BHARATHIDASAN UNIVERSITY

(Re-accredited with ‘A’ Grade by NAAC)

CENTRE FOR DISTANCE EDUCATION
PALKALAIPERUR, TIRUCHIRAPPALLI – 24

MCA
III - Semester
ENTERPRISE RESOURCE PLANNING
(Full Package)

Copy right reserved For Private Circulation only

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Chairman:

Dr. V.M Muthukumar

Vice-Chancellor
Bharathidasan University
Tiruchirappalli – 620 024.

Co-Ordinator:

Dr. R.Babu Rajendren

Registrar i/c
Centre for Distance Education
Bharathidasan University
Tiruchirappalli – 620 024.

Course Director:

Dr.V.Vinod Kumar
Director i/c
Centre for Distance Education
Bharathidasan University
Tiruchirappalli – 620 024.

The Syllabus Revised from 2017-18 onwards

Lesson Writer:

Dr.T.Kokilavani
Assistant Professor,
Department of Computer Science,
St.Joseph’s College,
Tiruchirappalli – 620 002.

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 ENTERPRISE RESOURCE PLANNING
Objective:
In this course students shall learn various components of
an application software that help computerize
functioning of an enterprise such as sales, materials,
production, financial , customer relationship AND
supply chain modules.
UNIT-I
A Foundation for Understanding Enterprise Resource
Planning systems – Reengineering and Enterprise
Resource Planning Systems – Planning ,Design ,and
Implementation of Enterprise Resource Planning
Systems – ERP Systems: Sales and Marketing – ERP
Systems: Accounting and finance ERP Systems
:Production and Materials Management ERP Systems:
Human Resources
UNIT-II
Managing an ERP Project – Supply chain Management
and the marketplace – Rules of the game – Winning as a
team.
UNIT-III
Solutions - Supply chains as Systems - Modeling the
Supply Chain – Supply Chain Software - Operations –
Meeting Demand – Maintaining Supply – Measuring
Performance
UNIT-IV
Planning – Forecasting Demand – Scheduling Supply –
Improving performance – Mastering Demand –
Designing the Chain – Maximizing Performance

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UNIT-V
Essentials of Customer relationship management –
Designing CRM application – Various modules of CRM
application - Advantages of CRM

TEXT BOOK:
1. Sumner Mary, Enterprise Resource Planning, First
edition, Pearson education, 2006 (ISBN 81-317-0240-5)
(Unit 1: Chapters 1 to 7; Unit 2: Chapters 8, 9 (continued
on text book number TWO)
2. Taylor David A., Supply Chains (A managers guide),
Pearson education, 2004 (ISBN 81-297-0334-3) (Unit 2:
Chapters 1, 2, 3; Unit 3: Chapters 4, 5, 6, 7, 8, 9; Unit 4:
Chapters 10, 11, 12, 13)
3. Tiwana, Essential guide to knowledge management :
The e-business and CRM applications, Pearson
education (ISBN 81-780-8326-4) (Unit 5)

REFERENCE BOOK:
1. ALTEKAR Rahul V., Enterprise wide resource
planning (Theory and practice), Prentice Hall of India,
2005 (ISBN 81-203-2633-4)
2. Garg Vinod K & Venkitakrishnan N.K, Enterprise
resource planning, Second edition, Prentice Hall of
India, 2006 (ISBN 81-203-2254-1).
3. Handfield R. B & Nichols. Ernest L., Introduction to
supply chain management, Prentice Hall of India, 2006
(ISBN 81-203-2753-5)
*******

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 ENTERPRISE RESOURCE PLANNING

UNIT - I
Lesson 1

Objectives
1. Develop an understanding of how ERP systems
can improve the effectiveness of information
systems in organizations.
2. Understand the business benefits of enterprise
resource planning (ERP) systems.
3. Understand the history and evolution of ERP.

1.1 A FOUNDATION FOR UNDERSTANDING

ENTERPRISE RESOURCE PLANNING SYSTEMS
The emergence of enterprise resource planning
systems
In the past several years, many organizations
have initiated Enterprise Resource Planning (ERP)
systems, using the packages like SAP, Peoplesoft and
Oracle. The ERP market is one of the fastest growing
markets in the software industry.
Advantages of ERP
1. Replacement of numerous heritage systems
2. Reduction in cycle times from order to delivery
3. Reduction in operating costs.
4. ERP systems enable managers to make better
decisions and improve responsiveness to
customer needs.
What is ERP?
ERP systems are the software tools used to
manage enterprise data. ERP systems help organizations

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deal with the supply chain, receiving, inventory
management, customer order management, production
planning, shipping, accounting, human resource
management and other business functions.
An ERP system is a packaged business software
system that allows a company to “automate and integrate
the majority of its business processes, share common
data and practices across the enterprise, and produce and
process information in a real-time environment. ERP
systems are different from legacy systems in that
organizations use ERP to integrate enterprise-wide
information supporting financial, human resources,
manufacturing, logistics and sales and marketing
functions. An ERP system provides an enterprise
database where all business transactions are entered,
processed, monitored and reported.
The Evolution of ERP
During 1960s, most software packages included
inventory control capability. In 1970s, Material
Requirements Planning (MRP) systems were introduced,
which used a master production schedule and a bill of
materials file with the list of materials needed to produce
each item. After that, closed-loop MRP systems were
introduced which has tools for sales planning and
customer order processing. In 1980s, MRPII systems
were introduced which included financial accounting
system along with manufacturing and materials
management systems. During 1990s, ERP systems were
introduced which integrated all information flows in the
company like financial accounting, human resource,
supply chain management and customer information.

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Integrated Systems Approach
Table 1.1 Systems Standpoint before and after ERP

ERP systems introduced an “Integrated Systems”

approach by establishing a Common set of applications
supporting business operations. ERP system usually
requires re-engineering business processes for better
alignment with the ERP software. Limited customization
makes it simpler to upgrade the ERP software. Table 1.1
shows how an ERP system overcomes the inefficiencies
of independent systems by providing integrated data to
support multiple business functions.
1.1.2 Business Benefits of ERP
 Maximizes information throughput
 Provides timely information to decision makers
 Integrates information throughout supply chain

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  Minimizes response time to customers and
suppliers
 Pushes decision making down to lowest levels
 Reduces cost and inventory
 Improves operating performance
Department wise Benefits of ERP
 In Sales, increased efficiency leads to lower
quotes, reduced lead times and improve the
responsiveness to customers’ needs
 In Manufacturing, Concurrent engineering leads
to faster design and production
 In Data Service, accurate customer service
history and warranty information are available
 Suppliers are paid more rapidly because accounts
payable systems are responsive and accurate.
Advantages of ERP from a systems standpoint
ERP Eliminates legacy systems by reducing
incompatible data which can cause fragmentation.
Integrates systems Allows sharing and monitoring of
information across organization. It is a foundation for
eBusiness because they provide back-office functions
that helps customers to place and track orders via the
web. Additional applications such as Customer
Relationship Management (CRM) rely on the foundation
of ERP.
1. 1.3 ERP Modules
The major ERP vendors, including SAP, Oracle
and People soft supports the major functional areas of
the business, including sales order processing,
purchasing, production planning, financial accounting,
management accounting and human resources. Vendors
addressing the mid-cap market include Microsoft’s Great

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Plains ERP software. Table 1.2 gives the various ERP
modules supported by different vendors.
Table 1.2 ERP modules supported by vendors

1. 1.4 ERP Design Alternatives

In evaluating ERP, most organizations consider
alternative design options and each of these options has
its own rice as well as its own advantages and
disadvantages. “Vanilla” ERP implementation, which is
the complete vendor package is costly and time-
consuming but offers the benefits of total integration
across all functional areas and re-engineering of all
business processes. Implementation of selected ERP
modules is less costly and time-consuming but lacks
total integration of data across multiple functional areas
of the business.
Building an in-house ERP system is the most
time-consuming and expensive alternative, but it poses
considerable risks. The advantage of this approach is that
the organization can create system based on its own
unique needs and competitors will not have access to
similar system. Another alternative is to maintain current
legacy systems which may be a competitive

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disadvantage. An ERP system built upon the re-
engineering of business processes offers the advantages
of data integration and standardization. By implementing
an ERP, an organization can keep up with its
competitors.
Based upon a number of factors, including data
integration, cost-effectiveness, competitive environment,
business impact and time, most organizations conclude
vanilla ERP implementation or partial ERP
implementation are preferable to in-house development
or maintaining the legacy system.
1.1.5 Cost-Benefit Analysis of ERP
The decision to implement an ERP system is a
business investment decision that must create
measurable business benefits that justify the acquisition
costs and the costs of system implementation. The
analysis of the cost components of ERP, indicate that
software cost and consulting costs are major cost
components which is shown in table 1.3.
Table 1.3 ERP cost components

One method of conducting a cost-benefit analysis

of an ERP project is to use net present value. Net present
value takes into consideration the time value of money.
A five-year timeframe is appropriate in evaluating an
ERP project since a minimum of three years will be
spent in actual implementation. In a large-scale project
the time-frame for evaluating returns on the investment

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in ERP might be as long as ten years. The cost-benefit
analysis for an ERP project, can be calculated using the
net present value method of evaluating the project
proposal. Costs are non-recurring, or start-up costs and
recurring costs. The start-up costs include the original
investment in the ERP software. The other non-recurring
costs include consultants’ time in installing and
configuring the software. The recurring costs (i.e., costs
which recur over time) include the costs of software
licenses, maintenance agreements, project management
time, internal team time committed to the project and
consultants’ time used on a recurring basis. The benefits
of the ERP project will not take place until the system is
in operation. The measurable or tangible business
benefits include inventory reduction. Intangible benefits
might include improved employee morale, improved
customer satisfaction and less duplication of effort in
maintaining multiple databases.
Can ERP Provide A Competitive Advantage?
To achieve a competitive advantage industries
should implement the ERP system better than anyone
else. Another way of achieving a competitive advantage
is to migrate to new software versions more quickly than
competitors do. Another source of gaining competitive
advantage through ERP implementation is to use vanilla
ERP modules to support core operations and to build
customized modules to support unique processes which
provide a competitive edge. The increased availability of
operational data and the use of data for analysis may also
provide companies with an advantage.

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The Challenge of Implementing an ERP System
The Realization of benefits for ERP
projects may take considerable time and cost. The
successful implementation of ERP requires a multi-stage
approach and the benefits of ERP may not occur until
later stages. Markus et al proposes three phases: the
project phase, the shakedown phase, and onward and
upward phase. The ERP software is introduced during
the project phase and is implemented into the firm’s
operations during the shakedown phase. The ERP
modules are successfully integrated with operations, in
the onward and upward phase.
Parr and Shanks identify four phases: planning
phase, re-engineering phase, design phase, and a
configuration phase and testing phase. They note that re-
engineering business practices around the ERP software
is critical to successful implementation. Holland and
Light suggest that the benefits of ERP occur after
implementation of advanced modules such as customer
relationship management.

1.2 RE-ENGINEERING AND ENTERPRISE

RESOURCE PLANNING SYSTEMS
Introduction
The definition of re-engineering is “the
fundamental rethinking and radical redesign of business
processes to achieve dramatic improvements in cost,
quality, service and speed”. Re-engineering makes every
effort for the efficient redesign of the company’s value
chain. The primary activities of the firm include inbound
logistics, operations, outbound logistics, marketing and
sales, service. These activities are essential for creating,

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producing, marketing, selling and supporting a product
or service. An information system supports each of these
primary activities. This information system can cut the
cost of performing a value activity, or it can be used to
provide a “value-added” feature to the product or
service. The secondary activities include organizational
activities, human resources, technology and purchasing.
Information systems will support each of these
secondary activities. Some of the major motivations for
streamlining and re-engineering business processes are
deregulation, consolidation, customer sophistication and
increased competition on a global level. These driving
forces provide a rationale for re-thinking existing
business practices and using technology to create new
forms of work as shown in table 1.5
Table 1.5 Motivation for Business Re-engineering

1.2.1 Business Process Re-Engineering

In many current systems, technology has
mechanized old ways of doing work. Most of the
companies maintain independent databases for various
departments like purchasing, receiving and accounts
payable. But after re-engineering an integrated database
supporting purchasing, receiving and accounts payable
included “common data”. The companies will create new

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“business rules” through which they eliminate
inconsistencies. One of the most important principles of
business re-engineering is to “break away from outdated
rules” which reduced the administrative cost. Common
integrated database reduced product development lead
times and improved responsiveness to market needs.
Elements of business re-engineering are summarized in
table 1.6.
Table 1.6 Elements of Business Re-engineering

At IBM re-engineering led to the design of credit

authorization decision there by eliminating the multi-step
authorization process involving multiple departments.
Similar to IBM many companies have applied re-
engineering process and achieved better results which
are summarized in table 1.7.
All re-engineering process support some common
themes. They are:
 Decentralized decision making to be responsive
to customer’s needs which has the effect of
flattening organizational layers.

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  Use of information technology that facilitated the
newly re-engineered process.
 Redesign of jobs
Decentralized decision making, led to new levels of
judgment, leadership and the ability to adapt to changing
customer needs.
Table 1.7 Re-engineering Case Studies

1.2.2 Process Modeling

In order to carry out the changes in data and
processes associated with business re-engineering, a
commonly used tool in systems analysis is the process
model. The process model consists of five objects:
– Business process which depicts the
Business activities
– Data store that depicts the data needed by
business process
– Data flow which depicts the data
transferred between processes or from a
process to data store
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 – Organizational unit that depicts the units
where processes take place
– The event, including triggers and
outcomes
The process model provides a graphical
representation of the activities which is useful for
analytical purposes. A process model can incorporate
changes based upon “best practices”. The best practices
supported by modules within ERP systems are based
upon the following:
– Re-engineered process models which
depict improved process change
depictions
– Data integration among multiple
processes
– Structural changes which streamline
business functions and maximized
productivity
1.2.3 Making Re-Engineering Work
Rosenthal analyzed the failure of re-engineering
efforts and argues that organizations need to apply a
“clean slate” approach. The reason why so many re-
engineering projects fail, Rosenthal notes that many of
these projects are narrowly focused or are too general in
nature. When a process is re-engineered, jobs need to be
re-designed and reward structures need to be applied to
provide incentives to change behavior. A clean state
approach calls for continuous training for new roles.
There must be a way of measuring performance and
tracking progress toward achieving new goals.
Communications are important so that people understand
why their behavior should be changed. Finally,

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information technology should support the re-
engineering of business processes.
1.2.4 How Information Technology Facilitates ERP
 Client-server computing - The emergence of
Client-server computing allows for increased
power and control
 Integrated databases – The advantages of
integrated databases are data sharing, reduced
data redundancy, improved data consistency, data
independence and data integrity. Data sharing
means a common data resource that supports
multiple functional units. Data independence
means that data can be maintained separately
from application modules which use the data.
Finally, database management systems improves
data integrity and provides central data
administration.
1.2.5 The Emergence of Process Enterprises
To emerge as a process enterprise, organizations
need to stress teamwork. One of the ways of making the
transition to process management is to give authority
over work and budgets to “process owners”. To
introduce re-engineering successfully, management
created organizational units responsible for product
development. The process owner had authority over
designing the process, measuring its performance and
training the workers.

1.3 PLANNING, DESIGN AND

IMPLEMENTATION OF ENTERPRISE
RESOURCE PLANNING SYSTEMS
Traditional Systems Development

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 The traditional systems development life cycle
included the phases of problem definition, feasibility
study, systems analysis, systems design, detailed design,
implementation and maintenance which is shown in table
1.8. In system analysis, the analyst undertakes a detailed
analysis of system using tools and techniques such as
Process models and Data models. The fundamental
approach used in traditional systems development is to
analyze the current system’s shortcomings and to
develop a “new” system, which builds in changes in
processes and data that will support the firm’s business
requirements. The system design process provides
opportunity to re-engineer current system prior to
automating it. It assure logical database design before
detailed design, during which the specifications for the
physical system are developed (e.g., output design, input
design). Once the design specifications are set, the
system is programmed, tested and implemented. The
problem with the traditional systems development life
cycle is that it takes too much time and too much cost.
New Approaches to Systems Development
Three approaches designed to speed up the
building of information systems were prototyping, end-
user development and software packages. Using
prototyping models are shown to end-users for feedback
and guidance. But it is not faster. End-user development
was another approach in which end-users create
information systems using spreadsheets and databases.
This approach is not effective for large-scale
development. Software packages offered economies of
scale in development, enhancement and maintenance and
companies moved toward purchasing commercial off-

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the-shelf software. ERP systems are large scale,
integrated commercial off-the-shelf software packages
that support the entire value chain of business functions.
Table 1.8 Traditional Approach of Information Systems
Design

1.3.1 The ERP Systems Development Process

The ERP systems development process includes
Planning, Requirements analysis, Design, Detailed
design, Implementation and Maintenance.
Planning
Planning starts with a needs assessment, which
provides a business justification for the purchase of
software. The business justifications for ERP include
tangible and intangible benefits.

