

inventory
 Two Managerial Levers to
Reduce Safety Inventory
• Reduce the uncertainty in demand
– Better market intelligence, sophisticated
forecasting methods, increased supply chain
visibility, link all forecasts throughout the supply
chain to customer data
• Reduce supplier lead time
– Flexible production methods, faster methods of
transport, supplier plant closer to parent facility
 Impact of Aggregation on Safety
Inventory
• Aggregation is one of the important
mechanisms through which a supply chain can
reduce safety inventory

• There are TWO ways to serve “k” regions

– Have local inventories in each region, OR
– Aggregate all inventories into one centralized facility
• GOAL: Compare safety inventory in the above
two cases
Variance Sum Law II
 Impact of Aggregation on
Safety Inventory

• How does aggregation affect forecast accuracy and

safety inventories
Di: Mean weekly demand in region i, i = 1,…, k regions
si: Standard deviation of weekly demand in region i, i =
1,…, k
rij: Correlation of weekly demand for regions i, j,
1≤i≠j≤k
 Impact of Aggregation on
Safety Inventory

Total safety inventory in k

=  z  LT  s i
decentralized option i =1

If all inventories are aggregated in a central location

k
DC = å Di ; ( )
var DC = ås i2 + 2å rijs is j ;
k

i=1
i=1 i> j

s DC = var DC( )
If all k regions have demand that is independent (ρij =0), and identically
distributed, with mean D and standard deviation σD, then above equation becomes

DC = kD s DC = k s D
 Impact of Aggregation on
Safety Inventory
k
=  z  L  s DC
Require safety inventory on
aggregation i =1

If all K regions have demand that is identically distributed, with mean D

And standard deviation σd, and have correlation of demand across any pair of
regions ρ

Holding-cost savings on aggregation per unit sold

FS–1(CSL) ´ L ´ H æk ö
= ´ ççås i – s D ÷÷
C

DC è i=1 ø
 Impact of Aggregation on
Safety Inventory
• Inventory aggregation are always positive
if the correlation coefficients are less than
1
 Impact of Aggregation on
Safety Inventory

• The safety inventory savings on aggregation increase with

the desired cycle service level CSL
• The safety inventory savings on aggregation increase with
the replenishment lead time L
• The safety inventory savings on aggregation increase with
the holding cost H
• The safety inventory savings on aggregation increase with
the coefficient of variation of demand
• The safety inventory savings on aggregation decrease as
the correlation coefficients increase
 Impact of Item movement on
Safety Inventory

• Fast moving items → decentralized locations

• Slow moving items → centralized locations

 Key Learning
• Aggregation reduces demand uncertainty
– and thus safety inventory—as long as
demand being aggregated is not perfectly
positively correlated
 Benefits of Aggregating Safety
Inventories
• Information centralization
– Gap and Walmart can use information system
to inform customers of the closest store with
the product in inventory

• Specialization
– If reduction in safety inv. high→ Central location
– If reduction in safety inv. low→ Multiple
decentralized locations
 Safety Inventory and Demand’s
Coefficient of Variation
• For a product with a low coefficient of variation,
disaggregate demand can be forecast with
accuracy
– Benefit of aggregation is minimal

• High coefficient of variation of demand,

disaggregate demand is difficult to forecast
– Benefit of aggregation is substantial
 Two Major Disadvantages of Aggregating
Inventories in One Location
• Increase in response time
• Increase in transportation cost to customer
Both disadvantages result because of the average distance
between inventory and the customer increases with aggregation

However, a desire to decrease customer response time is the

impetus for the firm to have multiple locations

The impact of pooling safety stock must be evaluated

against the possible advantage (product proximity)
provided by a larger number of warehouses.
 Class Exercise
• Page 389
• Problems 14, 15
 Inventory at Multiple Locations
(The Square Root Law)
• If demand in different regions is about the same size
and independent, aggregation reduces safety
inventory by the square root of the number of regions
aggregated

• Thus, if the number of independent stocking locations

decreases by a factor “n”, the average safety
inventory is expected to decrease by a factor √n.
This principle is referred to as the Square-root Law
 Square-Root Law
• The square root law states that total
safety stock inventories in a future number
of facilities can be approximated multiplying
the total amount of inventory at existing
facilities by the square root of the number
of future facilities divided by the number of
existing facilities
 Inventory at Multiple Locations
(The Square Root Law)

X2 = X1√(n2/n1)

Where n1 = # of existing facilities

n2 = # of future facilities
X1 = Total inventory in existing
facilities
X2 = Total inventory in future facilities
Square-Root Law
 Problem
(Square Root Law)
• A company operated 16 regional
warehouses. Each warehouse carried
$165,000 inventory on average. If all
stocks are to be consolidated into one
location, how much inventory can be
expected?
 Square Root Law
• Solution
X2 = X1√(n2/n1)
X2 = 165000×16√(1/16) = $660,000 ↓25%

• Question: If consolidated in two locations that

equally divide the stock, how much inventory can
be expected in each warehouse?
• X2 = $165000×16×√(2/16) = $933381 Reduction in
inventory: $2640000 (Before) - $933381 (after) =
$1,706,619
 Component Commonality and
Inventories
• When a supply chain is producing a large
variety of products, components can easily
become very large. The use of common
components in a variety of products is an
effective supply chain strategy to exploit
aggregation and reduce component
inventories.
 Postponement
• Postponement is the ability to delay
product differentiation or customization
until closer to the time the product is sold.
ECHELON INVENTORY
 Multi-Echelon Inventory
• Echelon: In a distribution network each
stage or level (i.e. warehouse, retailers)
often is referred as echelon

• Multi-echelon means (multiple stages or

levels) in a supply chain
 Echelon Inventory
• Echelon inventory refers to all inventory between a stage and
the final customer
• Inventories are located throughout the supply chain
• Inventories at retail outlets are backed by inventories at the
serving warehouse.
• In turn, inventories at warehouses are backed by inventories at
the plants
• If substantial amounts of inventory are maintained in field
warehouses, less may be needed in the downstream echelon,
retailer.
• Managing inventory throughout the entire channel becomes
important rather than managing at each individual stocking
point
 Echelon Inventory
• Planning inventory level for a particular
location is not determined from the demand
information of the next downstream echelon,
but rather on the demand from the end
customer (avoiding bullwhip effect).
Multi-Echelon Supply Chain
The Warehouse Echelon Inventory
(Warehouse Supplying Multiple Retailers)
 Echelon Inventory
• All inventory between a stage and the final customer is called
the echelon inventory

• Echelon inventory at a retailer is just the inventory at the

retailer or in the pipeline coming to the retailer

• Echelon inventory at a distributor includes inventory at the

distributor, plus the inventory in transit, and all retailers’ stock
served by the distributor.
– Thus, a distributor should decide its safety inventory based on the
safety inventory carried by all retailers supplied by it

• In a multi-echelon setting, reorder points (ROPs) and order-

up-to levels (OULs) are based on echelon inventory and not
local inventory.
 Inventory Position (IP)
• IP measures the item’s ability to satisfy a future
demand. It includes scheduled receipts (SR),
which are orders that have been placed but have
not been received yet, plus on-hand inventory
(OH) minus backorders (BO)
• Inventory position: OH + SR – BO
• When the inventory position reaches a
predetermined level, a fixed quantity Q of the item
is ordered
 Two-Tier Echelon
W R
S