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Requirements analysis
The Requirements analysis phase of an ERP
involves identifying business processes to be supported.
It include analyzing business processes and specifying
the processes to be supported by the ERP package. Most
ERP vendors offer “Best practices” for specific
industries. The process of selecting the best ERP system
entails working through a checklist of activities.
Design
In the design phase, the project sponsors
introduce “Best practices” which are models of
supported function. This entails re-engineering business
processes to fit software. Traditional SDLC defines new
business requirements and implements conforming
software. One of the fundamental design decisions in
implementing an ERP package is whether to re-engineer
the organization’s business processes to fit the software
or to customize the software to fit the organization’s
business practices. Re-engineering can disrupt
organization like changes in workflow and procedures
while customizing can make upgrading to be difficult.
1.3.2 Alternative ERP Design options
ERP systems can be designed using various
approaches. A complete “Vanilla” ERP package is easy
to implement because the organization can follow vendor
prescribed methodology and employ consultants with
specialized vendor expertise. Firms are more successful
in implementing ERP systems usually on time and on
budget implementations. Some organizations customize
ERP modules. When an ERP system is customized the
time and costs increase because it cannot be easily
integrated into new version. Some organizations

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maintain legacy systems and add ERP modules to
support specific functions. Though this approach is cost-
effective the organization doesn’t get full benefit of ERP.
The advantage is it is less disruptive but it lacks
integration. Another approach is outsourcing and to have
an external vendor to operate the system. In this
approach, ASPs provide the ERP software on a time-
sharing basis. The outsourcing decision is dependent on
the reliability and stability of vendor and the
organization is vulnerable.
Detailed Design
In the project’s detailed design phase the team
selects the models, processes, and information to be
supported by the system. The best practices methodology
provides models supporting the business processes for
each functional area within the business. The process for
using the best practices include these steps:
1. Select applicable business processes
2. Discard inapplicable processes
3. Those processes that do not match the
system will serve as foundation for re-
engineering
4. Identify any areas not covered as
candidates for customization
Detailed design involves interactive prototyping
and extensive user involvement in determining systems
design elements.
Implementation
ERP implementation includes address
configuration issues, migrating data from old system to
the new system, building interfaces, implementing
reports and pilot testing. Configuring the ERP system

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requires the project team to address a number of factors,
including data ownership and data management,
distribution of procedures and transactions at the
traceable level and aggregate level.

ERP implementation steps

ERP implementation includes establishing
security and permissions. Migrating data from old
system to the new system means ensuring that data to be
migrated are accurate and that data bridges work.
Building interfaces to other systems are important for
successful operation. Documentation is provided by the
vendor and should be reviewed. User training is also an
important priority. The decision of whether to cutover to
the new system all at once or to phase in modules
sequentially is an important one.
The Cutover approach known as the big bang
approach is rapid but requires many resources. Most
large firms choose to phase in modules by module or by
site. Smaller firms can implement big bang approach
with reasonable success. Large percentage of firms
employ mini big bang approach which is a partial vendor
implementation. Since ERP projects represent
considerable time commitments and cost, many risks are
involved in implementation, and these risks can trigger
time and cost overruns. Having a plan of action and
external resources available at the outset of the each
project phase can minimize the implementation risk.
Conclusion
Through ERP organizations can get cost-benefits.
ERP provides an opportunity to re-design business
processes.

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Exercises
1. List the business benefits of ERP.
2. Give a brief note on business process re-engineering.
3. Explain the planning, design and implementation steps
of ERP systems.

Lesson 2
Objectives
 Understand the sales and marketing module
 Understand the accounting and financial systems
within ERP

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 Understand the production and materials management
systems within ERP
2.1 ERP SYSTEMS: SALES AND MARKETING
Sales and marketing functions can create
problems, which lead to lack of responsiveness to
customer needs, lack of productivity and lack of
profitability. In the Atlantic manufacturing company,
which manufactures small motors, number of problems
are affecting order entry, credit management and field
service. The lack of an integrated system can cause
incorrect credit, inadequate inventory, shipping delays,
incomplete invoices and accounts receivable delays.
Sales and Marketing Processes
Sales and Marketing Processes include
operational-level and management control processes.
Operational-level processes include daily activities such
as prospecting, telemarketing, direct mail. Sales
representatives need to create and maintain lists of
prospects by location, by product category and by sales
potential and need to create a contact management
system which tracks customer preferences, sales history
data and the history of sales calls. Traditionally, sales
and marketing operational functions are supported by
sales order processing system which capture order data
and point-of-sale (POS) systems which capture data at
the point of sale. These systems are linked to inventory
management systems, which update inventory levels for
stock items based upon sales data.
Sales Management Control Processes
Management Control activities are designed to
allocate resources to achieve maximum revenues. One of
the most important areas is sales management. Sales

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managers are responsible for creating territories and for
allocating sales people’s time to generate maximum
revenue and service. The information used by sales
managers to make decisions is based on analysis of past
sales. The tools used to analyze sales trends and to
determine the best allocation of resources are:
 Comparison of sales, product revenues,
customer revenues and territory revenues against
benchmarks of success.
 Comparison of the productivity of each
salesperson to the average for the department.
 Listing of most profitable products, sorted
by territory and salesperson
 Listing of the products that represent the
highest percentage of sales
 Listing of the customers that represent the
highest percentage of sales
Sales management software is used by sales
managers to assess the productivity of the sales force and
the success of products by salesperson, by territory and
by customer type. Sales management software achieves
the following objectives:
• Allows for quicker analysis
• Able to identify trends
• Analyze salesperson performance
• Identifies both strong and weak products
• Can signal potential shortfalls or excesses in stock
levels
Sales Forecasting Process
Sales forecasting is important to determine
customers’ needs in different market segments. Sales
forecasting activities include segmenting the market into

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target groups of potential customers and planning
products / services to meet the customers’ needs. It can
be developed for overall sales, for sales by territory, for
sales by each product, for sales for new products and for
sales by sales representative. It uses information about
past sales history, customer demands, demographic
trend, competitor information.
Advertising and Promotion
Advertising and Promotion is an important
marketing process, which requires decision about how to
allocate resources. It identifies channels that will be most
effective in addressing specific market targets. The
effectiveness of advertising campaign needs to be
constantly monitored.
Product pricing systems
To make pricing decisions, the marketing
manager should know the expected product demand, the
desired profit margin, the production costs and the
competing products. Pricing models are built from
various forces that influence pricing, including
Consumer Price Indices, expected consumer disposable
income, production volumes, labor costs, costs of raw
materials.
Sales and marketing modules in ERP systems
ERP systems differ from traditional systems by
providing integrated marketing support systems,
including contact files, order entry files and sales history
files. In addition ERP systems provide integrated CRM
software which provides information to salespeople
about the previous experiences of customers.
With an ERP module, a customer places an order,
and a sales order is recorded as shown in figure 1.1. The

26
system schedules shipping, order parts from supplies and
schedule manufacturing. The module checks the
customer’s credit limit, updates sales forecasts and
creates a bill of materials. The salesperson’s commission
is updated. Product costs and profitability are calculated.
Finally, accounting data is updated. The purpose of sales
and marketing module is to identify sales prospects,
process orders, manage inventory, arrange deliveries,
handle billing and process payments. This module
provides the benefits of Standard codes and documents,
common database, provides audit trail and allows for
data Integration.
Customer OrderCreate DeliveriesPicking with transfer orderPacking

Update Stock ledgerGoods issueShipping documents

Figure 2.1 Sales and Distribution Process
2.1.1 ERP and Customer Relationship Management
ERP system provides a foundation for advanced
applications, such as CRM and Supply Chain
Management (SCM). CRM represents the systems that
interface with the customer and SCM represents the
systems which interface with the supplier. CRM is a
comprehensive approach to build long-term customer
relationships. CRM provides a single interface to the
customer. CRM is developed from sales force
automation software which is designed to provide sales
representatives with sales activity management, sales and
territory management, contact management, lead
management generation and monitoring and knowledge
management.
Sales Activity Management - It guides sales
representatives through each step of the sales process.

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Sales and Territory Management – It helps sales
managers to study the pipeline, monitor salespeople’s
activities and optimize teams.
Contact Management – It helps sales representatives
organize their contact data in databases so that they can
query these databases.
Lead Management – It enables sales representatives to
monitor leads, to generate next steps and to refine selling
efforts by using on-line support. Lead management
enables sales people to track prospect attributes, such as
product interests, budget amounts and likely competitors.
Configuration Management – It provides product-
specific configuration support to companies that must
build products for their customers. Companies need to
create product configurations, make price quotes and
communicate these electronically via a laptop while
sitting in the customer’s office.
Knowledge Management – It offers access to information
resources. Information resources in sales include
corporate policy handbooks, sales presentation slides,
company phone lists, proposal templates, industry and
competitor data, press releases and transcripts of sales
meetings.
The major functions of a CRM system include
one-on-one marketing, telemarketing, sales force
automation, sales campaign management, call center
automation, e-Selling, data warehousing and customer
service.
Customer Service
When the customer calls with a service request
then it triggers a service order which is dispatched to a
service technician. Once the job is complete, the

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technician confirms the hours worked and the materials
used. Based on the billing request from the service order,
accounting department generates a billing document.
Integration of sales and distribution with other
modules
The sales and distribution module is interfaced
with the financial accounting module, materials
management, human resources, quality management and
controlling modules as shown in table 2.1. Data
integration across functional modules saves time,
facilitates customer service and improves productivity
and profitability.
Table 2.1 Integration of Sales and Distribution with
Other Modules

2.2 ERP SYSTEMS: ACCOUNTING AND

FINANCE
Many problems occur when accounting
information is out of date or inaccurate. Lack of
coordination between different departments and
accounting leads to bottle-necks, lack of responsiveness
to suppliers and poor control. Business decision making
about product profitability is difficult when financial
information is maintained in separate databases for
marketing, production and purchasing. Accurate

29
inventory costing is the basis for determining product
profitability.
Accounting and Finance Processes

Figure 2.2 Conceptual model of an accounting system

At the conceptual level, an accounting system
supports operational and management control functions
as shown in figure 2.2. At the operational level, an
accounting system produces transactions, such as
paychecks, checks to vendors, customer invoices and
purchase orders.
The accounting processes begin when a sales
order is entered. This generates an inventory update to
the inventory system, which maintains information about
each item in stock and triggers the purchase of additional
stock when stock levels reach certain points. The
purchase system creates purchase orders and tracks
which purchase orders have been filled, which items are
on back order and when orders are expected to be
received. In the accounting system, payments to

30
suppliers or vendors are made through the Accounts
Payable System.
Management of Control Processes in Accounting
Control processes within accounting include
budgeting, cash management, capital budgeting and
investment management. Budgeting processes entail
tracking revenues and expenses and comparing these
amounts to actual expenses and revenues.
Cash management processes
Cash management ensures the organization has
sufficient cash to meet its needs and to place excess
funds into use through investments. A cash flow analysis
shows the estimated amount of revenues and
expenditures each month. Budget analysts can perform
what-if analysis to determine the impact of different
business conditions.
Capital budgeting processes
Capital budgeting processes analyze the impact
of possible acquisitions. Capital budgeting uses
evaluation tools such as net present value (NPV),
internal rate of return (IRR), and pay-back period. In
NPV analysis, the manager can determine the present
value of future cash flows. In IPR, the organization can
determine if it can make a better return by acquiring an
asset now or by investing its money in another venture.
In payback period, the time at which the increase in
revenues or savings in expenses will match the
investment in the new asset is determined.
Accounting and Finance modules in ERP systems
Traditionally, computerized accounting systems
provide operational-level software to produce invoices,
checks, statements and other financial outputs. Financial

31
accounting deals with financial statements required for
external reporting purposes. Management accounting
systems provide information on product profitability and
cost center profitability which enables managers to make
business decisions. The difference between traditional
computerized accounting systems and ERP modules is
that financial information is shared in an integrated
database. Financial statements are updated with up-to-
date information. The accounting module is an integral
part of the entire ERP system. The benefit of using the
accounting module within an ERP system is that the
system creates a document flow of transactions.
Financial Accounting Modules in ERP
It deals with financial statements required for
external reporting purposes. External reporting
requirements are set by general accounting standards, as
well as legal requirements. Financial accounting modules
post all accounting transactions and these transactions
are reflected in the general ledger. It includes accounts
receivable subsystem. This module monitors customer
accounts and updates, handles payments, creates due
date lists and produces statements. It interfaces with cash
management. Accounts payable handles payments to
suppliers, including international payments and takes
advantage of available discounts to maximize profits.
Management Accounting Modules in ERP systems
This module provides an internal accounting
perspectives for directing and controlling operations. It
also provides information on variances between planned
and actual data. The key management accounting
activities are:
• Cost center accounting

32
 • Internal orders as a basis for collecting and
controlling costs
• Activity-based costing of business processes
• Product cost controlling for profitability analysis
• Profitability analysis by market segment
• Profit center accounting of individual areas of
organization
• Consolidation of financial data for accounting
perspectives
These activities enable management to better allocate
resources, maximizing profitability and performance.
The New Role for Management Accounting
ERP systems provide on-line, real-time data for
decision making. ERP systems offer two types of data.
The first type of data is operational data, which provides
feedback on quality and efficiency of processes. The
information must be timely and specific because it is
used for real-time operational control. In ERP, managers
have access to activity-based cost (ABC) data. ABC
provides information on profitability of customers and
products with real-time data on sales and production. It
provides strategic information and it is the basis for
continuing improvement to operations. The partnership
between ERP and ABC establishes a connection between
the key enabler of management decision making and
information flow in the organization.

2.3 ERP SYSTEMS: PRODUCTION AND

MATERIALS MANAGEMENT
Many of the problems with traditional systems
occur because of lack of integration between production
planning, sales, purchasing and accounting. If production

33
plans are not linked to expected sales levels, then there
may not be sufficient inventory to meet demand.
Inaccurate production forecasts trigger incorrect
purchasing decisions by materials management, leaving
excess raw materials and finished goods inventory.
Excess inventories impact the cash flow and profitability
of the business because they represent significant costs.
To minimize excess inventory, production must be based
upon an accurate sales forecast.
Production Planning and Manufacturing Processes
This process includes all the activities necessary
to ensure production. The objectives of production
systems are:
 Create production plan
 Acquire raw materials
 Schedule equipment, facilities and human
resources
 Design products
 Produce appropriate quantities and expected
quality level at the required time.
The production planning and manufacturing
processes include operational level and managerial
control processes. Operational-level processes handle
daily activities such as purchasing, receiving, Quality
Control (QC) and inventory management. The function
of purchasing is to acquire correct quantity of raw
materials and supplies. In receiving, inspection of
delivered products and processing are done. Quality
control identifies vendors who ship badly made or
unreliable materials. QC continues to monitor the quality
of production goods as they move from raw materials, to
goods-in-process, to finished goods inventory. In total

34
quality management (TQM), emphasis is placed on
anticipating and preventing defects.
In modern Production planning and
manufacturing, information systems support these
processes. Data collection systems are used to enter data
about the status of goods-in-process. Material
management systems provide information on inventory
levels of production materials, usage of these materials
in production and location of materials. Bills of
Materials (BOM) systems provide a list of ingredients
for the final product including raw materials,
subassemblies and component parts. Inventory
management systems maintain inventories at their proper
levels. Economic order quantity (EOQ) identifies the
EOQ for each item. Finally, Cost accounting systems
collect and report information about the resources used
in production processes to determine accurate production
costs, including the cost of personnel, materials,
equipment and facilities.
Materials Requirements Planning (MRP)
MRP supports these processes:
– Identify stock needed
– Calculate lead time for stock
– Determine safety stock levels
– Assign most cost-effective order
quantities
– Produce accurate purchase orders
MRP takes inputs from the Master Production
Schedule (MPS). The MPS employs the sales forecasts
to identify the products needed. The ideal production and
manufacturing environment is a just-in-time (JIT)
system, in which enough inventory is on hand to serve

35
needs. To make JIT work, suppliers need to deliver
enough material to meet the production schedule. The
company needs to develop close working relationships
with suppliers to make this work. Suppliers can use
Electronic Data Interchange (EDI) or the internet to
monitor the manufacturers’ inventory levels by linking
into their inventory systems.
Capacity Planning Processes
The purpose of capacity planning is to evaluate
production capacity against production goals. It requires
specific information about human resources, BOM,
goods-in-process inventories, finished goods inventories,
lot sizes, status of raw materials, orders in the plant and
lead time for orders. It creates time-phased plans for
product and production area. Production scheduling
information systems allocate specific facilities for the
production of finished goods to meet the master
production schedule. Product design and development is
integrated with cost information in order to reduce costs.
A product designer can compare component costs from
two or three alternative sources and build the most cost-
effective component into the product design before the
product goes into manufacturing.
2.3.1 Production Planning and Manufacturing
Modules in ERP Systems
The introduction of ERP extends the production
information system to other modules. ERP modules for
production planning and manufacturing supports
materials requirement planning, inventory management
and capacity planning. The ideal computer-integrated
manufacturing system is designed to integrate all
software and hardware used in manufacturing by

36
merging of multiple databases. This concept eliminates
paperwork and bottlenecks. The objective is to decrease
design costs, lead time and personnel costs and to
increase productivity.
With an ERP system sales forecasts are employed
to develop production plans. Sales forecasts are an input
into the sales and operations plan, which determines
resource requirements for production. MPS created
through demand management determines quantities and
dates for finished products. Demand management links
the forecasts to the MPS and MRP. MRP creates
efficient, detailed material plan and determines what
needs to be ordered and when. The MRP function
develops the planned orders, and these orders are sent to
production as work orders. Each work order includes a
list of required materials from the BOM, and the
manufacturing operations which need to be performed.
Materials Management Modules in ERP systems
The procurement process determines needs,
identifies potential sources of supply, compares
alternative quotations, creates a purchase order, tracks
the status of a purchase order, receives goods and
verifies invoices upon receipt of goods. An ERP system
provides needed integration between the Materials
Management subsystem and other subsystems.