• A two-tier echelon consists of supplier, wholesaler and

retailers
• The inventory position at retailer echelon: OH + Quantity on
order from warehouse
• Inventory position for the warehouse echelon, but not the
warehouse itself: Sum of inventory at retailers + Inventory at
warehouse + inventory in transit (on order) to and from
warehouse
Note: ROP and reorder quantities are determined for the
“inventory position of the echelon” and not for the warehouse
itself
 Two-Tier Echelon
• The average stocking level in the
warehouse is found by subtracting the
retailers’ average inventory levels from the
echelon inventory, assuming there is
negligible inventory in transit.
 Multi-Echelon Inventory
• Failure to manage true network inventory
optimization leads
– Excess inventory in the form of cycle stock and
safety stock, thus incurring additional costs
– End customer failure occurs even when
adequate inventory exists in the network
• Goal of multi-echelon system is to decrease total
costs by coordinating orders across the supply
chain
 Echelon Inventory
• The retailer inventory is managed using the
following:
• The reorder level ( R )are calculated as follows:

• R = L× Avg Demand + Z × Std. Dev Demand× √L

• Thus, when the inventory position at a retailer falls below the

reorder point R, Q units are ordered
 Echelon Inventory
• Reorder point associated with distributor:
• R = Le × AVG + z × STD × √Le
• Where, Le = echelon lead time, defined as the
lead time between retailer and the distributor
plus the lead time between the distributor and
its supplier, the wholesaler
• AVG = average demand at the retailer
• STD = std. dev of demand at the retailer
 Echelon Inventory
• Problem
Transportation and Logistics
Management
 Logistics Management
• Part of supply chain management that plans,
implements, and controls the efficient, effective
forward and reverse flow and storage of goods,
services, and related information between the
point of origin and the point of consumption in
order to meet customers’ requirements.
• Logistics and SCM are intimately related, with
logistics perhaps being the “nuts and bolts” on
which SCM framework rests
 Logistics Estimates - INDIA
– Logistics spent: USD 110 Billion (2014)
• Expected to reach 200 Billion by 2020
– Share of GDP: Around 13% (estimated)
– Share of logistics cost (% of total)
• Transportation…………………..63%
• Warehousing……………………29%
• Others ……………………………8%
Improvement in transport and warehousing can
improve Indian logistics sector
Warehousing Equipment – AS/RS

Automated Storage Retrieval System

Warehousing Equipment -
AGVs

Automated Guided Vehicle System

 What is Transportation?
• Transportation refers to movement of a
product from one location to another as it
moves from beginning of a supply chain to
the customer
• 57% of goods transported by volume are
transported by road
• Road - least efficient among
• Inland water, rail, and road
 Transportation
• Single largest element of logistics cost (63%)

• Selecting mode(s) and carrier to move raw

materials, components, and finished goods

• Designing the most effective way of reaching

products to geographically dispersed markets
from plants in a cost-effective manner
 Parties the Influence the
Effectiveness of Transportation
• Shipper - Party that requires movement of
the product between two points in the
supply chain
• Carrier - Party that moves or transports the
product
• Owners and operators of transportation
infrastructure such as roads, ports, canals, and
airports
• Bodies that set transportation policy worldwide.
Infrastructural Issues that Hamper
Supply Chain in India
1. Scarcity of express highways
2. Pot-holed and clogged roads – reduce speed to
1/3rd of developed countries
3. Inability of ports to handle goods quickly
4. Lack of modern technology in warehouses
5. Varying tax rates across states prevent warehouse
to be located optimally from SCM perspective
6. Poor telecommunication network (poor IT
infrastructure)
7. Dwell-times for air cargo at Indian airports are
substantially higher than other countries
8. Multiple checkpoints for inspection and tolls and
taxes
 Modes of Transportation in SC
• Air
• Package Carriers
• Truck
• Rail
• Water
• Pipeline
• Intermodal
 Trucks
• Dominant mode of transport in India
• Highly fragmented industry
– 85% of total fleet controlled by unorganized sector
– 75% of the vehicles are owned by entrepreneurs who
own less than 5 trucks*
– 11% operate with more than 20 trucks
• Door-to-door shipment, shorter delivery time
• Less capable of handling all types of freight than rail
mainly due to highway safety restrictions that limit the
dimension and weight of shipments
• Most shipments must be smaller than 40’ to 53 ‘ trailer
and less than 8’ wide and 8’ tall to ensure road clearance
• Offers reasonably fast and dependable delivery

*Note: Few logistics firms in India with a fleet size larger than 100 trucks.
 Overview of Indian Infrastructure
for Transportation
• Roads
– Total 3,319,644 kms
• 12% are four lanes
• 56% are double lanes
• 32% are single lane
• Road conditions
– Narrow, pot-holed poor surface quality
– Congested
– average truck speed is only 30-40 km/h

• The Golden Quadrilateral

– 5952 kms connecting Delhi-Kolkata-Chennai-Mumbai via National
Highways

Note: Shipments by road that can be completed in three days in the U.S.,
for example, could take as long as nine days in India.
 Truckload (TL)
• Shorter delivery time
• Low fixed and medium variable costs
• Suited for transport between manufacturing
facilities and warehouses or between suppliers
and manufacturers
• Transhipments
• Types of freight
– Lumber, steel coils, machines, fabricated items,
consumer durables, cars, two wheelers, stone chips,
sand, containers, cement etc.
 Less Than Truckload (LTL)
• Suited for shipments in small lots
(< ½ TL) as TL is cheaper for larger
shipments
• Low capacity utilization or will have to
aggregate a number of small shipments in
one trip
• Higher delivery time than TL shipments
because of other loads to picked and
dropped
 Truck Costs
• Truck costs are typically grouped into three
categories
– Fixed costs
• Insurance, interest charges on money tied up in vehicles,
licensing fees, equipment amortization, expenses related to
housing vehicles, tax
– Operator costs (related to time rather than distance
travelled)
• Wages, health and pension plan, expenses while on road
(meal, hotel, telephone)
– Vehicle operating costs (incurred in keeping the
vehicle on road)
• Fuel, tyres, maintenance, spares, lubricants
 Rail
• Ideally suited for large, heavy or high density products
over long distances. 95% of the freight carried is bulk
goods
– Example: coal, steel coils, metal ores, cement, containers
– Coal accounts for more than 50% of the traffic
• Ideal for heavy, low-value ship shipments
• Not ideal for small, time-sensitive, short distance
shipments
• Major issues
– Vehicle and staff scheduling
– Track and terminal delays
– Poor on-time performance
 Rail
• Indian Railways account for 22% of the
freight movement in India
• High fixed costs in terms of rail, locomotives,
terminals, load/unload, billing
• High wages, fuel and oil, and maintenance
costs
• Traditionally, variable costs = ½ -1/3 rd of
total costs
• High idle time
• Government monopoly
 Overview of Indian Infrastructure
for Transportation
• Indian Railways – Fourth largest rail network in the world
– Total length: 63,465 km
– Transports 667 million tons of cargo/year
– Freight segment accounts for 2/3rd of revenue
– IR runs about 16,021 trains everyday
– Railway budget (2006-07) approved Rs 220 billion construction of
dedicated multi-modal high axle load freight corridor
– Factories
• Rail Coach Factory: Kapurthala
• Diesel Loc: Varanasi
• Integral Coach Factory: Chennai
• Wheel and Axle Plant: Bangalore
 Rail
• Rail has not been so popular in India
because of last mile delivery issues,
infrequent movement of trains, and lack of
flexibility
 Air
• Key issues:
– Fast and most expensive mode
– Appropriate for small, time-sensitive, high
value products
– Accounts for very small % of freight
– High fixed costs in infrastructure
– Large labour and fuel costs
 Major International Cargo Air
Carriers
• Airborne Express
• British Airways
• BAX Global
• DHL Worldwide Express
• Federal Express
• United Parcel Service (UPS)
 Package Carriers
• Companies like FedEx, UPS, USPS, Gati,
Bluedart that carry small packages ranging from
letters to shipments of about 150 pounds
• Expensive
• Rapid and reliable delivery
• Small and time-sensitive shipments
• Provide other value added services
– Track status of product in transit
• Pick package from source and deliver to
destination site
 Air Cargo vs. Package Carriers
• Air Cargo • Package Carriers
– Large Shipments – Small, time-sensitive
– Example: Dell uses air – Example: Dell uses
cargo to bring package carriers to
components from Asia ship PCs to customers
 Water
• Limited to certain geographic areas
• Used extensively for international cargo
• Ocean, inland waterway system, coastal waters
• Very large loads at very low cost
• Slowest among all modes of transport
• Significant delays occur at ports and terminals
– Turnaround time for a ship is at least 4 days in India which is
higher than in most countries
• Cheapest mode of transport
• Dominant in global trade (autos, grain, apparel, etc.)
• Though India has a coast line of 7517 km, none of the ports figure
in the top 10 ports of the world
• Largest post – Jawaharlal Nehru Port Trust, carries 37 million tons
of cargo against 4000 million tons by Shanghai airport
Ships can wait up to five days to dock at an Indian port, compared to little
or no wait time in Europe.
 Water
• Water transportation is used for low value
to weight ratio items like
– Timber, iron ore, coal, chemicals, grains,
petroleum, and cements
– For India, in 2010-2011, Iron ore constituted
(18%) of cargo traffic, coal constituted (15%)
of cargo traffic
• Commodities which are bulky but low
value where the items are not required in a
hurry are most suitable for water transport
Source: Business India, July 24, 2011
 Overview of Indian Infrastructure
for Transportation
• Waterways
– 12 major ports
• Managed by GOI
• High investments and high trade volume
– 200 minor ports
• Managed by state governments
• Low investments and low volume
Cargo Traffic in Minor Ports of India
(2010-2011)
Traffic Handled at Major Indian
Ports (2010-2011)

Source: Business India, Aug 2011

Commodity-wise Traffic Population

Source: Business India, Aug 2011

 Coastal Shipping
• Coastal shipping of goods is gaining momentum in India
– For example, cars are being transported from one
part of India to other part through sea
• Advantages
– Cost effective, environment-friendly, helps reduce
road traffic congestion
– Mitigating risk of road transport
• Dis-advantages
– Increased shipping duration compared to road
– Non-availability of return cargo
 International Commerce Terms
(Incoterms)
• Free on Board (FOB) Port of Departure
– FOB Paradip, India
– Exporter is responsible for the goods until they are
placed on the ship. The importer is responsible for
them after that.
• Cost, Insurance, and Freight (CIF) Port of
Destination
– CIF Kobe, Japan
– The exporter is responsible for minimum insurance
and freight (shipping costs) to the port of destination.
It is also responsible for clearing goods for export.
 Top Ocean Carriers
Ocean Carrier Rank by Capacity
A. P. Moller, Maersk - Denmark 3 Million TEU, Ranked 1
Mediterrain Shipping Co - Italy 2.6 Million TEU, Ranked 2
CMA CGM - France 1.8 Million TEU, Ranked 3
Hapag-Lloyd - Germany 0.94 Million TEU, Ranked 4

Evergreen Marine - Taiwan 0.93 Million TEU, Ranked 5

COSCO - China 0.85 Million TEU, Ranked 6
China Shipping - Sanghai 0.7 Million TEU, Ranked 7
Hamburg Sud - Germany 0.65 Million TEU, Ranked 8
Hanjin Shipping, Korea 0.63 Million TEU, Ranked 9
TEU = 20 feet equivalent unit. Used to measure ship’s cargo capacity.
1 TEU = 20 feet long, 8 feet tall
 Pipeline
• High fixed cost, low variable costs
• Primarily for liquid, gases, semi-solid materials
– crude petroleum, refined petroleum products,
natural gas, slurry (coal, iron ore, limestone,
copper)
• Best for large and predictable demand
• Would be used for getting crude oil to a port or
refinery, but not for getting refined gasoline to a
gasoline station
• Low cost compared with other modes
• Product movement by pipeline is very slow (oil
moves 1-6 metres / second)
• Product moves 24 / 7
 Overview of Indian Infrastructure
for Transportation
• Pipeline
– Gas, 5798 km
– Liquid Petroleum Gas: 1,195 km
– Oil: 5,613 km
– Refined products: 5,567 km
Example: 1,469 kms long Hazira-Bijapur-Jagdishpur
(HBJ) pipeline network is the most noteworthy
pipeline in India that carries natural gas from Gujrat to
Central India
Other examples are Gauhati-Barauni, Ankleswar-
Baroda, Mathura – Viramgam pipelines
 Inter-modal Transport
• Use of two or more carriers of different modes to move a
shipment to its destination
– Birdyback
• Airline + Truck
– Fishyback
• Ship + Truck
– Piggyback (most widely used)
• Rail + Truck
• Container on Flatcar (transporting container on
railroad flat cars: COFC)
 Containerization
• Large container box into which a firm places
commodities to be shipped.
• After initial loading, the commodities are not handled
until they are unloaded at their final destination
• Reduced cost of packaging
• Faster turnaround for ships (faster loading and
unloading)
• Ease of cargo transfer across multiple modes
• Reduced material handling, theft, damage
 TEU
• TEU stands for 20 feet equivalent unit
• Used to measure ship’s cargo carrying
capacity
• 1 TEU = 20 feet shipping container means
20 feet long, 8 feet wide and 8 feet tall
 Reefer Containers

refrigerated container or reefer is an intermodal

container used in intermodal freight transport
that is refrigerated for the transportation of
temperature-sensitive cargo
Reefer Containers
 Inter-modal Transportation
• Most common example: rail/truck
• Also water/rail/truck or water/truck
• Grown considerably with increased use of
containers
• Increased global trade has also increased use of
inter-modal transportation
• More convenient for shippers (one entity
provides the complete service)
• Key issue involves the exchange of information
to facilitate transfer between different transport
modes
 Problems in Intermodal
• Carriers are reluctant to participate
– When one carrier can transport the
commodity the entire distance over its own
lines, the carrier is hesitant to coordinate with
others
– Transfer of freight from one mode to another
• Creates time delay and adds to transportation cost
 ICDs and CFS
• Inland Container Depots (ICDs) and Container Freight
Stations (CFSs) are inland locations and designated as
dry ports for the sake of custom formalities related to
export import cargo to be handled in these locations
– For example, exporters in Delhi can complete their
custom formalities while handling over export cargo at
ICD, Tughlakabad without having to go through the
process at the seaport through which their cargo is
routed
• ICDs are located away from seaports, the CFSs are
adjacent to the port. CFS is a facility where containerized
cargo can be loaded or unloaded
Inland Container Depot (ICD)
Container Freight Station(CFS)
 ICDs and CFSs
• Functionally no difference between the two
• ICDs are located outside the port towns
• CFS is an off-dock facility (extension of
port)
Relative Ranking of Transportation
Mode by Performance Measures
 Key Point
• When selecting a mode of transportation,
managers must account for cycle, safety,
and in-transit inventory (or pipeline
inventory) costs that result from using
each mode. Modes with high
transportation costs can be justified if they
result in significantly lower inventory costs.
 Total Cost Approach to
Performance Measures
• Total cost = Transport cost + Cycle stock
inventory carrying cost + Pipeline
inventory carrying cost + Safety stock
inventory costs + Cost of losses and
damages
 Average Pipeline Inventory
• Shipping time (St) is 30 days,
• The order cycle (OC) is 5 days,
• A shipment is 100 units
• What is the average pipeline inventory?
• A shipment begins on days, 0, 5, 10, 15, 20, 25 & 30, …. .
• They arrive on days 30, 35, 40, …
• Formula to calculate # SHIPMENTS = St / OC
• # shipments in transit = 30 / 5 = 6
• 100 units per shipment = 600 units of transit inventory at
$3,000 per item = $1,800,000
 Pipeline Inventory