2.3.2 Future of ERP in Manufacturing and the

Supply Chain
Manufacturers are moving towards JIT
manufacturing environments since companies want to
carry less inventory and want to produce more

37
customized products. Emerging developments in
manufacturing are the convergence of manufacturing
execution systems and ERP, the use of advanced
planning and scheduling systems, advanced data
collection strategies and eBusiness.
Manufacturing Execution Systems (MES) and ERP
MES are factory floor information and
communication systems which provide feedback on real-
time basis. MES support data collection, detailed
scheduling, labor management, quality management,
maintenance management, product tracking and
performance analysis. MES vendors are expanding their
shop floor solutions to include front-end combined with
back-end applications.
Advanced Planning and Scheduling (APS) systems
APS systems work with ERP systems by
providing business analysis and decision support
capabilities. An APS system leverages the data residing
in a ERP system to provide decision support for
production planning, demand planning and
transportation planning.
Data collection
Real-time data are gathered directly from the
shop floor using mobile phone or Internet-enabled
devices. Automating routine data collection with mobile
user interfaces optimizes the flow of information.
Choosing a data collection system that integrates tightly
with a powerful ERP package gives companies a
competitive edge.
eBusiness Strategies in Manufacturing ERP
The business world is looking for less inventory
and more customized products. eBusiness offers the

38
potential to improve materials management by
facilitating communication between all links in the
supply chain.
Business-to-business (B2B) applications enable
procurement organizations to interact with a multitude of
suppliers, creating more competitive bidding. eBusiness
buyers benefit from the rise of eMarketplaces or
exchanges. eMarketplace aggregate buyers, sellers,
content and business services. eMarketplace lowers the
cost of doing business by eliminating inefficient
processes. Web technology enables suppliers to see
Requests for Proposals (RFPs), technical specifications,
and purchasing requirements so they can respond more
quickly to meet these requirements. Finally,
eMarketplaces have transformed the role of purchasing
agents. With eBusiness purchasing agents can devote
their efforts to more strategic activities, such as
organizing e-partnerships and analyzing alternative
sourcing possibilities.
2.4 ERP SYSTEMS: HUMAN RESOURCES
In recent years, recruiting talented employees has
become difficult. Paperwork supporting the HR function
seems to grow and grow. A number of problems are
affecting the quality and responsiveness of the HR
function. So a better human resources management is
needed.

Human Resource Management Processes

The business processes supporting HR can be
categorized into operational and decision-making
processes. Operational-level processes include creating

39
and maintaining employee information, position
information and handling the job application screening
and placement process. Other important operational-
level activities include government reporting, payroll
administration and performance management.
Managers need information to make decisions in
order to allocate human resources effectively to achieve
organizational goals. This means designing job
specifications that enable the organization to recruit and
retain highly qualified individuals. Designing
compensation packages to attract and retain employees is
important to achieve organizational goals.
Human Resources Information Systems
Traditionally HR information systems relied
upon stand-alone systems like specialized applications
for applicant tracking, compensation, benefits and
attendance. This leads to redundant data. Another
shortcoming is their failure to link HR data with
financial data.
An HR module within an ERP system offers the
linkage between HR applications and financial systems
and standard set of processes based on best practices.
Human Resource Modules in ERP systems
The Components of HR modules within an ERP system
include the following:
• HR Management records personnel activity from
the job application to retirement. Advanced systems
can read resumes and enter pertinent data into the
database.
• Benefits administration links employee data to
actual benefits. Advanced systems enable

40
 employees to elect and update benefits’ preferences
via the web.
• Payroll produces paychecks, tax reports and
accounting data to the general ledger.
• Time and labor management collects data for
time/work reporting.
• Employee/Manager self service provides web-based
self-service reporting for travel reimbursement,
personnel data and benefits changes.
Attributes of Human Resource Modules in ERP
systems
The Attributes of a HR module within an ERP
system include integration, a common database
underlying all individual modules and a common
relational database, which promotes ad hoc query and
reporting capabilities. ERP modules provide scalable and
flexible technology, an audit trail, which provides the
ability to review the history of changes to the database
and drill-down capability. Workflow management
depicts the electronic routing of documents and other
document management within the HR module. Process
standardization is also provided by HR module.
Additional ERP attributes include security, user
friendliness, web features and document management
and imaging capability.
Management Control Modules in ERP Systems
The objective of a good HR strategy is to acquire,
place, train and develop employees to meet
organizational needs. HR information system enables
managerial decision making through query and reporting
tools. A comprehensive HR module within an ERP
package maintains and updates employee files, skills

41
inventory files, job analysis files and occupational health
and safety files. Strategic HR applications are:
• Human capital inventory for tracking employees
from application to retirement.
• Position control linked to budgeting so that
managers can plan and budget for personnel
costs.
• Labor/management relationships for tracking and
analysis of grievances and worker’s
compensation.
• Business intelligence which uses advanced
analytical tools for predicting organizational
trends.
The integration of HR module with other
modules saves needless duplication of effort and
provides a cost basis for making HR decisions.
Conclusion
In this lesson the sales and marketing module,
accounting and finance module, production and materials
management module and human resources module of
ERP is presented.
Exercises
1. Explain the sales and marketing process of ERP.
2. Discuss about accounting and finance systems in ERP.
3. Give a brief note on production and materials
management module of ERP.
4. List and explain the Human Resources modules in
ERP systems.
UNIT – II
Lesson 3
Objectives

42
 Recognize the importance of project management in
ERP systems
 Understand the links in the supply chain from raw
materials to the retail customer
 Understand the complexity and variability of supply
chain
3.1 MANAGING AN ERP PROJECT
ERP projects represent the single largest
investment in some information systems for many
companies and in any corporate-wide project. Due to the
complexity of these projects considerable risk is
involved in implementing ERP systems.
Factors Influencing ERP Project Implementation
Success
Certain factors influence whether firms are under
budget or over budget for implementation. First, under-
budget or on-budget firms make fewer modifications
than the over budget firms. In addition to that, they
implement more effective communications. This enables
them to generate additional revenues to cover the cost of
ERP implementation. Some of the issues generated by
ERP systems projects are:
1. Technology challenges encountered in
implementing information management system
2. Organizational challenges
3. People challenges
4. Project size and scope challenges
5. Strategies for minimizing the risks associated
with the technology, organization, people and
size/scope.
Factors Causing Information Systems Project
Failures

43
 Poor technical methods is one of the cause and it
is relatively minor in comparison to larger issues like
communication failures and poor leadership. Robert
Block has classified the system failures under twelve
categories. They are:
1. Resource failures
2. Requirement failures
3. Goal failures
4. Technique failures
5. User contact failures
6. Organizational failures
7. Technology failures
8. Size failures
9. People management failures
10. Methodology failures
11. Planning and control failures
12. Personality failures
Block points out that successful projects are on time,
within budget, reliable, maintainable and meet the goals
and requirements of users. Successful managers do an
initial evaluation of the project.
Risk Factors in Information System Projects
Studies related to risk factors in information systems
projects describe the following issues.
 Organizational factors which include the extent
of Changes in scope, Sufficiency of resources,
Magnitude of potential loss, Departmental
conflicts and Lack of expertise, application-
specific knowledge and user experience.
• Lack of senior management commitment,
agreement on a set of project goals, effective

44
 methodology and poor estimation which may
lead to time/cost overruns.
• Software risk factors include developing wrong
functions, wrong user interface and problems
with outsourced components
• Lack of user commitment, ineffective user
communication, technology infrastructure to
support changing requirements and scope are
some of the project hazards.
• Project risk assessment is based upon project
size, technological experience and project
structure and managers need to control these
risks.
Risks in Implementing an ERP System
Technology Risks – It depends upon how consistent the
new technology is with the current infrastructure and
operating system environment.
Organizational Risks - Customization poses extra risks.
Redesign of business processes to fit package decreases
the risk of excessive time and cost investments.
Human resource factors – If the current skill mix of the
IT staff does not include knowledge of application-
specific ERP modules, the organization will incur
significant costs in re-skilling the workforce.
Project size – The size of the ERP projects as measured
in time, staff commitment, budget and scope poses
considerable risk.

Managing Large-Scale ERP Projects

Large-scale projects involving software packages
are MRP or ERP projects. Package implementation
differs from custom implementation because users want

45
to customize programs in the package to fit their unique
needs and users are dependent upon the vendor for
assistance and updates. Commitment from top
management and adequate training are critical success
factors for implementation. Lack of training leads to
difficulties in MRP system implementation. Presence of
a project champion, good communication with
stakeholders and effective project management are
critical success factors in ERP projects.
Managing the Risk Factors in ERP Projects
Strategies for controlling the risk factors in ERP
projects include re-engineering business processes,
including business analysts on project team, obtaining
management support, commitment to change and
changing corporate culture.
Comparison of Successful Versus Unsuccessful ERP
Projects
Customization, the use of consultants, supplier
relationship management, change management and use
of business impact measures are the factors that
distinguish successful projects and unsuccessful projects.
Project leadership, project focus, project champion role,
flexibility of the project schedule and the way projects
are divided also affect the success of the project.
Customization
Customization increases time and cost
dramatically. Implementing the “best practices”
embedded in the vendor package increases the chance of
project success.
Use of external consultants
Effective management of external consultants can
offer expertise in cross-functional business processes, in

46
system configuration and in application specific
modules. However, problems arise when management
outsources the entire ERP project without involving
internal IT department.
3.1.1 Supplier relationship management
It is important to build effective relationships to
facilitate and monitor contracts for a successful ERP
project.
Change management
Companies often fail to address resistant to
change. An organizational culture fostering open
communications is important to avoid resistance to
change. Individuals need to understand the
interrelationships the ERP system creates.
Business measures
Many firms fail to establish specific benefits in
measurable terms which makes it difficult to determine
the benefits. Success strategies are continuously
monitoring project outcomes and capitalizing on small
successes.
Project-Related Factors
Project division – To achieve tangible business benefits
subdivide the project into smaller projects.
Project leadership – Project leaders must have a proven
track record and they need to keep the project on track.
Project focus – Focus on user needs instead of
technology is a success strategy for ERP
implementation.
Role of the Project champion – A project champion is
essential for a successful project and project members
need to have the authority to make decisions on behalf of
their functional area.

47
Project schedule – Some slack needs to be built into the
project schedule because unforeseen issues will arise in
an ERP project.
Additional Factors
User training – It should focus on business processes
and not just technical training in how to use the software.
It is critical to ERP success.
Management reporting needs – Excellent query and
reporting tools for ERP systems can be acquired from
third-party vendors.
Technological challenges – It can be complex. Firms
need to recognize the complexity of data conversion and
interface development for implementing ERP.

3.2 SUPPLY CHAIN MANAGEMENT AND THE

eMARKETPLACE
Supply Chain Management (SCM)
The purpose of supply chain management is to
achieve integrated planning through the activities of the
supply chain as shown in figure 3.1.

48
 Figure 3.1 Supply Chain Management
SCM is defined as the planning and control of the
flow of goods and services, information andmoney
through the supply chain from the acquisition of raw
materials to the final product in the hands of the
customer. Through SCM, customers and suppliers can
partner with each other to achieve the objective of
maximizing responsiveness and flexibility, while
eliminating paperwork and cost. The sharing of
information across the supply chain is shown in figure
3.2

Figure 3.2 The Supply Chain

In the new supply chain relationship, the
retailer’s inventory can be maintained by manufacturer.

49
Sales at the retailers’ sites are deducted through point-of-
sale (POS) transactions transmitted every day. Then the
manufacturer replenishes the product. An innovative
strategy called cross-docking eliminates the shipment of
stock from the supplier to a retailer’s distribution center.
SCM creates linkages between supplier and retailer that
translate into lower costs, better customer service and
increased profitability. For the supply chain to work, the
information must be timely and must be shared by
demand chain partners. SCM software provides
information to translate sales transactions into
production processes and material requirements
Impact of SCM on Productivity
The benefits of SCM approach are cost reduction,
inventory reduction, cycle time improvement and
improved customer service. Integration of supply chain
requires commitment to strategy, process, organization,
and technology. The major issue to be addressed in
integrating the supply chain is what linkages should be
established with customers and suppliers. Advanced
communications and data integration are technology
factors that enable supply chain integration.
Partnership Evolution
In the past, manufacturers negotiate with many
different suppliers and customers negotiate with many
different manufacturers to get the best price. Over the
past ten years, partnerships have begun to emerge.
Vendor-managed inventory (VMI) transfers the daily
responsibility of inventory management on supplier. In
VMI supplier monitors inventory level and replenishes
inventories to maintain adequate supply levels. VMI has
a great advantage of eliminating the risk of stock outs.

50
The manufacturer can monitor inventories, response time
drops. The retailer can reduce inventory and
administration costs. Manufacturer benefits because
VMI increases the volume of business coming from the
retailer and no expedited orders from retailers. Returned
goods to manufacturer drops because customers receive
only the stock they need. Different strategies exist for
coordination between suppliers, manufacturers and
customers across the supply chain.
Electronic linkages facilitate the transfer of parts,
subassemblies and components that are needed on a just-
in-time (JIT) basis which reduces costs, improves
response time and increase responsiveness to customer.
3.2.1 Introduction to eBusiness
The emergence of eBusiness has established
interactive relationships between customers and
suppliers and between suppliers and distributors. The
eBusiness value chain, known as the virtual value chain,
provides information-based channels for selling and
buying products and services. This value chain uses an
information technology infrastructure to support the
primary value activities. eBusiness has changed market
relationships from transaction-based to contract-based
relationships to partnerships. eBusiness has moved from
vertically integrated to selective sourcing in which some
value activities are outsourced to partners.
Business-to-Business (B2B) Marketplaces in the
Supply Chain
eProcurement is one of the major breakthroughs
of eBusiness. Companies are posting requests directly on
the web, which makes the bidding process more
competitive so prices are lower. B2B marketplaces

51
expand the choices available to buyers and reduce the
transaction costs for all players. The B2B hubs have a
two-way classification scheme. They are:
– Spot sourcing of operating inputs,
including creative, information
technology.
– Systematic sourcing of inputs such as
office printing supplies.
B2B hubs bring together buyers and sellers of
similar or complementary products together at one web
site and reduce transaction costs by using one-stop
shopping. In general B2B hubs automate transactions
and reduce costs.
eSupply Chain and ERP
The ERP system is the foundation for the
eMarketplace. The whole supply chain, ranging from
consumers to suppliers facilitates real-time updates
across chain as shown in figure 3.3.

Figure 3.3 The eSupply Chain

The result is the ability to fill orders that might
not have been filled, leading to greater customer
satisfaction and a better understanding of customer
needs. The advantages of the eSupply chain are the
following: reduced cycle time, closer linkage with
supply chain partners, increased revenue, increased
speed, reduced costs, reduced production times,

52
optimized inventory management, more efficient
distribution and collaborative business processes.
Business Intelligence with ERP
The data generated by ERP need to be accessed
by managers to know about customers, products and
competitors on time to boost profitability. The solution
to meet these management information are:
Data warehouses
Data warehouse is a repository for making
management decisions. Data for a data warehouse are
gathered form operational systems and from external
data sources. Data integrity is accomplished by cleaning
inconsistent data, filling in gaps and developing
consistent formats before being entered into the data
warehouse.
Data mart
A data mart is a subset of data warehouse
information designed for a specific set of users. Data
marts are created for special data analysis.
Data mining
Data mining involves the analysis of large
quantities of data for sales forecasting, inventory
management or other applications. It includes
identification of a problem, development of research
questions, data collection and data analysis using
statistical analysis. Sometimes, data mining is used to
test a hypothesis.
Future Directions for ERP
Increased integration through SCM – ERP supports the
back office functions, including financial, HR,
manufacturing and sales. ERP provides the core
infrastructure for CRM and SCM.

53
Use of Shared Services and Application Service
Providers – ASPs will provide cost efficiency and access
to latest technology and support. Using ASP companies
can obtain off-the-shelf ERP systems for a fixed monthly
fee. Services range from standardized modules to fully
customized ERP systems. One of the strategies for
acquiring external services is netsourcing which provides
renting ERP services, applications, and infrastructure
over web. However, in case of networking additional
risks may arise during migration and contracts. In
netsourcing, internal IT capabilities must be maintained
for ERP development.
Application software integration – This is a strategy for
integrating legacy systems with ERP systems. ERP
systems will be built from plug and play modules.
Companies will be able to pick and choose flexible
modules that are best suited to their business.
3.3 THE NEW COMPETITION
The way you manage the supply chain can make
or break your company. Some of the most spectacular
business successes over the past 20 years have come
from finding more effective ways to deliver products to
consumers. The nature of the competition is shifting
away from the classic struggle between companies. The
new competition is supply chain vs. supply chain. Very
few companies are prepared to handle the new pressures
being placed on the supply chain. A recent survey of
executives in manufacturing companies found that 91%
of them ranked supply chain management as either “very
important” or “critical” to the success of their
companies.

54
 Companies realize that they are in trouble with
their supply chains, but they don’t really understand the
problems. Because no one in the company is responsible
for running the supply chain. Engineering designs the
products, marketing sets prices and promotions, sales
cuts deal with customers, purchasing negotiates with
suppliers, manufacturing controls the inventories,
logistics arranges transportation, accounting handles the
cash flow and so on. All the key activities take place in
different groups with different agenda and conflicting
goals. The first step to regain control over the chain is to
assemble the key decision makers from each group and
get them work together to find solutions.
3.4 THE RULES OF THE GAME
Supply chains consist of production and storage
facilities connected by transportation lanes and they exist
to support the flow of demand, supply and cash. The
difficulty of managing supply chains comes primarily
from the complexity that creeps into their structure and
the variability that characterizes their flows. It’s this
complexity and variability that make an easy game hard
to master.
Facilities and Links
A supply chain is basically a set of facilities
connected by transportation lanes. Facilities fall into two
categories, depending on their primary function:
production facilities and storage facilities. Transportation
lanes are categorized by their mode of transportation:
roadways, railways, waterways, sea lanes, air lanes and
pipelines. Facilities contain controlled quantities of
materials called inventories. Production facilities hold
inventory in three different forms:

55
  Raw material inventory consists of materials
ready for use in production.
 Work-in-process inventory includes all the
materials currently being worked on
 Finished goods inventory holds completed
products ready for the shipment.
Different forms of storage facilities are:
 Warehouses usually contain only a single kind of
inventory
 Distribution centers that do final assembly
contain all three kinds
 Cross docks, which are used only to transfer
goods between trucks, and they do not contain
any separately managed inventory.
Some vehicles used for transport can be decoupled
from their containers. Decoupling is an important
consideration because it offers more flexibility in
routing, dispatching, temporary storage and other
transportation activities. Each mode of transportation
offers a unique mix of speed, cost, availability and
capability. There are also different volume tradeoffs
within each mode. In trucking, it is much cheaper to send
full truckload (FTL) shipments than to use less-than-
truckload (LTL) shipments. Shipping within a limited
geographical region normally uses a single mode from
source to destination. For larger distances like
international trade, shipments generally use two or more
modes known as inter-modal transportation.
Like facilities, transportation lanes contain in-
transit inventory. This inventory bridges the gap between
the shipping facility’s finished goods inventory and the

56
receiving facility’s raw materials inventory as shown in
figure 3.4.