• Pipeline Inv. = Lead Time × Demand Rate

 Design Options for a
Transportation Network
• Direct Shipment Network
• Direct Shipping with Milk Runs
• All shipments via Central DC
– Cross Docking
• Shipping via DC using Milk Runs
• Tailored network
Most effective when large quantities are moved
Milk Run
Cross Docking
 Cross Docking
• Warehousing methodology is one in which
goods are not actually warehoused in a
facility. Instead, trucks from suppliers,
each carrying a different type of product,
deliver goods to a facility. There the
inventory is broken into smaller lots and
quickly loaded onto store-bound trucks
that carry a variety of products, some from
each of the supplier trucks.
Cross Docking
 Tailored Network
• Combination of previous options to reduce
cost and improve responsiveness
– Combination of cross-docking, milk runs, TL
and LTL carriers, along with package carriers
in some case
– Goal is to use appropriate option in each
situation
Mixing at DC
 Trade-offs in Transportation
Design
• Transportation and inventory cost trade-off
– Choice of transportation mode
– Inventory aggregation

• Transportation cost and responsiveness trade-off

– Mode of transportation that results in lowest transportation
cost does not mean lowest costs for a supply chain

– Cheaper mode of transport typically have longer lead times

and larger minimum shipment quantities, both of which
result in higher levels of inventory in the supply chain and
so higher inventory costs

– Faster modes of transportation allows shipment in small

quantities so lower inventory costs but higher transport cost
Trade-offs in Transportation Design
• High value-to-weight products --faster
modes of transportation

• Small value-to-weight products – cheaper

modes of transportation
Trade-off Between Transportation Cost
and Customer Responsiveness
• Small outbound shipments ► high
responsiveness and high transport cost

• Aggregated shipments over time

(Temporal aggregation) ►low
responsiveness and low transport cost
 Third Party Logistics (3PL)
• Outsourcing logistics function to third party
• These companies allow economies of scale that
were not feasible in single-customer relationship
• They operate by consolidating loads from
multiple suppliers located near each other,
realizing full truck load economies without the
batches coming from the same supplier.
• There are additional handling and administrative
costs for such consolidations or multiple pickups,
but the savings often outweigh the costs
 Outsourced Logistics Services
• Transportation
• Warehousing
• Customs Clearance
• Freight Forwarding
• Shipment consolidation
• Cross docking
• Reverse logistics
• Product labelling, packaging, assembly, kitting
• Fleet management
Logistics Companies - India
– OM Logistics
– Allcargo’s
– Jubilee Shipping and Forwarding
– DIESL
– Flyjac
– Logisticmart
– Capricorn Logistics
– Mahindra Logistic
– Pridel
 3 PL
• Logistics activities most outsourced based
worldwide
– Most frequently outsourced: Transportation
(90%)
– Warehousing (74%)
– Customs clearance (70%)
– Forwarding (54%)

Source: 2006 Eleventh Annual 3PL study, Georgia Tech

 Third Party logistics players in
India
• Market is highly fragmented with large number of small players
• Rail is state run while truckers are often family-run
• Poor warehousing and transportation infrastructure
• Foreign logistics competitors are DHL, Fedex, Blue Dart, Exel,
Danzas, Bax, Global, TNT, Panalpina – main revenue from freight
forwarding
• Logistics market is expected to grow by more than 20% over the
next 3 years as against the present rate of 12-15%
• Third party logistics market size is going to touch Rs 48000 crore by
2019
• EVOLVING

Source : Scope, Indian Logistics Industry, January 2002

 3 PL in India
• External supplier that performs all or part of company’s
logistics function such as transportation, warehousing,
distribution, financial services and so on.

• Mainly used by retail, pharmaceutical, automobile and

FMCG sectors
3PL Market

Source: Business India, July 22, 2012

 4PL
• 4PL first defined by Anderson Consulting (Accenture)
• 3PL manages a function, a 4PL targets management of
the entire process
• 4PL manages the entire supply chain process, i.e.,
manages 3PLs, truckers, forwarders, custom brokers
and others essentially taking responsibility of a complete
process for the customer
• Single interface between client and logistics provider
• Still at its infancy in India
• Example: Menlo Logistics, Kuehne and Nagel AG
– Menlo Logistics designs the supply chain, information systems,
integrates transportation, warehousing, home delivery, product
set up and reverse logistics for Homelife, a national home
furnishing retail chain
 Fourth-party Logistics
• A firm that “ assembles and manages
resources, capabilities, and technology of
its own organization with those of
complementary service providers to
deliver a comprehensive supply chain
solution
• In one sense, a 4PL is to manage and
direct activities of multiple 3PLs, and the
IT providers
3 PL and 4 PL
 Reverse Logistics
• Backward flow of goods returned to supply
chain from their destination. Goods may
be returned because they are defectives,
unsold, or simply customer changed their
minds
• Two elements
– Gatekeeping
– Avoidance
 Measuring Logistics Performance
• Delivered on time
• Shipped complete
• Invoiced correctly
• Undamaged in transit
 Risk Management in
Transportation
• Three main risks to be considered in transportation are:
1. Risk that the shipment is delayed due to congestion
2. Risk of not reaching destination due to disruptions by
external forces (weather or man made)
3. Risk of hazardous material
 Risk Mitigation Strategies
1. Delays due to congestion
➢ Use alternative lanes or alternative modes of transport
➢ Building buffer into the lead time
➢ Owning transport fleet or enter into long-term agreement
with third party
➢ Having inventories closer to customers
2. Disruptions by natural events or terrorism
➢ Use alternative routings
3. Risk of hazardous materials
➢ Use of modified containers, low-risk transportation modes,
modification of physical and chemical properties of material
to make it less dangerous
 Case
• Selecting Transportation Modes for China
Imports

Page 471-472
Sourcing in Supply Chain

Chapter 15
 What is Sourcing?
• Sourcing is a set of business processes
required to purchase goods and services
– Selection of suppliers
– Design of supply contracts
– Product design collaboration (80% of the cost
of the product is determined during design)
– Procurement of material
– Evaluation of supplier performance
 What is procurement?
• Purchasing, also called procurement, is
the process by which companies acquire
raw materials, semi-finished goods,
finished goods, capital equipment,
services etc. from suppliers to execute
their operations
 Outsourcing
• Outsourcing results in supply chain function
being performed by a third party.
– For example, since 2007 retailing function of Dell is
performed by Walmart (third party)
– Britannia outsources to other contract
manufacturers for its various low-end products
 Importance of Outsourcing
• Businesses have realized that efforts required to increase
profits through increasing sales were far greater than those
involved in generating equivalent returns through reduction in
procurement prices

• Today 70%-80% of the spending at a manufacturer is through

procurement compared to only 20% several decades back

• Organizations procure
– components, products, product design, service
(housekeeping, canteen, security services)
 In-house or Outsource
• The most significant decision is whether to
perform in-house or outsource
• Outsource results in the supply chain
function being performed by a third party
• Outsourcing makes sense only if it
increases supply chain surplus
– Supply chain surplus is the difference between the
value of the product for the customer and the total
cost of all supply chain activities involved in bringing
the product to the customer
 Importance of Outsourcing
• Tata Motors going for almost 80% auto component
outsourcing for its cars
• Procures through E-sourcing
– Conducts 400 reverse auctions every year
– Sources direct materials (tyres, bearings, castings,
forgings), indirect materials (lubricants, MRO),
machine tools, material handling equipment, services
(food, housekeepng)
• Maruti and Ashok Leyland have similar outsourcing
practices
• Cisco has major suppliers across the world
• Apple has more than 70% of components outsourced
 Make-or-Buy Decision Strategy
• Make or buy decision is based on
– Cost
• Outsource if the cost is less if procured from third party
– Core vs. non-core activities
• Focus on core activity and outsource non-core
 Fine and Whitney Framework for
Outsourcing of Components
• Reasons for outsourcing
– Dependency on capacity
• Firm has knowledge and skills required to produce the
components but for various reasons (time, money, space,
or management’s attention) decides to outsource
– Dependency on knowledge
• The firm does not have the people, skills, and knowledge
required to produce the components and outsources in
order to have access to these capabilities