Figure 3.4 Inventory in Transit

In-transit inventory is different from other forms
in that it is unavailable for use, is at higher risk of loss
from theft and accidents, and is subject to delays due to
vehicle breakdown and lane congestion. This is the
fourth type of inventory.
Another transportation medium, called package
carriers use a distinct mode when making transportation
decisions. In reality, these carriers use a mix of air and
highway transport to deliver their packages, using their
own fleets of aircraft and trucks.
Demand, Supply and Cash
The essential goal in managing a supply chain is
to achieve an orderly flow of goods from extractors to
consumers. The difference between the current supply
chain management from its predecessors is that it is
equally concerned with two other flows: the flow of
demand and the flow of cash up the chain as shown in
figure 3.5.

57
 Figure 3.5 Three Basic Flows
Without these other flows, the goods would never
move. The basic operation of a supply chain could
hardly be simpler. Demand flows up the chain and
triggers the movement of supply back down the chain.
As suppliers reach their destinations, cash flows up the
chain and compensates suppliers for their goods. The
three flows in a supply chain are discrete rather than
continuous. That is, they move in distinct “packets” that
they convey particular quantities at particular times.
Demand is normally conveyed through orders, supply
through shipments and cash through payments. Each
exchange of demand, supply or cash takes place between
a customer and a supplier.
Orders trigger the flow of goods, but, depending
on the production strategy, they may or may not trigger
their immediate production by a supplier. In the make-to-
stock strategy, a supplier makes products in advance of
demand and holds them in finished goods inventory,
satisfying demand from that inventory as orders come in.
In the make-to-order strategy, the supplier doesn’t build
a product until it has an order in hand. There is also an
intermediate strategy, assemble-to-order in which a
product is partially built in advance of demand, but final
assembly is postponed until an order is received. Some

58
companies use a mix of these three techniques, but
choose one as their primary strategy.
The choice of production strategy has a major
impact on the dynamics of a supply chain. These
dynamics are often used to characterize supply chains as
either push chains or pull chains, but in reality every
chain is a mixture of push and pull. Consumers follow
pull link while extractors follow push chain. Somewhere
in between the two is the push-pull boundary, the point
at which the flow of goods switches from being pulled
by consumers to being pushed by extractors.
Of the three primary flows in supply chains, cash
flows is the one that receives the least attention. But cash
is the ultimate driver for the entire process. Without cash
the whole business would come to a halt quickly. In
addition to the three key flows, there is something else
that moves across the chain, information. Actually,
information is already implicit in the three flows. Unlike
the three basic flows, information can move across the
chain at any time, without being part of a particular
transaction, and it is not constrained to move
sequentially up or down the chain. Instead, it can be
broadcast simultaneously to any subset of the chain.
Information can often be substituted for inventory.
Instead of requiring every member of the chain to
maintain safety stock to buffer against uncertainty in
demand, that uncertainty can be reduced by sharing
information that helps members anticipate coming
changes in the flows of demand, supply and cash.
Information is usually far cheaper than inventory, and it
has the advantage that it can be in many places at the
same time.

59
Distribution and Procurement
Every facility that downstream a plant is a destination for
its finished goods and forms a part of the plant’s
distribution network. Every facility that upstream a
source of supplies, forms a part of its procurement
network. These two networks of the supply chain are
radically different from the plant’s perspective. Some
plants ship only to a single destination, but this is rare.
Normally, each plant serve many destinations within a
particular geographical region. These destinations, in
turn, may ship the goods onward to still more
destinations and so on, until the products eventually
reach their ultimate consumers. The successive layers of
this supply chain are commonly referred to as echelons
and they are numbered outward from the plant as shown
in figure 3.6.

Figure 3.6 Echelons in Distribution

The difficulty of managing distribution goes up
dramatically as the number of destination increases.
With more facilities to serve, the available inventory has

60
to be divided more finely, increasing the risk of not
having the right amount of product at any one facility. In
addition, the time and expense of handling the goods
increases with each echelon. On the other hand,
transportation costs go down with more echelons
because products can travel with more economical
shipments.
Normally, the plant receives supplies from
multiple sources, each of which receives its supplies
from multiple sources, and so on, up to the point where
the raw materials are obtained directly from extractors.
The successive layers of this supply chain pattern are
called tiers. Like echelons, tiers are numbered outward
from the plant.
An important consideration in analyzing supply
chains is identifying ownership boundaries. A sequence
of facilities owned by the same company makes up its
internal supply chain, and the links outside of the
ownership boundary are its external supply chain.
Internal supply chains often run more smoothly than
external chains because they can be centrally controlled,
and no buying and selling are required to move the
goods. One of the big advantages of the classic strategy
of vertical integration, in which a single company owns
as much of the supply chain as it can acquire.
Complexity and Variability
The complexity begins with the way the three
primary flows relate to one another. In principle, it’s
simple – orders trigger shipments, and shipments trigger
payments. The relationship of orders to shipments and
payments quickly becomes tortuous. A single production
run generates orders to many different suppliers, and

61
these orders are usually combined with orders for other
production runs to achieve economies of scale in
purchasing. Another source of complexity is the way
supply chains are managed, with different groups
handling each of the three basic flows. On the customer
side of a transaction, orders might be placed by a
centralized purchasing department, shipments received
by various local assembly plants, and payments made by
a regional accounting department. On the suppler side,
orders might be received by satellite sales offices,
shipments made from regional distribution centers, and
payments received by the accounting office of a parent
firm. All of these groups operate according to different
and all too often, deeply incompatible agendas, and no
one group is responsible for the outcome of the entire
transaction. Complexity is also created by the
proliferation of documents associated with orders. Yet
another source of complexity is the structure of the chain
itself.
The second core challenge of supply chains is
coping with variability. No matter how well managed, all
business activities exhibit natural variability in their
duration, quality and other attributes. A great deal of
supply chain management is devoted to coping with this
variability. Inventories of finished goods act in part as a
buffer against variability in demand, and raw material
inventories offer comparable protection against
variability in supply. Supply chains are particularly
vulnerable to the effects of variability because they
involve long sequences of interdependent activities. A
relatively small delay in an upstream process, for
example, can cascade down the entire supply chain,

62
throwing off production schedules and disrupting any
number of deliveries. Just as variability in supply can
amplify down the chain, variability in demand can
amplify back up the chain.
The problem associated with complexity and
variability are both worsened by scale. Supply chains are
not likely to get any smaller in the years to come, but
both complexity and variability can be greatly reduced.
The complexity of modern supply chains is ultimately a
self-inflicted wound, the product of business practices
that date back to the Industrial Revolution. Although
variability itself is a fact of life, there is a ready arsenal
of weapons to prevent it from attacking supply chains.
Conclusion
This lesson gave an idea of supply chain
management, its complexity and its variability.
Exercises
1. What are the various risk factors in managing an ERP
project? Explain.
2. Define SCM. Explain the steps in supply chain.
3. Give a brief note on the three basic flows of supply
chain.
4. Elaborate on the complexity and variability of supply
chain.

63
 Lesson 4
Objectives
 Understand the importance of the collaboration
among trading partners

4.1 WINNING AS A TEAM

If complexity and variability make supply chain
management a hard game to master, then the best tactics
are those that lead to simplicity and stability.
JIT Supply Programs
To improve the flow of raw materials into
production facilities, JIT manufacturing method has been
extended upstream toward suppliers. One of the key
elements of the JIT approach is eliminating excess
inventory throughout the production process by timing
the movement of materials to each workstation to arrive
just at the moment they are needed for the next
operation. This practice minimizes inventories
throughout the production process, helping
manufacturing companies reduce holding costs,
minimize obsolescence and improve their return on
assets. These benefits have led to the widespread
adoption of JIT throughout industries that use repetitive
production techniques. Of the three inventories held in
production facilities, the work-in-process (WIP)
inventory is most easily reduced using JIT. In order to
bring down the inventory of raw materials, JIT producers
work with their suppliers to switch over from large
shipments of materials that go to central receiving
facilities to small, frequent shipments that go directly
from trucks to the factory floor.

64
 As soon as manufacturers begin to make these
kinds of changes, JIT quickly expands from a production
initiative to a much broader program that requires
systematic changes in supply chain management. JIT
practices offer important insights into how supply chains
can be improved. Although the apparent focus of JIT is
on reducing inventory, the true spirit of the method is a
systematic pursuit of quality, one aspect of which is
eliminating any unnecessary complexity. Although with
reducing complexity, the JIT philosophy of quality also
seeks to reduce variability in every stage of production.
Of course, not every form of variability can be
eliminated and herein lies the downside of JIT, it can
make supply chains so fragile that any interruption in the
flow of suppliers brings the entire chain to a halt.
Shutdowns can quickly wipe out the savings
associated with reduced inventory levels. Because of this
kind of financial impact, many firms that adopted JIT
wholeheartedly are now rethinking their position and
taking a more conservative approach. Even with
appropriate risk management, JIT is not the right
approach for every supply chain. It does not work in job
shops, which do not use production lines and it is not
relevant to process manufacturing. It is not a good choice
for low-volume products or for products with uncertain
demand. However, JIT effort illustrates how much can
be done to reduce complexity and variability in supply
chains.
Retail Replenishment Programs
The second major class of supply chain programs
deals with the distribution side, and is concerned with
replenishing retail inventories. The link between retail

65
stores and their immediate suppliers has been a difficult
juncture in the supply chain. If the desired product is not
on the shelf when a consumer walks in to buy it, even the
most perfect sequence of supply operations is a failure.
The first generation of retail replenishment
programs was based on shifting the control of
inventories. In the traditional arrangement, retailers
manage their own inventories and replenish them as they
see fit. Consignment is a technique in which producers
retain both ownership and control over inventories of
their products at a retailer’s site. Consignment has
proved to be an effective tool for selling products that
retailers might not be willing to carry on conventional
terms.
A more recent development, vendor managed
inventory (VMI) separates control from ownership, both
of which usually transfer at the same time. In VMI, a
producer receives continuous updates on retailer’s
inventory level and replenishes it as needed, with the
retailer taking ownership of the goods on delivery. In
addition to VMI, several other programs have been
developed to smooth the flow of goods through retail
stores. One of the earliest was the quick response (QR)
program, an effort to combine some of the techniques of
JIT with technologies for monitoring inventory levels in
real time. Electronic point of sale (POS) systems
automatically captured data about clothing sales as they
occurred, then transmitted this data to producers using
electronic data interchange (EDI) connections.
In 1980s, an extension of the QR program called
continuous replenishment (CR) was introduced. CR
incorporated VMI for better inventory control, and it

66
introduced joint forecasting so that producers and
retailers could pool their understanding of consumer
demand to better predict future sales. In 1993, the
grocery industry launched its own version of continuous
replenishment, calling it the efficient consumer response
(ECR) program. ECR’s major contribution was the
addition of category management, which organizes
promotion and replenishment activities around groups of
products that consumers view as roughly equivalent in
satisfying their needs. The most ambitious replenishment
program to date is collaborative planning, forecasting
and replenishment (CPFR), is a multi-industry effort that
was formalized in 1998.

Figure 4.1 The CPFR Program

The CPFR program as shown in figure 4.1 relies on
advanced, Internet-based tools to pool information about
demand and supply. Although CPFR is not a direct
extension of any of the preceding programs, it draws on
the experience gained with all three.
The Problem with Programs
All methods described above have succeeded in
reducing inventories and accelerating the flow of goods
across the chain. But there is one problem with these

67
impressive results: they may not be real. A research
study states that most of the decline in total inventory
was due to a small number of industries that made
structural changes in their supply chains. The problem is
that the reductions were achieved by displacing the
inventory within the chain instead of actually eliminating
the inventory. Retail is one of the few sectors that has
made dramatic progress in reducing its total inventory,
neatly paralleling the rise of mega-retailers.
Manufacturers now hold more finished goods, reversing
the historical dominance of producers in the supply
chains for consumer goods. Of course, producers can
compensate for this pressure to some extent by
streamlining their internal operations and putting
pressure on their own suppliers for more prompt
performance, reducing their inventories of raw materials
and work in process.
The pattern of pushing inventory up the chain is
also found in JIT programs. One important difference
between programs at the production level and those at
the retail level is that producers are in the middle of the
chain rather than at the end, so they have the option of
pushing inventory downstream as well as upstream as
shown in figure 4.2.

Figure 4.2 Producer Displacing Inventory

68
 Viewing in the larger context of trade
relationships, this pattern of pushing the burden up and
down the chain rather than eliminating it altogether is not
surprising. When companies act as true trading partners,
working together to pull time and cost out of the chain,
they can create a situation in which everyone makes
more money. The idea of replacing competition between
trading partners with cooperation, creating win-win
relationships, is so obvious and so often repeated that it
no longer has much currency. The techniques of game
theory will help to distribute the profits in a supply chain
through cooperation.
Insights from Game Theory
When trading partners compete with each other
over a fixed sum of money, they are playing what game
theorists call a zero-sum game. In zero-sum games, there
is a fixed amount of money at stake, and players compete
to see who can win the largest share. The outcome of the
game is a single point called as tradeoff point and all the
possible outcomes are referred as tradeoff curve. Most
supply chain transactions play out as zero-sum games. If
the parties involved in transaction can influence the total
winnings, then the transaction turns into a non-zero-sum
game. A non-zero-sum game can go either way,
depending on the relationship between the two parties. If
the relationship is cooperative, the parties can push the
tradeoff curve up into the win-win region as shown in
figure 4.3. If the relationship is antagonistic, they move
the tradeoff curve down into the lose-lose region.

69
 Figure 4.3 Non-Zero-Sum Games
On a more positive note, trading partners that
want to improve their combined profits rather than just
fight over a fixed amount of money can look for ways to
change their relationship into a positive-sum game.
Chrysler’s SCORE program completely recast the
relationship to focus on cooperation and provided a
simple set of mechanics to resolve the competitive
element. The first lesson to be drawn from game theory,
is that trading partners should place most of the emphasis
on maximizing the total winnings. In the real world, the
customer would express outrage at having to spend so
much to compensate for poor quality and would insist
that the supplier get its act together and eliminate the
defects. This may not be fair to the supplier, but this
inequity is easily rectified by having the producer
compensate the supplier in other ways.
Winning Through Collaboration
Although supply chain management has come a
long way from its origins in transportation management,
the discipline still tends to reflect the original focus on
managing the flow of goods across a single link in the
chain. The new competition between supply chains is not
based on the effectiveness of individual links; it is based
on the ability of the chain as a whole to bring better

70
products to the market faster and cheaper than other
chains. To get this effect, the members of the team need
to plan and act with the integrity of a single organization,
working together to simplify and stabilize the flow of
demand, supply and cash across the chain. In supply
chain vertical integration all the members of the chain
are owned by the same company. Today, it is far more
common for companies to focus on their core
competence and cooperate with other companies to
assemble complete supply chain. Attempts to gain a high
degree of integration without compromising independent
ownership approach is called virtual integration.
There are two major trends in supply chain
management. One trend is away from common
ownership and toward independent companies. The other
trend is away from ad hoc transactions and toward
tighter integration. In the future, collaboration has to
span enough links in the chain to truly pull time and cost
out of the chain, not just displace it within the chain.
Achieving this level of collaboration will require
managers to take a much wider perspective on the supply
chain than they do today, thinking of their companies as
part of a larger whole rather than the center of the
business universe. This may be a bleak conclusion for
the supply chain industry as a whole, but it represents a
tremendous opportunity for companies that are ready to
move to the next level.

71
Conclusion
The importance of collaboration among trading
partners is presented in this lesson.
Exercises
1. Elaborate on JIT supply programs and the Retail
replenishment programs.

72
 UNIT – III
Lesson 5
Objectives
 To understand how the systems are designed,
how they work and how they are controlled
 To understand the mathematical and simulation
models
 To understand the supply chain software
5.1 SUPPLY CHAINS AS SYSTEMS
Integrating a supply chain requires assembling an
ad hoc collection of facilities into a coherent system that
can function with a single purpose. In order to succeed in
this effort, knowledge about systems is needed, that is
how they are designed, how they work and how they are
controlled.
Business Cybernetics
In cybernetics, a system is viewed as an assembly
of components that interact to produce collective
behavior. Computers are systems, of course, but so are
companies, factories and supply chains. The key insight
of cybernetics is that there are common principles across
all these different kinds of systems, principles that help
explain the behavior of each. One of the key
contributions of cybernetics was the insight that all
systems can be seen as transforming inputs into outputs.
When systems are constructed by people, as supply
chains are, they are usually designed to produce outputs
that have greater immediate value than the inputs.
Systems made by people are designed to be controlled
and monitored so that their performance can be
improved over time. Control is achieved by regulating
the flow of inputs, and monitoring involves measuring

73
the resulting outputs. But even in the best-designed
systems, there are usually some inputs that can’t be
controlled by the people operating the system. In the
case of supply chains, economic cycles and natural
disasters can have a profound impact on performance,
but these are outside the span of control. Economists call
these inputs extrinsic factors because, in contrast to
intrinsic factors such as plant capacity and budget
allocations, they originate from outside the boundaries of
the system.
Similarly, it may not be possible to measure
every output of a system. For example, measuring the
contribution to consumer value added by each stage of a
production process is highly desirable but difficult in
most industries. To manage supply chains, the
understanding of how the settings affect the operation of
the chain is needed, together with some coordination of
the changes to get the best overall performance.
Understanding provides the insights necessary for you to
predict how a system will behave in response to changes
to its inputs. Figure 5.1 illustrates the relationships
among three key processes in managing systems:
understanding, prediction and control.

Figure 5.1 Understanding, Prediction and Control

74
 Of the three processes, understanding is arguably
the most important, yet it is also the most neglected.
Instead, the emphasis proceeds in the other direction:
Control is the primary concern, prediction is invoked
only as needed to improve control and understanding is
viewed as an incidental by-product rather than the prime
mover of the sequence. To be fair, some systems are so
well designed that very little understanding is required to
control them. But for a complex system, understanding is
not a luxury, it is a necessity.
A Rogues Gallery of Relations
One of the most basic characteristics of systems
is the way in which they map values on the inputs to
values on the outputs. This mapping or relation can take
on a variety of different types which range from the most
straightforward to the truly bizarre. This system is easy
to understand and operate because the relation between
the input and output is so simple. Unfortunately,
relations in real-world systems are rarely this simple.

Figure 5.2 The Rogues Gallery of Relations

Figure 5.2 shows a particular kind of relation,
together with the name most commonly used for that
type. The relation shown in Panel A of the gallery is
called a linear relation because the mapping of inputs to
outputs is described by a straight line. The monotonic
relation in Panel B of the gallery is not as well behaved.
The only restriction on this relation is that increasing the

75
input never reduces the output. The continuous relation
illustrated in Panel C is even less well behaved; the only
guarantee with this relation is that the output will rise or
fall smoothly with changes in the input, without any
sudden jumps. The single-valued relation shown in Panel
D is still harder to work with because even the smallest
change in input can produce a huge leap in the output,
with no smooth transition between successive levels. The
multi-valued relation illustrated in Panel E is the worst of
rogues because it does not even promise to give you the
same output for a given input.
The Dynamics of Delay
The range of behavior that can be observed with
just a single component barely hints at what can happen
when two or more components are combined. The
components don’t actually do anything, they just pass
their inputs to their outputs without changing them in
any way. It only takes a tiny alteration to make the new
system behave differently from the simpler one: a small
delay from the time a component receives a change in its
input to the time that change is reflected in its output. All
systems involve some delays, so it is normal for their
components to be out of phase. In supply chains, delays
occur in all three flows – demand, supply and cash – and
they can range anywhere from minutes to months. Based
on the most current data, each company might reach
totally different conclusions about how the chain ought
to be responding to current demand. Phase shifts are
rarely apparent even in the best of circumstances.
In supply chains, the familiar economies of scale
represent a common source of distortion: customers
order more than they need in order to get a quantity

76
discount, producers run larger batches than necessary to
reduce unit costs and so on. Such decisions may save
money in immediate operations, but the distortions they
cause in the signals for demand, supply and cash extract
a much higher cost than most companies realize.
Demand amplification is a problem of our own creation,
one we have woven into the very fabric of supply chain
practices. The only sure way to get rid of the problem is
to eliminate the practices that cause it.
Feedback and Stability
In most of the systems, the signals all travel in
the same direction, from the inputs towards the outputs.
Although such systems exist, they are rare, in most real-
world systems have additional pathways that carry
signals upstream as well, from outputs back to the inputs
of earlier components as shown in figure 5.3. Such
signals are called feedback because they feed
information about the output back into the input, creating
a loop in the system that would not be there otherwise.

Figure 5.3 Feedback System

Feedback can take on many forms. The most
basic kind of feedback simply takes a portion of the
output and mixes it in with the incoming signal as shown
in the upper link of figure 5.3. The more common kind
of feedback in supply chains, shown in the lower link,
uses a separate signal that communicates information
about the current output to an upstream component
77
rather than redirecting part of the original signal.
Feedback can be entirely automatic or it can require
human intervention. Positive feedback amplifies the
incoming signal strength. The result of positive feedback
is an ever-accelerating increase in the output level.
Negative feedback dampens incoming signals. With
negative feedback, each increase in the original signal
has a smaller effect on the output. This kind of feedback
tends to keep a system within set bounds rather than
pushing it toward extreme values.
Feedback is the lifeblood of supply chains, and
many of the supply chain initiatives are designed to
improve the flow of feedback up the chain. In addition to
facilitating the flow of goods down the chain, feedback
facilitates the flow of demand and cash back up the
chain. The great power of feedback in supply chains is
that it reduces uncertainty by giving companies advance
information about upcoming variations in demand and
supply, allowing them to better cope with these
variations.
5.2 MODELING THE SUPPLY CHAIN
To understand complex systems, a simplified
model of the system is constructed and played with the
models to see how they work, and then it is applied to
the real-world system. Two powerful models such as
mathematical and simulation models are used as
precision tools for prediction and control.
The Case for Models
A model is nothing more than a simplified
representation of a real-world system. This
representation can take a wide variety of forms,
including verbal explanations, whiteboard diagrams,

78
mathematical equations, physical structures and
computer programs. All these models serve a common
purpose: they take a system that may be hard to
understand or dangerous to manipulate, and they render
it in a form that is easier to understand and safer to play
with.
Models help with all three of the key business
processes: understanding, prediction and control.
Building a model of a system requires that you analyze
the system to identify its key components, figure out
how those components work, and then reassemble them
in a way that replicates the essential behavior of the
system. Once you have assembled a model, you can use
it as a test bed to generate predictions about how the
system it represents would behave under a variety of
conditions. Good models are useful to take good
decisions. Models are also used to control real-world
systems. This use of models is less obvious than the
other two because the models used in control are usually
implicit – that is, they are embedded in the design of
business systems, but are never communicated to the
people who own and operate those systems.
Business models come in a wide variety of forms,
but most of them fall into one of the three broad
categories as shown in figure 5.4.

79
 Figure 5.4 Three Kinds of Models
Conceptual models use diagrams and descriptions
to represent a business system. Mathematical models
represent a business in terms of formulas or procedures,
and they are solved by evaluating those formulas or
procedures under a particular set of assumptions.
Simulation models use software objects to represent the
components of a business, and they are solved by
“running” the model to see what happens when the
objects interact with each other. Mathematical and
simulation models are often referred to as formal models
because they have strict forms and generate numerical
predictions, in contrast to the informality of conceptual
models. Conceptual models are the easiest to build and
understand, they are the best choice for achieving a
shared understanding of the supply chain. Mathematical
models are the most powerful, and they are best used to
predict and optimize the performance of the chain.
Simulation models are the most flexible, and they should
be used to study the behavior of a model under the most
realistic business conditions.
Conceptual Models
The conceptual model is by far the simplest of
the three types. This sort of model is basically a
description of a business system and is usually expressed
as some combination of diagrams explanations.
Regardless of how you express a conceptual model, the
key is to find the right balance between precision and
ease of communication. For systems analysts trained in
the use of entity relationship (ER) diagramming, formal
ER diagrams and detailed scenarios may be just the right
tools. For managers who have never engaged in business

80
modeling before, the right balance may be a combination
of simple diagrams and informal explanations.
Conceptual models can be developed by individuals, but
for systems that cross organizational boundaries, as
supply chains inevitably do, the best approach is to
assemble a team of representatives from all the groups
involved and hammer out the model together. Although
conceptual models form the basis for understanding
systems, they are of little value in prediction and control.
5.2.1 Mathematical Models
A mathematical model is actually a special kind
of system, one in which relations are specified using
equations. The equations are actually a recipe for
carrying out calculations. Like all systems, mathematical
models have inputs and outputs. As shown in figure 5.5,
in the linear model, the input is represented by the letter
x and the output by y. The other two quantities, labeled a
and b are called parameters, and they are used to adjust
the model to a particular set of circumstances. In the
linear model, a changes the angle of the line and b
changes its height. Parameters can act either as inputs or
as outputs, depending on how you want to use the model.
The linear model is a particularly simple type, making it
easy to understand and apply.

Figure 5.5 The Linear Model

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 The formulas used in mathematical models are
often complex and hard to understand, particularly when
the relations are nonmonotonic. But the basic pattern
remains the same: all relations are expressed as
equations. The most common tool for mathematical
modeling is a spreadsheet program such as Microsoft
Excel. Spreadsheets started as out tools for accountants,
but their primary use today is in building business
models. These models usually deal with financial flows,
but the numbers can just as easily express the flow of
supply or demand. In many situations, mathematical
model can not only tell you what output you can expect
from a given set of inputs, but also what inputs to use in
order to produce the best possible output. This ability
known as optimization can be a tremendous tool for
making decisions about how to run a supply chain.
In supply chain management, the most commonly
used optimization technique is linear programming (LP).
Linear programming is an extremely powerful
management tool, one that comes about as close to
magic as anything in business. Linear programming can
be done in Excel, using its built-in optimizer. Linear
programming makes some stringent simplifying
assumptions about the real-world system. One such
assumption is that all relations be of the well-behaved
linear form.
5.2.2 Simulation Models
Like a mathematical model, a simulation is a
special kind of system, with inputs, outputs and
parameters. The difference is that simulations are a bit
more literal than mathematical models: They just try to
imitate the behavior of a system’s components rather

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than distilling that behavior down to an equation.
Building a simulation consists of programming a number
of software objects to act out the roles of real-world
objects, then running the system to see how those objects
interact with each other under realistic business
conditions. The objects represent customers and
suppliers, orders and shipments, materials and products,
vehicles and containers and all the elements of supply
chains. Simulations can be constructed using a variety of
tools. The most cost-effective approach is usually to use
a commercial simulation system. These systems include
graphical tools for building models, automated routines
for testing them under different conditions and reporting
tools for analyzing the results. Once you have
constructed a simulation model, you test it by running it.
First, you initialize the objects in the system by setting
their parameters to reflect real-world production
capacities, shipment times, material and labor costs,
retail prices and the like. You then start the simulator and
feed it a sequence of inputs as they would occur in real
time, including shifting levels of demand, seasonal
variations in price and so on.
Simulations allow the parameters and inputs to
vary about some average value rather than being locked
down to a fixed value. Adding variability to a simulation
makes it more accurate, but it also complicates matters
because the results of running the model now have a
random element to them. If the output can vary each time
you run a model, you have to run it many times and
average the results to see how the model is most likely to
behave under a realistic range of circumstances. This
technique of running a model many times with random

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values is called the Monte Carlo method. A Monte Carlo
series provides a detailed look at how a supply chain
design will perform under a single set of realistic
business conditions.
Although simulations are better than
mathematical models at exploring the effects of
variability, they are not as good at finding optimal
solutions. The best you can do with a simulator is to vary
the value of one or more parameters in a systematic way
and look for the one that gives you the best fit. That can
be tedious, but most simulators support a technique
called hill-climbing to accelerate the process. Hill-
climbing is a great time-saver in simulation work, but
there is no guarantee that it will find the best possible
value. The most common problem, is that it can
converge on a solution that is the best within a region,
but fail to find a better solution that lies farther out.
5.2.3 Combining Models
The nature of the problem you are trying to solve
and the kind of answers you are looking for influences
the kind of model chosen for business. The most
important consideration is to apply each kind of model to
the problems it is best at solving. Because the three kinds
of models have complementary strengths, many
problems are best attacked with two or more models in
combination. The best starting point is usually a
conceptual model because it provides a quick way to
identify the key information required for building a
formal model. If it is not clear based on the problem
which kind of formal model to use, consider using both
models as shown in figure 5.6. One option is to use a
mathematical model to find an optimal solution, then use

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a simulation to make sure the results are robust across
the many kinds of variability that can affect the
performance of the system.

Figure 5.6 Combining models

All three kinds of models – including conceptual
models – require special training in order to use them
effectively. The best way to start any effort to model the
supply chain is by gathering together the managers who
make the chain work, bringing in a professional
facilitator, and building a conceptual model. Once you
have that model in hand, then you can bring in specialists
to translate it into a formal model and analyze it in
further detail.
5.3 SUPPLY CHAIN SOFTWARE
5.3.1 The Manufacturing Problem
The easiest way to understand the many forms of
supply chain software is to view them in the context of
the business processes they support. Because supply
chains are concerned with moving manufactured goods,
the functions of supply chain software are a natural
extension of existing manufacturing systems. Today, the
dominant software in manufacturing companies is the
enterprise resource planning (ERP) system. The basic
flow of ERP-based planning is shown in figure 5.7. The
heart of an ERP system is a set of planning modules that
translate anticipated demand into plans for managing
supply, production and distribution. Using historical and

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expected sales as input, the distribution requirements
planning (DRP) module builds a distribution plan that
indicates how many products of each type need to be at
each location in each period. The resulting plan is passed
as input to the master production scheduling (MPS)
module. The MPS module then calls on the services of
two other modules to validate its schedule. The materials
requirements planning (MRP) module makes sure that all
the necessary materials and components can be acquired
in time and the capacity requirements planning (CRP)
module checks to see whether the available production
facilities will be able to perform the work. ERP was
developed to manage the activities within a single
production facility and it does not lend itself to planning
activities that span multiple facilities.

Figure 5.7 Modules of an ERP system

5.3.2 Advanced Planning Systems
The most important application aimed at
managing supply chain is the advance planning and
scheduling (APS) system. APS systems include a large
number of modules that can be combined in various
ways and not every vendor offers the same selection of
modules. ERP supports the planning and operations

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module while APS focuses on combining planning and
design as shown in figure 5.8. APS takes a network of
supply chain facilities as its starting point. Setting up an
APS system involves using the network design module
to enter a detailed description of the chain, including its
facilities, transportation links and other characteristics.
Once this information is in place, the planning process
follows the arrows shown in figure 5.8. First, the demand
planning module forecasts the demand for each product
in each region. The master planning module then
combines this forecast with the capabilities of the chain
as described to the network design module, developing
an overall plan for moving supplies through the chain. In
order to develop that plan, it calls on the services of three
specialized modules to analyze the impact of the master
plan on materials, production capacity and distribution
requirements.

Figure 5.8 Modules of an APS system

APS is based on mathematical models that
support optimization, including the linear programming
method. These models are used for design as well as
planning. Although APS systems offer planning and
scheduling capabilities, they don’t provide the

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operational modules necessary to translate these plans
into action. The usual solution to this problem is to link
APS systems into existing ERP systems. Several vendors
now offer APS modules that communicate with their
existing ERP modules.
5.3.3 Supply Chain Applications
Warehouse management system package focus
primarily on operations, offering just enough planning
functionality to smooth the flow of inventory through the
facility. The modules on the supply side are concerned
with automating the process of receiving incoming goods
and assigning them to the appropriate storage locations
and the modules on the demand side are concerned with
assembling outbound orders and preparing them for
shipment. The materials handling module bridges the
gap between the two sets of modules, and the yard
management module governs the movements of vehicles,
containers and inventory held in staging areas adjacent to
the warehouse.
Another important class of supply chain software
is the transportation management system. Because
transportation requirements differ across industries and
modalities – scheduling tanker ships is quite different
from tracking the locations of rail cars – transportation
systems are usually highly specialized for individual
markets. Customer Relationship Management (CRM) is
designed to integrate all customer-contact activities,
including sales, service and support. Supplier
relationship management (SRM) is the logical
counterpart of CRM. CRM and SRM are usually limited
to interactions with immediate trading partners, so they
each span only a single link in the supply chain.

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Implicit Business Models
Some of the supply chain models are explicit and
directly modifiable by users. Unfortunately, the explicit,
modifiable models used in design systems are the
exception rather than the rule. A weak model would not
be so bad if it could be modified, but systems with
implicit, hard-wired models don’t offer that opinion. The
result is that using one of these systems requires a
company to adapt its business to the software rather than
the other way around. This problem is most apparent
with ERP systems because they automate so may core
business functions, but it is also true of more recent
systems such as the CRM packages, which are based on
implicit models of how companies interact with their
customers. The presence of implicit business models in
supply chain software is a problem without a good
solution. But what are the alternatives? Supply chain
software is now so large and complex that building your
own system is rarely a viable option, and trying to run a
large chain without software is a nonstarter in today’s
fast-paced markets. The best you can do is to be aware
that implicit business models are lurking inside all
commercial software packages and carefully choose the
model that comes closest to fitting the way you do
business.
Internet-Based Systems
The biggest change taking place in supply chain
software today is the move to the Internet. The Internet
provide a vastly improved communication medium for
coordinating the movement of goods. The primary
impact of the Internet is on the speed and not the nature
of business process. Supply chain management consists

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of choreographing the flow of demand, supply and cash.
Two of these flows, demand and cash flow can be moved
entirely to the Internet as shown in figure 5.9. Orders
consist entirely of textual data that is readily transmitted
in electronic form and payments can be made using
electronic funds transfer (EFT). All the supporting
information that is passed up and down the chain –
forecasts, plans, notices and the like can be shifted to the
Internet as well. With the exception of actually shipping
the goods, every function of the supply chain can be
performed faster, cheaper and more accurately using the
Internet. The advantages are profound, and the Internet is
rapidly becoming the standard medium for supply chain
management.