Fine and Whitney, 1996

 Illustration of Framework:
Outsourcing at Toyota
• The company designs and makes 30% of its car
components
• Engines: Toyota has both the knowledge and
the capacity to produce engines and 100% of
the engines are produced internally
• Transmissions: Has knowledge but lacks
capacity – 70% of components outsourced
• Vehicle electronic systems: Designed and
produced by Toyota’s suppliers – lacks both
capacity and knowledge

Fine and Whitney, 1996

 Key Learning from Toyota
• Toyota seems to vary its outsourcing practice
depending on the strategic role of the
components and subsystems
• The more strategically important the component
is, the smaller the dependency on knowledge or
capacity

Fine and Whitney, 1996

 Toyota Sourcing
Toyota Independent Dependent for
Sourcing and for knowledge knowledge
Strategic
Choices

Independent ENGINES Rare Case

for capacity

Dependent for Transmissions Electronics

capacity
 Benefits of Using Third Parties
• Capacity aggregation
• Transportation aggregation
• Warehousing aggregation
• Procurement aggregation
– Group Purchasing Organizations (GPOs) in
hospitals in USA
• Receivables aggregation
 Major Risks of Using Third Party
• The process is broken
• Quality is compromised
• Underestimation of the cost of coordination
• Reduced customer/supplier contact
• Loss of internal capability and growth of third-party hard-to-replicate
expertise
• Leakage of sensitive data and information with firm’s competitors
• Conflicting objectives
– Buyer looking for flexibility in design to match supply and demand.
In contrast, supplier looking for economies of scale
– Vendors may produce parts that suit their schedule and
capabilities and not necessarily what is required by a specific
buyer, thus delaying the delivery of goods
 Multiple and Single Sourcing
Approaches to Supply Management
• Multiple Sources • Single Source
– Deal with several suppliers for – Deal with one supplier
every item procured – Avoid engaging in any conflicts
– Set-up competitive position – Engage in joint cost reduction to
among suppliers obtain low-cost inputs, quality
– Engage in price negotiation improvement efforts
every time an item is procured – Engage in product development
– Withhold information, obtain exercises
better price – Exchange relevant business
– Suppliers face uncertainty information
about future business, – Suppliers informed of future
uncertainty weakens supplier business prospects, capacity,
position technology investments
– Customers benefit from – Benefit from cooperation and
suppliers’ weaknesses, mutual trust
confusions, and fears
– Creates a degree of
competition
 Multiple and Single Source
Multiple Suppliers - Single Supplier -
Disadvantages Disadvantages
• Increases complexity • Risk of supply disruption
• High administrative costs from
– Fire, natural calamities
• Difficulty in
– Purchased by a competitor
communication and
– Goes out of business
control
 Supplier-Partnering Hierarchy
(Toyota and Honda)
• Six steps:
– Understand how suppliers work
– Conduct joint improvement exercises
– Share information intensively but selectively
– Develop suppliers’ technical capabilities
– Supervise suppliers
– Turn supplier rivalry into opportunity

Source: Building deep supplier relationships, HBR, Dec 2004

 Kraljic’s Framework
• Kraljic argues that firm’s supply strategy
should depend on two dimensions
– Profit impact
– Supply risk
Procurement Strategies:
Kraljic’s Supply Matrix

Long term contracts Supply contracts

Spark plugs, brake linings Engines, transmissions

Nuts, bolts, oil seals Car seats, tyres

 Kraljic’s Supply Matrix
• Top right quadrant:
– Strategic items where supply risk and impact on profit
are high
– Highest impact on customer experience
– Price is a large portion of the system cost
– Typically have a single supplier
– Focus on long-term partnerships with suppliers
• Bottom right quadrant
– Items with high impact on profit
– Low supply risk (leverage items)
– Many suppliers
– Small percentage of cost savings will have a large
impact on bottom line
– Focus on cost reduction by competition between
suppliers
 Kraljic’s Supply Matrix
• Top left quadrant:
– High supply risk but low profit impact items.
– Bottleneck components
– Do not contribute a large portion of the product cost
– Suppliers have power position
– Ensure continuous supply, even possibly at a
premium cost
– Focus on long-term contracts or by carrying stock
(or both)
• Bottom left quadrant:
– Non-critical items
– Simplify and automate the procurement process as
much as possible
– Use a decentralized procurement policy with no
formal requisition and approval process
 Sourcing Process
Vendor Selection Order Placement
Need Identification ▪Search vendors ▪Price fixing
▪Receive purchase request ▪RFQ ▪Dely and payment terms
▪Estimate order size ▪Negotiations ▪PO generation
▪Finalize specification

Payment, Vendor Rating Order Acceptance Order Receipt

▪Payment authorization ▪Inward goods inspection ▪Follow-up with vendor
▪Performance Rating ▪Acceptance / rejection ▪Receipt of material as
▪Vendor-record updating ▪Updating stocks per specification
 Sourcing Process
• Simplest purchasing procedure
– Off-the-self buying
– Oral orders over phone
– Placing repeat orders with an existing supplier
• Sourcing in public-sector and government agencies
– Technical bids
• Screened and short listed
– Commercial bids
• L1 (lowest), L2, L3 suppliers
• Supplier selection should be based on total cost of using
a supplier and not just the purchase price
E-PROCUREMENT
 E-Procurement
• E-procurement means procurement of goods
and services online using internet

• The intention is to automate the entire

procurement process, along with tender bid
submission and payment by suppliers, in an
online web based real time environment

• E-procurement can resolve many of the

constraints and delays of traditional procurement
 Modes of E-Procurement
• Electronic procurement activities could be
done using one of the several ways or
modes given below, or a combination of
these could also be used as per need:-
1. e-Tendering
2. e-Auctioning: Reverse Auction
3. e-Catalogue based buying/e-Ordering
• Procurement by individuals
 What is an Auction?
• The two major types of auction
• Forward auction in which several buyers bid
for one seller's good(s) say IPL

• Reverse auction in which several sellers bid

for one buyer's order. An auction is complete
(and a binding contract is created) when a bid
is accepted by the seller or the buyer (as the
case may be).
 Modes of E-Procurement
• In common parlance, a basic E-
procurement application consists of
❖E-Tendering and E-Auctioning system

• It could also encompass E-Catalogue

based buying also
 Major Benefits of E-Procurement
• Reduces cycle time of procurement
• Reduce cost of procurement
• Remove cartelization by supplier group
• Removes clandestine dealing between suppliers and
a section of officials from buyer side (pact)
• Increases transparency of the procurement process
• Almost complete elimination of paper work for
speedy and efficient functioning
 Contents of a Tender
1. Notice inviting Tenders
2. Instructions to the bidders
3. Form of submission
4. Documents required to be submitted along with the bid
5. Draft of the Agreement proposed to be signed between the two
Parties
6. General Conditions of Contract
7. Special Conditions of Contract
8. Trade Specifications including that for Material & Workmanship
9. Bill of Quantities (BOQ)
10. List of Materials proposed to be issued by the Owner
11. Tender drawings and sketches
 Reverse Auction
• The traditional auction is a Forward Auction. It normally
involves a seller offering an item for sale, while potential buyers
compete for purchase. Thus, price is driven up, until no buyer is
willing to go up further.