Figure 5.9 Moving to the Internet

For products that consist primarily of
information, it is possible to move the flow of supply to
the Internet as well, creating a fully electronic supply
chain. Newsletters, books, designs, pictures, software,
music and other information products can be packaged
as pure data and delivered almost instantly anywhere in
the world. Not only is electronic distribution faster and
cheaper for such products, it promises to change the very
definition of what it means to deliver a product. For
example, music can be delivered each time it is listened

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to rather than being stored by the consumer between uses
and software can be continuously updated by a vendor to
reflect bug fixes and enhancements. These kinds of
changes are already taking place in many information-
based products.
To move transactions onto the Internet requires a
lot more than human-readable messages and web pages.
It requires taking people out of the loop entirely and
letting machines do all the work. The key technology for
making that happen is now in place with the advent of
XML, the extensible markup language. XML can be
used to make web pages readable by machines and it can
be used in messages to allow machines to communicate
directly with each other. Given its simplicity and clarity,
XML is rapidly becoming the common language for data
exchange over the Internet. XML can be used today in
web pages and messages, but its greatest potential lies in
allowing applications to interact over the Internet
without any human involvement. In order for this to
happen, applications need to be able to “call” each other
over the Internet, ask for particular services and receive
the results of their requests. The essential capabilities,
collectively known as Web services, are already
operational in real systems. The Internet is changing
supply chain management at every level. To date, most
of the changes have come at the operational level, with
more and more transactions taking place electronically.
As XML and Web services become widely adopted, all
the routine interactions required to run a supply chain
will shift to the Internet. Because programs will
communicate directly with other programs, these
transactions will occur below the level of human

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awareness and they will happen faster than a person
could even follow.
Conclusion
This lesson analyzes how the systems are designed,
how they work and how they are controlled. It also
discusses the mathematical model, simulation model and
the supply chain software.
Exercises
1. Explain the various relations between the input and
output systems.
2. Discuss about the three kinds of business models.
3. Write short notes on Internet based systems.

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 Lesson 6
Objectives
 To understand the fulfillment cycle
 To understand the replenishment cycle
 To understand the various supply chain measures
6.1 MEETING DEMAND
Communicating Demand
The way orders are transmitted from
customers to their suppliers has changed many times
over the years, constantly moving toward faster media,
but the information contained in orders is as old as
business. Essentially, an order answers the classic W
questions: who is doing the buying and selling, what is
being requested, where is it to be delivered, and when is
it supposed to arrive?
In the case of who, there may be just two parties:
the customer and the supplier. Specifying the what of an
order can have a complicated answer. A single order
usually requests a variety of different products, and it is
not sufficient to simply name these products. Off-the-
shelf goods must be specified using unique identifiers
such as part numbers, universal product codes (UPCs) or
stock-keeping unit (SKU) numbers. Orders for
customized goods must contain very detailed
specifications regarding dimensions, composition,
material quality and the like. Stipulating the quantities of
these products, normally a matter of just specifying a
number and a unit can also be challenge when the two
companies measure the same goods in different ways or
use different measurement systems.
The answer to the where question can also be
complex. It may be a single location or it may be

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multiple locations, with a different mix of products going
to each destination. These destinations are more than just
addresses, each can have its own receiving capabilities,
hours of operation and other characteristics. Even the
question of when can introduce complications. Although
usually specified as a simple date, delivery targets are
actually intervals of time. There is a question of whether
all the goods have to meet the same delivery date. At one
extreme, a customer can stipulate that the order is ship
complete, meaning that all the items that are currently
out of stock. At the other extreme, each item could have
its own schedule of deliveries, causing a single order to
be spread out over many deliveries.
In addition to answering the who, what, where
and when questions, an order can also address how
questions: how the goods are to be packaged, how they
are to be shipped, their form and quality on receipt and
so on. As shown in figure 6.1, an order consists of three
basic parts: a header, a body and a footer.

Figure 6.1 The structure of an order

The header specifies generic information as the
parties involved, the critical dates for the transaction and
the terms of payment. The body contains line items, each
of which specifies a quantity of product to be delivered
together with the price per unit and the extended price

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for the quantity requested after any discounts are applied.
The footer contains financial information that depends
on the content of the line items, such as the total price,
taxes and delivery charges. Some orders require an
extension to handle multiple deliveries. This form,
commonly known as a customer schedule is usually
found in JIT environments.
Processing an Order
Orders can be transmitted in a variety of forms
and can make use of several different media.
Historically, orders were either sent in the mail or
dictated over the telephone. With the invention of fax
machine, paper orders could be sent over telephone lines,
greatly speeding the delivery process. The development
of electronic document interchange (EDI) protocol
allowed companies to transmit orders in seconds over
private networks. Companies must be able to handle
orders received in most of these techniques if not all of
these modes.
The major steps in order processing are:
validation, configuration, pricing, credit check, product
check and confirmation. Ordinarily, the first step in the
process is to check all the entries in the order, to make
sure they are reasonable and valid. Many of these checks
are handled by the order management system, which
filters out such basic errors as letters in fields that require
numbers and values that lie outside of typical ranges.
The system can also make sure that the customer is
already known to the supplier and has a line of credit to
back up its orders.
The next step, configuration is required only if
the mix of products of an order is intended to be used

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together. This process typically involves two different
checks, one for compatibility and the other for
completeness. The first check makes sure that the
components will work together properly, and the second
ensures that the customer receives everything necessary
for the assembled system to function as expected. The
pricing step is often a complex process, involving a
sequence of tasks. The major tasks are:
1. Determining the correct unit price
2. Applying appropriate discounts
3. Computing the extended price
4. Calculating the additional charges
Once the order total is known, the next step is to
make sure that the customer has enough credit to cover
the purchase. In a full-featured credit management
system, each customer is assigned a maximum amount of
credit, and outstanding purchases are subtracted from
this maximum to determine the available credit for new
purchases. In the case of products made to stock, current
and planned inventory may be checked to make sure that
the product is available to promise (ATP) to the
customer. For products that are made or assembled to
order, the plant is checked to ensure that it is capable to
promise (CTP) the products. At present, the best tools for
performing real-time ATP and CTP checks are the
advanced planning and scheduling (APS) systems. The
last step in order processing is getting the order
approved. Depending on the size of the order, it may go
through an internal review and approval within the
supplier before being sent to the customer for approval.
Once the order has been confirmed by the customer, the

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demand phase is complete, and the process of filling the
order begins.
Assembling the Goods
A complex sequence of activities is required to
prepare an order for shipment. The same activities occur
when pulling inventory from factories, stockrooms and
other storage locations. All of these activities are
supported electronically by warehouse management
systems. Most of the warehouses are organized into five
different areas: a receiving dock, a bulk storage area, a
picking area, one or more assembly areas and a shipping
dock. Each area is dedicated to a different function and
has specialized equipment to support that function.
Warehouses use both push and pull dynamics to control
the flow of stock from the receiving dock to the shipping
dock, with the push-pull boundary located at the picking
area. When it is time to ship an order, the warehouse
management system generates a pick list indicating the
quantities of each item included in the order. With
relatively small, lightweight items, picking is usually
done by hand. For larger products, pickers use hand
trucks, motorized loaders, or other equipment to gather
and move stock. In some facilities, conveyor systems
move the stock, automatically routing packages to their
destinations.
Once the stock is in the assembly area, other
workers perform any final operations that might be
needed to prior to shipment. After the order is
assembled, it is packaged for shipment. Depending on
the product, there may be up to three levels of
packaging. The primary package is the box, can, blister
pack or other container that holds the actual product. The

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secondary packaging is usually a carton that groups a
standard number of primary packages together for
convenient handling. The third layer, the transport
packaging, is usually a pallet in combination with a
protective covering such as a polyurethane sheet. Large
shipments of a product are normally loaded onto full
pallets, which contain only one kind of product. For
smaller shipments, the various products going to a single
destination are loaded onto mixed pallets.
Shipping the Order
The basic problem to be solved is finding the best
route to take from the supplier’s warehouse to the
destination facility. When customers order in full
truckload (FTL) quantities, routing is usually a simple
matter of finding the shortest path between two points.
The main problem with FTL shipments, however is
figuring out what to do with truck once it has made its
delivery. Because driving it back to the warehouse empty
is a waste of fuel and driver time, companies are
constantly looking for backhauls, which are shipments in
the opposite direction that make use of the capacity
provided by the truck.
A special problem arises when orders require
shipments from multiple facilities. The simplest solution
is to make the shipments independently but coordinate
them such that they arrive on the same day. The
alternative is a merge in transit, in which the multiple
shipments are sent to a distribution center close to the
customer site, reloaded onto a single truck and sent on as
a single delivery. The most cost-effective way to achieve
this is to use a technique called cross docking, in which

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goods are moved directly from a receiving dock to a
shipping dock without intermediate storage.
One of the biggest challenges of shipping is
tracking orders while they are in transit from a supplier
to a customer. Part of an efficient tracking system is
automating the entry of information regarding each
shipment. Not only does this save time, it dramatically
reduces errors.
Collecting the Cash
Once an order has been delivered to the
customer, the third and final phase of the fulfillment
cycle begins, getting paid. The first step in this process is
determining the actual amount due. Once the amount due
has been determined, the supplier generates an invoice
for that amount. Invoices have to reference the
customer’s purchase order, the supplier’s sales order or
both. In an ideal world, all invoices would be paid
promptly and accurately. In the real world, customers
usually take as much time to pay as they can get away
with because this gives them the use of the cash in
interim. If the customer does not pay within the time
allowed, the next step is to include the balance due on a
monthly statement with a reminder of past due amounts.
The task of collecting payment is simply delegated to the
accounting department, which applies its own policies
and procedures for collecting payments.
Accelerating Fulfillment
In light of all the operations necessary to fill an
order, it should come as no surprise that so many
companies have trouble with fulfillment. These problems
tend to frustrate everyone involved in fulfillment,
including not only your customers but also the people in

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your company who serve those customers. Expediting
individual orders is clearly not the best way to solve the
fulfillment problem, but finding a better way to fix these
problems can be a challenge. Many companies have
applied the techniques of business process reengineering
to improve their fulfillment process, but usually with
limited success. The problem they ultimately come up
against is that the practices that make fulfillment slow
and complex are difficult to change, in part because
customers have come to expect a certain way of doing
business.
The alternative to incremental improvement is
radical change, simply throwing out the old way of doing
business and coming up with a dramatically streamlined
process. Making radical changes clearly requires deep
changes in the nature of your relationship with
customers. Changes like these have to come as part of a
larger package that redefines the relationship, and the
package has to be attractive to both parties. For example,
instant payment is one way to compensate JIT suppliers
for the extra cost associated with making frequent, small
deliveries.

6.2 MAINTAINING SUPPLY

Triggering Replenishment
Each time a facility fulfills an order, it reduces its
inventory of finished goods. Sooner or later, that
inventory has to be replenished. There are several
options for deciding when to replenish inventory. One
solution is simply to wait until the current inventory is
exhausted. Attractive as it might be, the zero-inventory
solution is rarely an option because customers want to

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take delivery faster than the replenishment lead time.
Then a facility has to order stock in advance of demand
and keep enough on hand to fill orders and place a new
order wile it still has enough stock to avoid running out
before the order arrives. This monitoring can take one of
two forms, called periodic review and continuous
review. With a periodic review policy, inventory is
counted at fixed intervals and an order is placed
whenever the count falls below a preset reorder point
(ROP). Under a continuous review policy, the count is
monitored at all times and an order is placed as soon as
the count hits the reorder point.
Under both review policies, inventory levels
describe a sawtooth pattern over time, with gradual
declines as inventory is consumed followed by sudden
jumps when replenishment stock arrives. With
continuous review, a new order is triggered whenever the
stock reaches the reorder point. Stock continues to
diminish during the replenishment lead time, but the
reorder point is set high enough to minimize the
frequency of stockouts, in which sales are lost due to
lack of inventory. The periodic review policy produces a
similar pattern, but orders wait until the next inventory
count occurs rather than being placed immediately.
Although continuous review is more efficient
than periodic review, it is also more expensive because it
requires an accurate inventory count at all times.
Historically, periodic review was the preferred method
because it avoids this added expense. However, there are
ways to get the benefits of continuous review without the
cost of constant counting. The ability to switch from
periodic to continuous review is good example of how

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information can replace inventory, producing substantial
savings.
Determining Order Quantity
The decision of the amount of quantity to be
ordered with each replenishment is dependent on the
relative costs of placing an order and holding inventory.
The order cost is the basic cost of placing and receiving
an order, independent of the quantities involved. The
holding (or carrying) cost is the cost of stockpiling
inventory in advance of consuming it. It includes the
costs of storage and handling, the opportunity cost of the
capital tied up in the inventory, the loss of value due to
obsolescence or spoilage and the cost of insuring against
risks such as fire and theft. A quantity at which the sum
of these two costs is minimized, can be found using a
mathematical model known as the economic order
quantity (EOQ). Holding costs increase linearly with
quantity, while order costs decrease inversely with
quantity. The total of these two costs drops with
increasing quantity and then rises again. The lowest
point on this curve is the EOQ, and it is easily calculated
using standard formulas.
Maintaining Safety Stock
In reality, the number of units sold varies from
day to day, shipments are delivered late, and goods
arrive in an unusable condition and so on. If any of these
events cause a stock out, customer orders go unfilled.
There is no margin for error in the basic EOQ model.
The standard solution to this problem is to hold excess
inventory, safety stock that is used to avoid stockouts
when demand is greater than expected or supplies arrive
late. A company needs to maintain enough inventory to

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support its normal operations, a quantity known as the
cycle stock plus enough safety stock to cover variations
in supply and demand. Given that stockouts can’t be
eliminated altogether, the best that safety stock can do is
reduce stockouts to an acceptable level. The standard
procedure is to set a target level of product availability,
called the customer service level (CSL), then adjust the
safety stock to meet that level.
Streamlining Replenishment
Replenishment has become increasingly complex
over the years, producing corresponding increases in the
time, cost and errors associated with the process.
Collaborating with suppliers to integrate operations and
streamline replenishment is a significant undertaking,
and the effort should be reserved for suppliers that
provide critical materials, such as custom components
and standard items that subject to shortages. Historically,
commodity suppliers were selected by digging through
stacks of catalogs to find out who offered the required
products, checking price books to compare costs, sorting
through flyers to see whether anyone had a promotion in
progress and calling the supplier to check availability.
Today, searchable electronic catalogs on the Web reduce
the time and tedium of this process to a fraction of its
former level, significantly reducing order costs for
catalog purchases. These catalogs become even more
useful when they are incorporated into electronic
exchanges, Web-based marketplaces in which buyers
and sellers conduct business without having to leave
their desks even pick up their phones.
Although most exchanges work from the prices
set by suppliers, some host electronic auctions, in which

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supplies are sold to the highest bidder. In a normal
auction, suppliers post products on the exchange, and
customers post bids indicating how much they are
willing to pay for those products. At the end of the
bidding period, the exchange automatically compares the
bids and notifies the bidders of the outcome. In reverse
auction, the roles are switched: customers post requests
for quotes (RFQs) for specific products, suppliers submit
bids and the sale goes to the lowest bidder rather than the
highest.
Public exchanges require only that participants be
qualified to buy and sell the materials handled by the
exchange, and they are usually hosted by independent
organizations that specialize in managing a market.
Private exchanges are accessible to companies that have
been approved for membership, and may charge a fee for
use of the exchange. Private exchanges can be
independent organizations or they can be hosted one or
more of the trading parties. In the latter case, they are
sometimes referred to as captive exchanges.

6.3 MEASURING PERFORMANCE

There are four broad categories to measure the
performance of supply chain: measures of time,
measures of cost, measures of efficiency and measures of
effectiveness.
Measuring Time
Time is the easiest measure to capture because it
involves nothing more than taking two readings and
performing a subtraction. The times of greatest interest
in supply chains are process times, which measure the
amount of time required for key business processes to

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run from initiation to completion. The processes
involved can be measured on any scale from seconds to
months. The overall fulfillment can be broken down into
component processes dealing with the supporting flows
of demand, supply and cash. The primary concern is with
the fulfillment lead time, which is the sum of the first
two phases. The third phase is usually handled by the
accounting department, where it is measured indirectly
in the aging of accounts receivable. In the replenishment
process, the primary concern is with replenishment lead
time, which is measured from the time a request for
goods is submitted for purchasing to the time those
goods are available for use.
Times that are not directly tied to a single
business process are usually referred to as intervals. One
such interval is the time that elapses between orders from
a particular customer, a measure that might range from
hours in a JIT environment to weeks in a traditional
production operation. Another interval of interest is the
cash-to-cash time, which is usually measured in days.
The third interval, machine cycle time raises the question
of how the popular measure of cycle time fits into the
framework. Originally, cycle time referred to the interval
between repetitions of a periodic process, which is not
necessarily the same as the duration of that process.
Another approach to measuring times is to invent
them and express them as speed, which is a distance
divided by a unit of time. When speed takes on a
particular direction, it is called velocity. Recently,
inventory velocity has become the term of choice for
describing the speed at which material flows through a
supply chain and the current emphasis is on finding ways

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to increase that velocity. The last type of measure is
throughput, which is defined as units of work divided by
a unit of time. This type of measure is really a variant of
speed, but it is concerned with how quickly work is
performed rather than how quickly something moves.
Measuring Cost
Direct costs, the first type of cost, are those you
can attribute directly to the production of finished goods.
This category includes the cost of raw materials together
with the cost of the processes necessary to acquire these
materials, transform them into finished goods and deliver
them to customers. Indirect costs, the second type, are
those that are necessary to run your company but that
can’t be attributed directly to the creation of a particular
product. These include the costs of purchasing and
maintaining the equipment used in producing goods, the
costs of building and operating the facilities that house
this equipment and the costs of running all the support
organizations that are essential to a manufacturing
enterprise. The most systematic approach to allocating
indirect costs is activity-based costing (ABC). In this
approach, indirect costs are allocated to products by way
of activities and the resources they require.
A third kind of cost is the expense attributable to
errors in supply chain processes. These errors include
incorrect quantities, invalid product substitutions,
inaccurate prices, inventory stockouts, late shipments,
deliveries to the wrong location, damaged goods and
missing items. Like all measures, costs can be expressed
either as a simple number or as a ratio to some other
number, usually a measure of time or work.

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Measuring Efficiency
Costs, although critical to supply chain
performance, fail to capture an important aspect of
supply chains: the efficiency with which a chain utilizes
its resources. Of the many assets required for supply
chains, inventory usually receives the most attention
because it inflicts such a heavy financial burden. Several
measures are used to monitor inventory levels, including
current and average counts, but the most widely used
measure is the inventory turnover ratio, also called
inventory turns. The turnover ratio for a product is the
annual sales of that product divided by the average
quantity on hand. Sometimes, it is both easier and more
precise to measure inventory in terms of days on hand,
the number of days the inventory would last for is given
normal consumption. If you reduce the amount of
inventory you keep on hand for a given product,
individual items in that inventory move through the
chain faster. A number of studies indicate that, despite
attempts to accelerate inventory movement, products in
the pipeline still spend the majority of their time sitting
around.
The second type of efficiency measure deals with
the use of fixed capacity such as facilities and
machinery. The most important measure is the load,
which represents the percentage of capacity that is in use
at any time. The third kind of efficiency measure is
concerned with the use of capital, which is particularly
important because it is the medium for acquiring other
resources. The most common measure for assessing the
efficient use of capital is the return on investment (ROI)

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ratio, obtained by dividing net profit by the capital
required to produce the profit.
Measuring Effectiveness
When efficiency is critical to profitability, it is of
little value unless it is accompanied by another quality:
effectiveness. Unlike efficiency, which is concerned with
the economical use of resources, effectiveness reflects
how well a process achieves its business objectives.
Effectiveness is a concern for all the processes involved
in replenishment, production and fulfillment, but the
fulfillment end of the business usually receives the most
attention because it is the most visible to customers. The
most important measures of effectiveness are concerned
with customer service levels. Customer service can be
measured in a variety of different ways. In years past,
customer service level (CSL) was usually defined in
terms of proximity, the percent of customers within 400
miles of a warehouse, say under the tacit assumption that
holding inventory close to the customer was tantamount
to good service. A more common measure today is the
on-time delivery rate, the percentage of orders that arrive
at the customer site within a certain time limit. However
it is defined, the CSL metric can be applied in two ways:
sometimes it is a measure, and other times it is a
constraint.
Maintaining good fill rates and delivering orders
on time are vital to good customer service, but it is
possible to hit target levels for these metrics and still
have problems with fulfillment: items may be shipped
that weren’t ordered, products may be incorrectly labeled
or packaged, the order may be priced incorrectly,
supporting documentation may be missing, goods may

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be damaged in transit or the entire order may arrive
precisely on time in perfect condition at the wrong
location. To help control these kinds of errors, many
firms are now adopting a perfect-order measure as their
standard of customer service. The other way to measure
effectiveness is to measure customer satisfaction, which
can be monitored either passively or actively. The
ultimate measure of effectiveness of course is customer
retention.
Conclusion
This lesson explains the fulfillment cycle from
processing the order to getting paid. The replenishment
cycle and the various supply chain measures are also
analyzed in this lesson.
Exercises
1. Explain the major tasks involved in processing an
order.
2. Write short notes on safety stock.
3. Elaborate any two supply chain measures.

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 UNIT – IV
Lesson 7
Objectives
 To understand demand forecasting
 To understand the production planning and
movement of goods across the supply chain
 To find out the business objectives to improve
the performance of supply chain

7.1 FORECASTING DEMAND

Projecting Trends
For a product with a known sales history, the best
guide to future sales is past performance. Using the
techniques of time-series analysis, you can apply
standard formulas to analyze a sales history, extract
information about recurring patterns, and use those
patterns to project sales into the future. Time series
techniques can be as simple or as sophisticated as you
like. For a product with a flat sales curve, your forecast
is just the past month’s sale. For products that show a
simple trend over time, it may be sufficient to use a
moving average to predict the next month’s sale. But if
you want to forecast sales further into the future than the
next month, then you need to use the full model. This
model analyzes a sales history into four distinct
components:
1. The level component is a single value that
represents average sales. All other components
are variations around this level.
2. The trend component is a straight line that
reflects the overall tendency for sales to increase
or decrease.

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 3. The seasonal component is a curve that captures
the rise and fall in sales over the course of each
year.
4. The random component represents all other
variation in demand, regardless of its cause, and
has no systematic pattern over time.
The first three components are called the systematic
components of demand because they behave consistently
over time and can be predicted. Each of these
components is represented by a parameter in the time-
series model. When you run a time-series analysis, the
model first estimates these parameters by adjusting them
to fit the historical sales data as closely as possible, then
uses its estimates to project future sales.
The most distant period for which you generate a
forecast is called the forecast horizon. Given the way the
time-series model works, you can set the forecast
horizon as far in the future as you like. You can increase
the accuracy of your forecasts substantially by updating
them continuously based on current sales, a technique
known as dynamic forecasting. In years past, when
forecasting was done by hand, the more common
practice was static forecasting, in which a forecast was
generated and then used as is through the forecast
horizon. Now that forecasting is fully automated, most
companies use dynamic forecasting.
Aggregating Demand
In practice, you would generate forecasts for
individual products only in special situations, for
example, when you are deciding whether to introduce a
new product or enter a new market. Setting those
situations aside, the cost of generating separate forecasts

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for thousands of different products would be prohibitive,
and the standard procedure is to group similar products
together when making forecasts. This technique called
aggregation might seem like it would degrade the quality
of the forecasts because it would ignore differences
among the individual products. These aggregate
forecasts, as they are called, are actually more reliable
because they are based on larger samples of customer
behavior.
In addition to aggregating demand across
products, forecasts also aggregate demand across
customer type, geographical region and other factors.
One of the most important considerations for aggregating
products into groups is the overall level of sales. It has
long been recognized that in most companies, a handful
of products account for the majority of sales. This
phenomenon is known informally as the “80:20 rule”,
which states that 80% of sales come from 20% of the
products. A more forma technique, called Pareto
Analysis, uses three categories, with a breakdown of
80% A products, 15% B and 5% C. In addition to
reflecting the classic 80:20 rule, Pareto Analysis also
expresses the observation that half the products of a
company usually account for 95% of the company’s
sales.
Analyzing the Future
In situations where time-series analysis is not
enough, forecasting requires the use of old-fashioned,
cause-and-effect reasoning. This reasoning generates
numbers, and it may involve a formula or two, but unlike
time-series analysis it is much more art than science, and
its methods are not nearly as well established. These

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techniques are known as subjective or judgmental
techniques.
The general approach for subjective techniques is
to consider all the business influences that might affect
future sales, estimate their individual effects, and then
combine them to form a prediction. Most of these
influences are extrinsic factors because they lie outside
your immediate control. The extrinsic factors include the
state of the economy, the characteristics of the market
for the product being forecast and the needs and wants of
the customers who will buy the product. Intrinsic factors,
such as your own decisions about pricing and
promotions also play a role.
The major effect of general economic factors is
to act as a multiplier on sales: A robust, expanding
economy generally increases sales, and a weakening
economy reduces sales. Market factors are harder to
incorporate because they interact in complex ways.
These factors include changes in the size of the market,
the actions of competitors and the effects of changing
styles and fashions. The best way to predict changes in
market size and share is to apply trend analysis
techniques from statistics and use the results to adjust
sales forecasts.
The most critical set of extrinsic factors are the
requirements and objectives of the target customers for a
product. The only intrinsic factors are the actions of your
own company with regard to the positioning, pricing and
promotion of your product. Because there are so few
intrinsic factors compared to extrinsic factors, you need
to use them to full advantage to influence demand.
Exactly how you use them depends on your supply chain

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strategy. The biggest challenge in demand forecasting is
predicting the sales of a product that breaks new ground.
The difficulties in forecasting innovative products lie in
predicting how soon a product will enter its growth
phase, how quickly sales will take off and how high they
will eventually go. One reason that predicting the sales
of innovative products is so difficult is that the behavior
of sales levels over time can be extremely complex.
Integrating Forecasts
A good way to improve the reliability of demand
forecasts is to have multiple analysts generate forecasts
independently and then combine their results. The
problem here is figuring out how to integrate the
forecasts in a meaningful way. One solution is simply to
average them all together, but this can be risky. Just as
aggregating across seasonal products with different
packs can cancel out the effects of seasonality, averaging
independent forecasts can mask patterns that are evident
in each forecasts but that don’t align precisely across
forecasters. The better approach is to try to understand
the reasoning behind each forecast and somehow
combine the reasoning rather than just the numbers.
Combining forecasts to gain consensus is
difficult within a single department, but the problem
becomes harder still when forecasts are generated by
different departments. If combining forecasts across
departments is too difficult for most companies, it should
come as no surprise that fewer still take the next step and
integrate forecasts with those of other companies in the
supply chain. Yet the failure to do so is one of the most
pernicious problems in supply chain management
because it impairs both the efficiency and the

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effectiveness of the entire chain. A bit of reflection on
where demand ultimately comes from suggests a much
better approach. When a supply chain is viewed as a
whole, there is only one true source of demand: the
consumers of final products. All other demand for raw
materials, subassemblies, intermediate products and the
like ultimately derives from consumer purchases. To
reflect this distinction, consumer demand is known as
independent demand. All of the purchases made by
companies upstream of consumers depend in some way
on consumer’s choices, so these purchases are called
dependent demand. The modern view of forecasting is
that only the independent demand should be forecast,
and that all other demand should be derived from these
forecasts.
Collaborative forecasting neatly addresses the
following problems: first, duplication of effort is
eliminated, often reducing the overall forecasting effort
by 80% or more. Second, there is no cascade of errors up
the chain to distort demand. The most dramatic benefit,
however, is the improvement of forecasting accuracy
that results from sharing knowledge about consumer
behavior. There are many obstacles to collaborative
forecasting. Sales forecasts are usually considered highly
confidential, and sharing this data requires a degree of
trust and openness that simply is not compatible with the
adversarial relationship that has long characterized
customers and suppliers. But the competitive advantages
of integrating the supply chain are driving deep changes,
and the long-standing barriers to cooperation are
decomposing in the wake of JIT, quick response,
continuous replenishment and other industry programs.

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The time for collaborative forecasting has arrived, and
most companies seem ready to accept it.
7.2 SCHEDULING SUPPLY
Planning with ERP
Supply chain planning starts with a conceptual
model of what has to be done, determines the time
required by each component process, and then schedules
each process in a way that completes the sequence at the
right time. At the broadest level, meeting demand
consists of three core processes: procuring the necessary
materials, producing the goods and distributing them to
customers. There are two broad approaches to
scheduling, called forward scheduling and back
scheduling. Forward scheduling begins with a start date
and adds processes in the order they will be executed,
scheduling each process to start as the preceding process
completes. This kind of scheduling is most appropriate
when the start date is known and the completion date has
to be determined from the results of the scheduling
effort. When a company has a required completion date
and needs to figure the necessary start date, the back-
scheduling approach is the more natural choice. Back
scheduling aligns the completion of the last process with
the target completion date, then adds processes in reverse
order of their execution. ERP systems, the operational
foundation of contemporary manufacturing are based on
the back-scheduling approach.
The first step of an ERP run is to feed a demand
forecast into the DRP (distribution requirements
planning) module, which works backward from the
required delivery dates to figure out when finished goods
need to be shipped. DRP passes the required shipping

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dates to the MPS (master production scheduling)
module, which determines when the required raw
materials have to be ordered. The last module in the
chain, the CRP (capacity requirements planning)
module, determines when the necessary labor and
equipment will have to be available to perform the work.
The operation of these modules is complicated by the
fact that each product in the demand forecast is normally
composed of multiple raw materials. In order to handle
these complications, products are described in terms of
two documents, which are stored in electronic form by
the ERP system and accessed by the planning modules as
required. The bill of materials (BOM) is a nested list of
all the raw materials that go into the product, structured
according to the subassemblies of the product. Similarly,
the bill of operations (BOO) uses its own nested
structure to describe the sequence of operations
necessary to create each component of the product.
The first two modules in the planning sequence,
DRP and MPS, are entirely driven by requirements. That
is, these modules work backward from the necessary
completion dates to calculate when purchasing and
production should begin without regard for the feasibility
of those starting dates. Once the plan moves to the MRP
and CRP modules, however, purchasing and production
constraints enter the picture and these modules may
discover that the necessary resources can’t be in place at
the required time. If this happens, human planners
examine the problem and look for ways to solve it.
ERP systems assume that you already know what
you want to produce and they are not much help when it
comes to making decisions about how to prioritize

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production when demand exceeds supply, how to find
the most cost-effective mix of products for each plant
given local demand and selling prices and other
questions of this nature. Fortunately, the newer
generation of APS systems can do these things and more,
making them an excellent complement to ERP’s
powerful scheduling abilities.
Optimizing with APS
Advanced Planning and Scheduling (APS)
systems are similar to ERP systems in that they have
separate modules for planning procurement, production
and distribution, but the way those modules interact to
produce a master schedule is different. Rather than
taking a demand forecast as an input, most APS
packages include a demand planning module to generate
that forecast for you. The demand planning module
passes its forecast to a master planning module, which
calls on the services of three subordinate modules to
work up the best plans for purchasing, production and
distribution.
All three of these specialized planners work on
the problem concurrently, feeding tentative plans back to
the master planner as those plans take shape. The master
planner combines that feedback to reduce the set of
possible plans, then requests a revised set of plans from
its subordinates. This iterative process continues until the
master planner identifies the most cost-effective plan for
meeting expected demand. Once the human planners
approve this master plan, the modules responsible for
materials, production and distribution pass their plans on
to another set of modules that produce detailed schedules
for purchasing, production and distribution operations.

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 A powerful feature of the APS planning model is
that changes can propagate in both directions. The reason
APS systems are able to find the most cost-effective
production plan is that they use mathematical models to
calculate optimal solutions. Another attractive feature of
APS systems is that they respond intelligently to
situations in which there are not enough materials,
production capacity or distribution options to handle the
required load. APS allows you to automatically prioritize
orders and also find the most profitable mix of products
for any given plant. Gaining the advantages of APS does
not require giving up your existing ERP system. In order
to use APS in combination with ERP, you need to set up
data linkages so that the systems can interact with each
other.
Validating with Simulators
Although the models used by APS are superior to
those of ERP, they are still limited in important ways.
Fortunately, simulation models are entirely free of these
restrictions; they can represent even the most complex,
nonlinear relations, and they can accommodate any
degree or type of variability in parameter values.
Because simulators incorporate variability by running a
series of Monte Carlo trials, they produce distributions of
expected values for each output rather than just a single
number. The reason distributions are so important is that
variability in supply chains translates directly into risk,
and one of the goals of planning is to reduce risk. In
addition to helping you manage risk, simulations offer
other important benefits. Simulation models generally
stick much closer to the underlying conceptual model
than do the more abstract models used in ERP and APS

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systems. Furthermore, simulators include graphical
animation tools that display the conceptual model on a
computer screen during both design and execution.
Despite these benefits, simulation is not a
replacement for either APS or ERP. Although simulators
can improve a supply plan using the techniques of hill-
climbing, they lack the ability to seek out optimal
solutions the way APS systems do. Simulators also lack
the ability to generate the detailed schedules of ERP, and
they offer none of ERP’s support for day-to-day
operations. In the case of supply planning, one of the
most effective strategies to use a combination of ERP,
APS and simulation systems. In this approach, your
planners use the APS system to develop an optimal plan,
then use a simulator to fine-tune that plan to handle the
effects of variability, non-linear relations and other
factors beyond the scope of APS. They then pass this
tuned version of the master plan on to the supporting set
of ERP systems for detailed scheduling and operations.
Integrating Schedules
The scheduling techniques are designed to help a
single company plan its production operations,
integrating plan across multiple facilities as necessary to
produce a coordinated flow of goods. There remains the
problem of integrating production plans across multiple
companies in the supply chain, smoothing the flow of
goods between as well as within companies. This
problem is directly analogous to shared forecasting:
when companies plan their production operations
independently, they engage in a great deal of redundant
effort and the likelihood that their separate plans will

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mesh correctly when they are executed is effectively
zero.
Each company generates its plans for what it will
buy, make and sell in the coming months. Because two
of these three activities involve interacting with trading
partners, each company’s plans include implicit
predictions about what those other companies will be
buying and selling during those same months. The
supplier is holding extra stock of its finished goods to
cover unexpected demand on the part of the customer,
and the customer is holding extra stock of those same
goods to cover unexpected shortages on the part of the
supplier. This redundant buffering is an example of how
standard practices can lead to lose-lose situations
between trading partners. The insurance represented by
safety stock is being paid for twice over, which
inevitably raises the total cost of the delivered goods. If
trading partners did nothing more than agree on the total
level of risk and divide the necessary buffer between
them, they could at least get this aspect of their
relationship back to the win-lose line. This cost reduction
can be achieved even if there is no reduction of
uncertainty in the quantity of goods that will flow across
the link.
In one respect, collaborative supply planning is
easier than you might expect because it uses the same
tools and techniques as internal planning. In particular,
APS systems provide an excellent platform for
integrating plans across companies, and supply chain
simulators give trading partners the ability to build shard
models of how their supply chain works today and how
they could work better in the future. In the most basic

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form of joint planning, each pair of adjacent trading
partners produces a common plan for the goods that will
flow between the two companies. A much better solution
is to expand the joint planning effort to include multiple
links in the chain. At present, collaborative planning
across ownership boundaries is the exception rather than
the rule. At the technical level, posting and updating
shared plans requires a common communication medium
and standard protocols for exchanging production data.
The internet provides the necessary medium, and
standards based on XML are beginning to emerge.
7.3 IMPROVING PERFORMANCE
Setting Objectives
You need a clear and coherent set of business
objectives to guide your attempts to improve your supply
chain. If you don’t know what you want to accomplish,
no amount of measurement will solve the problem. Once
you have set your objectives, measuring progress toward
these objectives is straightforward. The first step is to
choose an appropriate set of measures for tracking your
progress toward each objective. For each measure you
select, you need to take a baseline reading to determine
your current performance, set a target level for your
future performance, and then take periodic readings to
monitor progress toward that target. If you want to
improve the efficiency of your fulfillment process, you
may decide to measure fulfillment lead time, order
processing cost, and the number of orders per customer
service representative. This would attack the problem
from three different perspectives: time, cost and
efficiency.