• In a Reverse Auction, multiple sellers vie for the business of a

single buyer. Therefore, the price is driven down.

• There are 3-4 types of reverse auction, called as: English

Auction, Dutch Auction, Sealed Bid Auction etc.
 How Does Reverse Auction
Work?
• Pre-screening/Pre-Qualification of suppliers is
essential to have technically qualified vendors
• Complete requirement specification are pre-
known/agreed and frozen for all before
auction
• Usually, online auction service provider is
engaged
 How Does Reverse Auction
Work?
• Suppliers are required to be pre-registered
with the auction service provider and have
received training before participation
• All the vendors are notified in advance
about the start and closing time of auction
• Bidders submit their price bids by remotely
logging-in from their offices
 How Does Reverse Auction
Work?
• Bidders identities are masked but they can
see in real time the competing prices and
could revise their bids as desired
• There is no communication or negotiation
with bidders during the auction
• Buyer also watches the progress of
bidding from his office
 How Does Reverse Auction
Work?
• In reverse auction, competition is high,
bidders get tempted to bid lower and lower
to clinch the deal, until they are unwilling
to go any further
• At the conclusion, the lowest bidder
emerges as the winner of the auction
 Auctions in the Supply Chain
• Auctions:
– Sealed-bid first-price auction
• Each potential bidder to submit a sealed bid for the contract by a
specified time. These bids are opened, and the contract is assigned
to the lowest bidder.
– English auctions
• Auctioneer starts with a high price and the suppliers can make bids if
each successive bid is lower than the previous bid
– Dutch auctions
• Auctioneer starts with a low price and then raises it slowly until of the
suppliers agree to the contract at that price
– Second-price (Vickrey) auctions
• Each potential supplier submits a bid, and the contract is assigned to
the lowest bidder but at the price quoted by the price quoted by the
second-lowest bidder.
 Auctions in the Supply Chain
• Links to auctions
– http://www.ariba.com/
– http://www.freemarkets.com.
• Indian companies’ portal
– http://www.indiamarkets.com/imo/
– //etender.ongc.co.in
– Eproc.karnataka.gov.in
 Benefits of Online Reverse
Auctions to Buyers
• Helps achieve significant reductions in procurement
costs on account of Dynamic Bidding process

• Access to many vendors.

• A tool for efficient price discovery complementing

the direct negotiation process.
Source:indiamarkets.com
 Benefits of Online Auctions
• Ensures savings in marketing costs /
distributor margins
• Allows vendors to access hitherto
inaccessible buyers
• Increased transparency in buying process
• Facilitates flexibility in pricing decision
• Quick decision on supplier selection
• Less paperwork
Source: Indiamarkets.com
 Total Cost of Ownership
• Comparing suppliers based on total cost of
ownership (TCO)
• TCO considers all the costs incurred before,
during and after the purchase of a good or
service
– Acquisition costs
– Ownership costs
– Post-ownership costs
 TCO
When the costs occur Type of costs
Before the transaction Time and money spent in searching,
visiting, evaluating, and certifying
suppliers

During the transaction Purchase price, costs of ordering,

expediting, transporting, receiving,
inspecting etc.

After the transaction Costs of inventory, potential defects

and repairs, production downtime,
warranty costs, lost sales, damaged
reputation
 Supplier Development
• Supplier certification
– Assesses the financial and equipment capabilities,
the cost structure, the contract performance, the
quality assurance system, and the value analysis
effort of the supplier under consideration

• Vendor rating
– Systematic method to evaluate suppliers’
performance using data from the delivery of items in
response to purchase orders placed
Supplier Certification Programme
Value Analysis
Effort
Quality
Financial
Assurance
Capability

Single Source
Certification
Program
Equipment Cost
Capability Structure

Contract
Performance
 VENDOR RATING SYSTEM
(Yardstick for Measuring Performance)
Criterion Weights Excellent- 5 Very Good - 3 Average -2 Below
Good - 4 Average -1

Quality 28 <1000 ppm 1001- 5001- 10,001- >50,001

5000 ppm 10,000 50,000 ppm
ppm
Delivery 24 100% 1 day 2-4 days 5-7 days > 7 days
reliability schedule after due after due after due after due
adherence date date date date
Price 21 Base price Upto 1% 2-3% 4-5% >5% above
above above base above base base price
base price price price

Delivery 14 Free delivery FOB Only Chargeable Ex works

Terms collection basis
free
Payment 13 60 days 45 days 30 days 10-15 days Immediate
Terms

Total 100
 VENDOR RATING SYSTEM

Criterion Weights Vendor 1 Vendor 2

Performance Rating Factor scores Performance Rating Factor
Scores

Quality 28 792 ppm 5 140 5400 ppm 3 84

Delivery 24 1 day after 4 96 2-4 days after 3 72

Reliability due date due date

Price 21 2-3% above 3 63 Up to 1% 4 84

base price Above base
price

Delivery 14 FOB 4 56 FOB 4 56

Terms

Payment 13 45 days 4 52 60 days 5 65

Terms
Total 100 407 361

Vendor 81% 72%

Rating
 Video
• Video – Flexible Manufacturing Strategy
(Ford)
 Bose Corporation Case
• Q1. What are the three aspects of Bose
strategy?
• Q2. Is Bose a good buyer?
• Q3. How procurement was done at Bose?
• Q4. Should plants source their own components
locally? Yes or No? If yes, why? If no, why?
• Q5. Why Tom Beeson wants to integrate
vertically? Do you disagree to Beeson’s
argument?
• Q6. What is vendor managed inventory (VMI) or
JIT II?
 Bose Corporation Case
• Q7. Should Bose participate in the JIT II
program? Should G&F? What are the
potential risks for both the companies?
 Sourcing Related Metrics
• Days payable outstanding
• Average purchase price
• Range of purchase price
• Average purchase quantity
• Fraction of on-time delivery
• Supply quality
• Supply lead time
• Supplier reliability
VEHICLE ROUTING
Risk Management in Supply
Chains
SUPPLY CHAIN RISKS AND THEIR DRIVERS
IMPACT OF VARIOUS MITIGATION STRATEGIES
 Vehicle Routing
• Transport costs typically range between
50%-60% of the total logistics costs
• To reduce transport and delivery costs and
to improve customer service, finding the
best paths that a vehicle can follow
through a network of roads, rail lines,
shipping lanes is a frequent decision
problem
 Objectives of Routing and
Scheduling
• Decrease total distance traveled by a
vehicle
• Decrease total travel time of vehicles
• Eliminating service failures

• In sum: decrease transport and delivery

cost and improve responsiveness
 Vehicle Routing and Scheduling in
Transportation
• Savings Matrix Method
1. Identify the distance matrix
2. Identify the savings matrix
3. Assign customers to vehicles or routes
4. Sequence customers within routes

Note: Steps 1- 3 are used for assigning

customers and step 4 is used for
sequencing customers
Vehicle Routing and Scheduling
1. Identify Distance Matrix
Distance Matrix for Peapod
Deliveries
Reduced Travel Distance Though Stop
Consolidation on a route
 2. Identify Savings Matrix

S (x,y) = Dist (DC, x) + Dist (DC, y) – Dist (x , y)

3. Assign Customers to Vehicles or
Routes

Vehicle capacity = 200 units

3. Assign Customers to Vehicles or
Routes
3. Assign Customers to Vehicles or
Routes
 Four Routes
• Groups
– (6,7,11), Weight 163 < 200, vehicle capacity
– (1,2,4), Weight 183 < 200, vehicle capacity
– (5,10,12,13), Weight 197 < 200, vehicle cap
– (2,8,9), Weight 123 < 200, vehicle capacity
 4. Sequence Customers Within
Route
• Consider the truck that has been delivered to
customers 5, 10, 12 and 13
– If the deliveries are in sequence 5, 10, 12, 13,
the total distance travelled by truck from DC to
back is 15+9+9+8+15 = 56
– In contrast, if deliveries are made in the
sequence of 12, 5, 13, and 10 from DC and
back, the distance travelled is
11+14+22+16+16 = 79
– Clearly, 1st option is better
Vehicle Sequencing (Sweep
Method)
 Vehicle Sequencing
(Sweep Method)
1. Locate all stops including the depot on a map or grid
2. Extend a straight line from the depot in any direction.
Rotate the line clockwise or anticlockwise. Ask the
question: If the inserted stop is included in the route, will
the vehicle capacity be exceeded? If the answer is no,
proceed with the line rotation until the next stop is
intersected. As the question: Will the cumulative volume
exceed the vehicle capacity? Use the largest vehicle
first. If the answer is yes, exclude the last point and
define the route. Continuing with the last sweep, begin a
new route with the last point that was excluded from the
previous route. Continue with the sweep until all points
have been assigned to routes.
 Vehicle Sequencing
(Sweep Method)
3. Within each route sequence stops to
minimize distance. The sequence may
be accomplished using the tear-drop
method or by using any algorithm that
solves “travelling salesman” problem
 Advantages of Sweep Method
• Simple to calculate
• Average error rate is approx 10%
• Provides very good solutions when each
stop volume is a small fraction of the
vehicle capacity
• All vehicles are of same size
• No time restrictions
 Guiding Principles of Good Routing
1. Load Trucks with stop volumes that are in closest proximity to
each other
2. Stops on different days should be arranged to produce tight
clusters
3. Build routes beginning with farthest stop from the depot
4. The sequence of stops on a truck route should follow teardrop
pattern
5. The most efficient routes are built using the largest vehicles
6. Pickups should be mixed into delivery routes rather than assigned
to the end of routes
7. A stop that is greatly removed from a route cluster is a good
candidate for an alternate means of delivery

Note: These guiding principles produce satisfactory, although not necessarily optimal
Solutions to realistic routing and scheduling problems
Poor and Good Stop Sequencing
Clustering for Assigning Stop
Volumes to Vehicles
Clustering Stops By Day of Week
Route Sequencing
Route Sequencing to Minimize
Number of Trucks
 Reference Book
• Business Logistics/Supply Chain
Management, 5th Ed, Chap 7, pp. 229-295
• Authors: Ballou and Srivastava
 Video
• DHL (13 mins)
• International Logistics (9 mins)
 Article
• Insights into INDIA, Supply Chain
Management Review, July/August 2012
THANK YOU
IT in Supply Chain

Chapter 16
Alternative Solutions to Manage the
Supply Chain
• Electronic Data Interchange
• Intranet and Extranet
• Data warehouse / Data mining
• E-commerce
• Bar Coding Technology
• Other Technologies
– RFID
– Smart Card
 Benefits of EDI
• Greater effectiveness/efficiency
• Give competitive advantage
• Helps to keep customers happy
• Reduced transaction costs and time
• Increased accuracy
• Improved decision making
 Benefits of Intranet/Extranet
• Facilitates two way communication
between the manufacturing floor and other
areas of the plant
• Allows distribution of many categories of
information
• It enhances overall performance
 Benefits of Data Mining
• Associations, or when one event can be
correlated to another event (beer purchase and
peanuts)
• Sequences, or one event leading to another
later event ( a rug purchase followed by a
purchase of curtains)
• Profiling of customers who make purchases
• Forecasting – discovering patterns in data that
can lead to predictions in future
 Benefits of E-Commerce
• Improved productivity
• Improved quality
• Improved customer service
• Reduced costs
• Shortened supply chain
• Faster product development
• Reaching new markets
• Improvement in cash flows
 Information Technology: A Supply
Chain Enabler
• Information is the essential link among all
supply chain members. Computers and
information technology allows real time,
online communication throughout supply
chain.
SUPPLY CHAIN ENABLERS
RFID CAPABILITIES
RFID CAPABILITIES
Build to Order (BTO)
Games in Supply Chain
 Computerized Beer Game
• See Simchi-Levi & Others (pp 485)
 Risk Pool Game
• See Simchi-Levi & Others (pp 501)
Cases in Supply Chain
 Cases in Supply Chain
• Ford Motor Company
• HP Supply Chain
Wholesaler
Wholesaler
Retailer
Distribution Center
Healthcare Supply Chain
Management
Manimay Ghosh, Ph.D.
Healthcare Supply Chain
Management
Healthcare Supply Chain
Management

Manimay Ghosh
GDP Spend on Healthcare (Global)
• USA: 15.3%
• France: 11%
• Japan: 8.1%
• Chine: 4.1%
• India: 1%

Source: Dataquest, 2011

Healthcare Spend
Comparison of Healthcare Spend (%)

Country Public Private sector

China 44.7 55.3

Brazil 41.1 58.4

India 26.2 73.8

USA 45.5 54.5

 Doctors and Bed Density
Comparison (per 10,000 people)
Indicators Year India USA UK Brazil China

Hospital 2009 12 31 39 24 30
Bed
density

Doctor 2009 6 27 21 17 14
density
 Healthcare in India
• Present size of industry: USD 40 billion
• By 2012: USD 79 bn
• By 2020: USD 280 bn
• Average CAGR: 21%
Indian Healthcare Market
 Healthcare in India
• Number of beds available per 1000 in
India is 1.27 which is less than half the
global average of 2.6
• Beds available in urban areas : 369,351
• Beds available in rural areas: 143,069
• In urban area: 6 doctors per 10,000 people
• In rural area: 1 doctor per 10,000 people
Source: Dataquest, 2011
Number of Beds
 Purpose of Healthcare Supply
Chain
• The main purpose of the healthcare supply
chain is to deliver products in a timely
manner, in order to fulfill the needs of the
providers
Healthcare Supply Chain
Configuration
Healthcare Product Flow
 Healthcare Supply Chain
• Highly fragmented
• Relatively inefficient
• Healthcare supply chains have lagged
behind manufacturing supply chains
 Hospital Supply Costs
• Supply costs are second largest expense for hospitals after
personnel costs
• Hospital supply expense represents 25-30% of expenses
• Hospitals overpay suppliers 2-7% of the available contract price for
contracted medical and surgical products
• Purchasing personnel spend about 40% of their time manually
processing transactions
• Average cost to process a purchase order is $10 to $30, compared
with as much as $75 for a manual purchase order
• Accounts payable personnel spend 60% of their time processing
transactions manually
• Note: Many processes are manual, prevalence of legacy information
system, not properly interlinked
– Johns Hopkins Hospital, USA

Source: Gene Long, 2005

 Hospital Supply Costs
• Current usage of EDI stands at only 30-40% of
transactions available for automated processing

• About 35-40% of hospital supply related costs

are devoted to handling, moving, and processing
materials/supplies (other industry average –
10%)

• A 5 – 15% savings in supply chain costs would

equate to a 1-3% improvement in hospitals
operating margin

Source: Gene Long, 2005)

 Reducing Direct Costs
• GPO relationship: Maintain one strong GPO
relationship instead of many GPOs
• Supply Standardization: Reduce proliferation of
items, leverage better volume based pricing
– Involvement of physicians, nurses, equipment
specialists, purchasing and materials manager
• Contract management: Avoid renewing contracts
regularly, and negotiate for favorable terms. Is
the organization being charged correctly based
on the contract price?
 Reducing Direct Costs
• Freight Costs: Evaluate total landed costs and
look for improved terms with top vendors

• Distribution: Check for distributor’s fee

commensurate with value provided
– Ask for materials distributed directly from
manufacturer, bypassing distributor Freight Costs:
Evaluate total landed costs and look for improved
terms with top vendors
 Where is Inventory Held in
Hospitals?
• Hospital store: 6.3%
• Stock in hospital and not in store – 93.7%
 Current Scenario-Inventory
Management
• Hospital don’t track perpetual inventory.
Rather use visual cues to decide when to
order. Employees pull inventory with no
record of accountability
– Inflated inventory or high occurrence of stock
outs
• Hospitals employees concerned more
about patient care and less about material
control
Inventory Management in Hospitals
• Poorly implemented inventory management
techniques
• Use of personal judgment to determine safety
stock
• Lack of inventory control
• Frequent stock-outs
• Costly emergency deliveries
• Workflow interruptions
• Expensive rework
 Inventory Wastes
• Excess stock (stock held over lead time
and usage requirement)
• Obsolete stock (has been superseded by
another product)
• Expired stock (use-by-date has passed)
• Damaged stock (broken, crushed)
• Pilfered stock (taken by staff for other use)
• Borrowed stock (taken by other parts of
hospital but never replaced)
 Solution to Current Inventory
Problem
• Stockless inventory
– Distributors are responsible for supplying materials in
pieces than in bulk
– Holding inventory and replenishing individual
locations
– Distributors capture larger share of the hospital’s
purchases and charge a mark up between 3-7% of all
materials delivered
– More visibility of the actual usage and less bull-whip
effect
– Less stock outs, less inventories, and less labour
costs
 Solution to Current Inventory
Problem
• Vendor Managed Inventory (VMI)
– Distributor hires its own employees to work in
the hospital and assume following
responsibilities
• Material handling, warehousing, and purchasing
• Distributors buys materials from its own facilities,
manufacturers and competitors as directed by
medical staff
– VMI removes redundant functions and
inventory within the channel
Automated Point of Use Systems

Medical Supplies Pharmeuciticals

AGVs in Material Delivery
AGV Movement in a Hospital
Warehousing Models
Pros and Cons of On-site Model
ADVANTAGES DISADVANTAGES
• Full control of inventory • Usually located in
• Close proximity to basement
customers • Difficult to access by
• High level of service trucks (docking problem)
• Faster problem solving • Capacity constrained
• Better patient care • Lower height leads to
inefficient use of space
• More labour requirements
• Operationally inefficient
• High opportunity costs
 Pros and Cons of Off-site
Warehousing
• Advantages • Disadvantages
• Clean sheet approach to lean • Compromise customer service
manufacturing design levels, if not planned properly
• Clear height of 20 feet • Higher transportation costs
minimum – Buying transport equipment
• Low operating costs
• High throughput
• High productivity
• Accommodate future
institutional growth
• Reduced annual operating
costs
• High density vertical storage
 Quality Management Initiatives in
Supply Chain
• Lean Management
• Six Sigma
• PDSA
• Rapid Cycle Improvement
Quality Management Initiative in
Hospitals
Quality Management Programs
Quality Management Initiative
Benefits
 Lean Philosophy
• One of the corner stone of lean philosophy
is waste elimination

• 80% of Toyota Production System is

waste elimination

Shigeo Shingo, 1981

 Class Task
• Each participant to list how time is spent
on an average day (morning until
evening) on a piece of paper

• Write name and department

 Point to ponder
• Everything you observe in a company can
be translated as having one of the two
impacts
– Generate waste
– Adds Value
 Operations

Labour Goods

Capital
Transformation Products
Process

Material
Services

Energy
 Activities
• Value-added
• Non-value-added
• Required non-value-added

Source: Carreira, 2007

 Value-added Activity
• An activity that makes a product a more
complete product, in the view of the customer

• The value is defined from customer’s point of

view

• End result is the receipt of cash for our actions

 Required Non-Value Added
Activity
• Activity for which the customer is likely to
pay

• We can change and improve the method

of performing these activities

Source: Carreira, 2007

 Non-Value Added Activity
• The activity that consumes time and
resources but does not advance the
product to a more complete or finished
state

• Adds no value in the customer’s eyes and

that customer is unwilling to pay for
 Seven categories of Waste
• Waiting
• Unnecessary material or inventory
• Transport
• Unnecessary motion
• Rejected product
• Over production
• Process

Source: Russell and Taylor, 2003

Waiting

Source: Russell and Taylor, 2003

Unnecessary Inventory
 8

Reducing Inventory
Assume the
river is
inventory.

As long as the river (the inventory)

covers the rocks, the (production)
problems are hidden.

Source: Douglas Cloud, 2004

 9

Reducing Inventory

If the river (inventory) is reduced,

the problems are exposed.

Machine
breakdowns
Poor Untrained
Unreliable
quality employees
suppliers

Source: Douglas Cloud, 2004

Transport
Unnecessary Motion

Source: Russell and Taylor, 2003

Rejected Product

Source: Russell and Taylor, 2003

Over Production

Source: Russell and Taylor, 2003

Process

Source: Russell and Taylor, 2003

 Components of
Lead Time

Start of production End of production

for a single item for a single item

Conversion Time Wait Time Move Time Down Time

Value-added Nonvalue-added

Total Lead Time

Source: Douglas Cloud, 2004

 Basic Words
• Seven forms of waste composed of non-
value added activities, add cost

• The value added activities, generate

revenues
 Wastes in Hospitals
• Rework
• Waiting
• Transporting
• Other wasted actions
Vas and NVAs in Hospitals
Vas and NVAs in Hospitals
 Class Task
• Now ask participants to identify those that
are wastes in their work area as per our
definition, and discuss. Summarize and
calculate what % of their time are wasteful.

• Share findings with others

 How can we
reduce non-value
added activities?

Source: Douglas Cloud, 2004

 Value Stream Mapping
• Look at the big picture and improving the
whole, i.e., system wide view
• Simple flow chart
• End-to-end perspective
Degrees of Granularity
Steps in Value Stream Mapping
1. Review and capture the current state
value stream map
2. Capture issues and bottlenecks and look
to realize changes that can make rapid
improvement
3. Develop a “to be” future state value
stream map
4. Develop a plan and deploy the future
state process.
 VSM Class Exercise
• Ask students to draw the VSM for a
healthcare process (dental appointment to
patient discharge)
 Rule 1: Activities
• All work shall be highly specified as to
– Content
– Sequence
– Timing
– Outcome
 Rule 2: Connections
• Every customer-supplier connection must
be direct and there must be an
unambiguous yes-or-no way to send
requests and receive responses
 Rule 3: Pathways
• The pathway for every product and service
must be simple and direct
Toyota - A3 Process
 5 – Whys, Root Cause Analysis
The following example demonstrates the basic process:
My car will not start. (the problem)
1. Why? - The battery is dead. (first why)
2. Why? - The alternator is not functioning. (second why)
3. Why? - The alternator belt has broken. (third why)
4. Why? - The alternator belt was well beyond its useful
service life and has never been replaced. (fourth why)
5. Why? - I have not been maintaining my car according to
the recommended service schedule. (fifth why, root cause)
Shewhart Cycle – Deming Wheel: P-D-C-A
Grasp the
Situation – Contain
the problem

Act Plan
•How to improve •What to do?
next time? •How to do it?

Check Do
• Did things happen •Do what was
according to plan? planned

Walter Shewart, 1920

 Kaizen Prevents Backsliding
“New Way” Actual

Innovate
Improvement

Innovate

“Old
Standardize Way”
Actual

Adapted from: Imai, “Kaizen” Time

Risk Management in Supply
Chains
SUPPLY CHAIN RISKS AND THEIR DRIVERS
IMPACT OF VARIOUS MITIGATION STRATEGIES