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 Using multiple measures for each objective can
help ensure that your company is actually improving its
performance rather than just making its numbers. You
have to look for patterns in the way related measures
change over time. The fact that multiple measures may
be required for each objective underscores the
importance of tackling a reasonable number of objectives
at any one time. Another key to successful improvement
is setting a realistic, achievable target for each measure.
There are three common ways of setting targets for
objectives: going for a percentage improvement over the
current performance, benchmarking yourself against the
competition and using formal models to discover
opportunities for improvement. Another attractive aspect
of industry benchmarks is that they reveal the spread
among the competition and larger spreads generally
translate into bigger opportunities. The least common
technique for setting targets is using formal models,
which is unfortunate because this approach can be the
most revealing of the three. If you use an APS system or
a simulator to model your supply chain and search for
optimal solutions, you may find that you have the
potential to achieve breakthrough performance in an
unsuspected area.
Avoiding Conflicts
Once you have chosen your measures and set
their targets, the actual values you record will give you
continuous feedback on how you are doing on your
objectives. In principle, as long as each measure is
moving in the desired direction, you should be seeing
steady improvement in your supply chain. In practice,
however, objectives often conflict with each other, so

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that progress toward one objective takes you further
away from another objective. This problem of
conflicting objectives can be particularly hard to detect
in supply chains because different groups within the
company may set their own objectives without ever
realizing that they are creating conflicts. However, if you
fail to detect and eliminate these conflicts, your company
will work against itself, exerting greater effort but
reducing its ability to make any real progress.
Instead of guiding the company on a steady
course of improvement, the incompatible objectives of
different departments like manufacturing, purchasing
and sales, create a chronic tension that pulls the company
in different directions. Clearly, the only way to make any
real progress is to align objectives across all the groups
involved in managing the chain. One approach to solving
this problem is to find single, common objective and
map all other objectives back to it. The obvious
candidate for this common objective is profit; if
achieving an objective reduces profits rather than
increasing them, then it may not be such a good
objective.
In fact, it is helpful to think of objectives as being
on three levels, corresponding to the three levels of
management: operations, planning and design. Mapping
objectives to profit is simple in principle, but in practice
it can quickly become so complex that the only way to
understand the joint impact of objectives on profit is to
model the chain with these objectives in place and watch
what happens. There is a slight conflict in that increasing
the price beyond a certain point discourages buyers and
reduces the sales volume, as indicated by the negative

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link between price and volume. This means price has
conflicting effects on revenue: at low prices, increasing
the price increases revenue and at higher prices
increasing the price decreases revenue. The point where
the profits reach a peak would, of course, be a good
practice to actually put on the product. Every manager
knows that price involves a tradeoff between profit per
unit and the number of units sold. But the model gets a
bit more interesting with the addition of a few objectives.
Aligning Incentives
Improving the performance of your supply chain
involves using formal models to find the performance
levels that maximize profit, setting objectives for moving
toward these levels and taking systematic measurements
to track your progress. This picture of success is nearly
complete, but there is still a large piece missing:
motivating your people to achieve these objectives. You
have to provide incentives that reward people for making
the right kinds of choices and the incentives have to be
powerful enough to produce significant changes in
behavior.
To date, incentives have not been handled very
well in supply chain management. Employees often
receive incentives that are at cross-purposes with
corporate objectives and their incentives are rarely tied
to supply chain performance. Instead of basing sales
commissions on total sales, you can base them on
contribution to profit. Not only this would the bottom
line, it could help motivate your sales force to support
profit-oriented initiatives that they might otherwise
resist, such as raising prices on products that don’t cover

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their costs or keeping inventories of finished goods
within reasonable bounds.
Incentive alignment is a complex discipline with
robust mathematical foundations, but the business
message is simple: you have to make sure that
everyone’s personal win is consistent with your
objectives as a company. With the addition of this
missing piece, alignment of incentives across the
organization the picture is complete. Getting the
maximum performance out of your company requires
four distinct steps. First, use business models to identify
the combination of performance targets that maximizes
profits. Second, set achievable objectives that bring your
company closer to its ideal configuration. Third,
motivate your people to strive for these objectives by
making their incentives contingent on hitting the targets.
Fourth, set up a systematic program of measurement to
track your progress on each objective.
Improving Planning
Planning processes also need improvement in
your chain. You can increase your customer service level
by holding inventory closer to your customers, but that
requires higher inventory levels, so it just trades one
operational objective off against another. On the other
hand, if you can increase your ability to forecast your
customers’ requirements and schedule supplies to arrive
just as they are needed, you may be able to improve
customer service while reducing total inventory. That
would be a win on both measures. Meeting the goal
requires two different measures, one to monitor the
magnitude of forecasting errors and another to monitor
their bias. Both of these measures are calculated from a

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set of comparable predictions, such as the set of forecasts
for a particular product across different sales territories.
Forecasting experts have several good statistics
for analyzing the magnitude of errors, but for
management purposes your best bet is probably the mean
absolute percentage error (MAPE). The MAPE tells you
how many percentage points your forecasts tend to be off
the mark, regardless of whether they are too high or too
low. By monitoring the MAPE over time, you can see
whether you are making any progress in reducing the
size of errors, or make sure that a reliable forecasting
procedure doesn’t go bad on you. For monitoring the
bias of forecasting errors, the tracking signal is a good
choice for managers because, like the MAPE, it
expresses bias in standard units that don’t depend on
sales volumes. When there is no bias, the tracking signal
is zero. A positive signal means that most errors
occurred because demand exceeded the forecast, whereas
a negative signal means that demand fell below the
forecast.
Forecasters set thresholds on these measures and
let their forecasting systems call their attention to
forecasts that go out of bounds. If the magnitude goes
out of bounds and you are basing your forecasts on
market research, you may be able to improve the
reliability of your data by increasing your sample sizes.
The breakdown of a forecasting method is not always
bad news. Suppose you have been successfully running
averages for a number of years, but now the error
component is getting larger each month. That just means
that the demand for that product use do be static but is

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now increasing, and you need to add a trend component
to your forecasting model to accommodate the increase.
Forecasting and scheduling are usually treated as
separate activities and are carried out by different
groups, but there is a natural continuity between the two
in which the forecasting process flows smoothly into the
scheduling process. Although it is not common practice,
another helpful technique is to use the analysis of
forecasting errors to improve the quality of the
scheduling process.
7.4 MASTERING DEMAND
Knowing the Customer
With contemporary software, designing a supply
chain is vastly easier than it used to be. Rather than
laboriously calculating distances, costs, times, order
sizes and other quantities, planners can now use software
to generate these values automatically, based on a
geographical analysis of demand and supply. With these
powerful new tools in hand, supply chain managers can
focus their attention on the high-level tasks of analyzing
demand, defining objectives and identifying constraints.
The starting point for this process is performing a
geographical analysis of demand. This analysis can be as
simple as plotting customer locations on a map or as
complex as combining consumer profile data with
population density figures stratified by income and other
characteristics. If your customers are large companies
and you only have a few dozen of them, you can work
directly with individual customers’ locations. If your
customers number in the thousands, you will need to
group them into service regions and use the data for the
regions in the analysis. There are various techniques for

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allocating customers to regions, but the easiest way is to
use postal codes.
In addition to analyzing the volume and type of
products that customers buy, it is important to examine
their actual buying patterns. The analysis should focus
on five major factors: the total volume of product that
customers purchase per period, the frequency of orders,
the lot sizes within each order, the variety of products
included in each order and the customer service level
(CSL) required to keep them happy. Analyzing the
customer service level (CSL) requirements of individual
customers can help you identify opportunities for major
savings in your supply chain. Once you have analyzed
your customers with regard to their buying patterns, the
next step is to look for correlations between how they
buy and where they are located. The common practice of
defining regions based on the number of customers in
each area works only if demand is fairly evenly
distributed across customers. This is often the case when
the customers are end consumers, but it is rarely the case
when they are companies.
Your customer base is sufficiently homogeneous
that a simple breakdown of demand by region captures
all the information you need. More likely, your
customers will fall into a relatively small number of
types based on their habits and requirements. Assume
that your analysis reveals fall into three broad segments,
which you designate as Types A, B and C in keeping
with their corporate personalities. If you design a single
supply chain that treats all three groups the same, the
most likely outcome is that you will be constantly
expediting deliveries for your Type A customers in order

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to get those deliveries to move faster than the bulk of
your goods an you may well find that the cost structure
of your chain makes you too expensive for many of your
Type C customers. If you set up specialized facilities and
procedures, you may be able to keep everyone happy at a
reasonable cost.
Analyzing the Product
In addition to the requirements customers place
on products and their delivery, the qualities of the
products themselves impose constraints on how they are
packaged, transported and stored. These requirements
can be understood in terms of three key considerations:
form, density and risk. Shipping and storing bulk
materials is much cheaper than handling packages. When
materials are shipped in bulk form the state of the
materials is a key consideration because solids, liquids
and gases differ in the way they are transported. Density
expressed as the ration of weight to volume, is also an
important consideration in supply chain design. Low-
density products are more expensive to ship. A property
closely related to density is the product’s value-to-weight
ratio, as this ratio increases, the relative cost of
transportation drops and more options become
economically feasible.
A variety of qualities related to risk can require
special handling, packaging, transportation and storage.
Fragile items require additional packaging to prevent
breakage during transport and storage. Perishable
products risk spoilage, placing constraints on the length
of time they can be in transit or storage and some need
constant refrigeration to preserve their freshness.
Hazardous products, such as explosives and flammable

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gases, pose a more serious type of risk and usually
require special handling to comply with government
regulations. All of these kinds of risk increase the cost of
transportation and high-risk products are often shipped
separately from other goods to isolate these added costs.
In addition to these intrinsic qualities, the design
of the chain has to take into account whether the
products it handles are standard or custom. The degree of
customization can vary from standard, off-the-shelf
products to ones that are designed specifically for a
single customer. Another important consideration is the
variability in demand for products over time. Products
with steady, predictable demand are the easiest to handle
because their requirements are well known and the chain
can be designed around those requirements. If the
demand varies but does so in a predictable way, this puts
more stress on the chain but is till manageable. A better
approach to coping with seasonable variability is to use
products with different seasons to counterbalance each
other, distributing the load on the supply chain as evenly
as possible over the course of a year.
The most difficult products to handle are those
with highly variable demand that can’t be predicted with
any consistency. This situation is commonly encountered
with innovative products, which have little or no history
and whose sales are driven by trends or fashions. Given
the high uncertainty of demand for new products, it’s
hard to know how many to build or how much capacity
to devote to production and inventory. In supply chain
design, products are subject to the same constraint as
customers with regard to how many products can be
planned independently. For some companies, the

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demand patterns that distinguish their product groups are
sufficiently well aligned with conventional product
families that these families can be used to aggregate
products when designing the chain. In designing how to
aggregate products for design purposes, it is important as
always to take the sales volume of products into account.
Shaping Demand
It is possible to take a more proactive stance
toward demand, actively shaping it to suit your purposes
rather than working within the constraints it imposes.
The obvious example of this is using marketing
techniques to increase demand, but that’s not the only
approach to shaping demand, and it may not even be the
best one. In fact, some of the most effective techniques
for improving demand actually involve reducing it, at
least in the short run. One of the most important things
you can do to improve the shape of demand is make sure
that you are serving the right customers. No matter how
well you design your supply chain, it can’t meet the
needs of every kind of customer. If your primary
objective is to pull time and cost out of your chain, then
you are going to have a hard time meeting the needs of
customers that require fast delivery and perfect
fulfillment in response to unpredictable orders.
The relentless pursuit of revenue often blinds
companies to the harm that comes from serving
customers at a loss. Indeed, most don’t even know which
customers are producing their profits. The idea of turning
away customers may sound like conflict, but if it
produces dramatic increases in profits it may be the only
rational choice. Of course, it would be bad form just to
call up certain customers and tell them you no longer

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wish to do business with them, but there are market
mechanisms that can achieve the same end and may
produce an even better result. Eliminating profit sinks
from your customer base is only half a solution, the other
half is avoiding such customers in the future. The
simplest way to do this is to be sure your marketing and
sales messages attract the right kinds of customers and
that means being clear about your distinctive
competence.
The idea of being selective about your customers
will strike some managers as a radical notion, but it’s no
more radical than being selective about your suppliers.
Just as serving the right customers is vital to shaping
demand, being selective about the products you sell is
also critical. As with culling out unprofitable customers,
dropping products that don’t fit your supply chain is only
half a solution, the other half lies in making sure that all
new products are well suited to your chain. The current
emphasis on improving the efficiency of supply chains
can obscure the fact that the biggest opportunities still lie
in innovation. The fewest dollars are spent at the design
level, where there is the most opportunity for innovation.
If you want to gain a few points of market share, by all
means shave a few points off your costs. But if you want
to dominate your market, you need to do something that
the competition can’t match just by increasing
efficiency.
Stabilizing Demand
In addition to focusing on customers and
products that fit your supply chain, you can also shape
demand by stabilizing it. Variability is one of the most
costly problems in supply chains, particularly when it

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amplifies as it flows up the chain. The biggest source of
variability in supply chains is a phenomenon called
demand lumping, in which a steady flow of demand is
divided up into arbitrary chunks that appear as sudden
surges in demand. Lumping distorts the demand signal in
two ways. First, it throws off the timing, delaying the
demand signal as it moves upstream. Second, it amplifies
the apparent signal. Demand lumping is usually a by-
product of such routine practices as quantity discounts,
economic replenishment policies, volume packaging and
batch production runs.
There are other causes of demand lumping that
are not related to economies of scale. One is forward
buying, in which customers purchase supplies before
they are needed in order to take advantage of favorable
prices. These prices may be the result of natural
fluctuations in the market, but they are usually caused by
promotions on the part of suppliers. You can modify
common practices to reduce the problem of lumping in
two ways. Instead of basing promotional prices on the
quantity purchased by your customers, base them on the
quantity they sell to their customers. Using this sell-
through amount reduces forward buying and helps
ensure that promotions actually move product down the
chain rather than just pushing it to the next link.
Similarly, you can reduce hoarding with a turn-end-earn
system, in which customers can only purchase scarce
products in proportion to their outgoing sales. This
discourages customers from “gaming” the system,
inflating their orders in hopes of increasing their
allocations. One of the most effective techniques is to

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use a promotions to stabilize demand rather than inflate
it.
Conclusion
This lesson presents the demand forecasting,
production planning and ways to improve performance.
It also gives an overview of mastering demand.
Exercises
1. Explain the time-series analysis.
2. What are two approaches for ERP scheduling?
Explain.
3. Write short notes on aligning incentives.
4. Discuss about knowing the customer.

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 Lesson 8
Objectives
 To formulate a strategy for designing the supply
chain
 To identify techniques to maximize performance

8.1 DESIGNING THE CHAIN

Choosing a Strategy
In the new, chain-based competition, success
depends on formulating and executing a clear strategy
for your chain. This is not yet a common insight, the
very idea that supply chains require a strategy would
come as a surprise to many managers. In past, when
logistics was viewed as a support function, managing the
chain was primarily a matter of finding the best way to
move whatever the company chose to sell. But in the
new competition, the priorities are reversed: if you can’t
create and deliver products in a timely, cost-effective
manner, it doesn’t matter much how well you design and
market them. This reversal places supply chain decisions
at the very heart of corporate strategy.
Supply chains have jumped from the backroom to
the boardroom so quickly that most companies are just
now beginning to formulate a strategy. This widespread
lack of strategy is what makes supply chain management
such a hotbed of activity today. The stakes are high and
the bar is low, so the business opportunity is huge.
Simply put, you don’t need to formulate the perfect
strategy to win this game. If you can just put together a
reasonably good strategy and implement it consistently,
you will be well ahead of the competition. Many
considerations go into formulating a supply chain

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strategy, but one concern dominates the rest – the
tradeoff between flexibility and efficiency. Most
managers, if asked whether they wanted their chain to be
flexible or efficient, would answer “both” without a
second thought.
However, the tradeoff between efficiency and
flexibility isn’t absolute. In the tradeoff graph there are
intermediate “win-win” positions that allow the two
qualities to be combined to some degree. But there is
also an upper bound, called the efficient frontier, that
constraints the total of the two. The most important
consideration in deciding where to place your company
along this tradeoff curve is your corporate positioning
strategy. In the manufacturing sector, positioning is
based primarily on three qualities: product, price and
service. Staking out a position for your company
involves yet another tradeoff among competing qualities.
The business reality is that the qualities “faster, better,
cheaper” trade off against each other. The best product
costs more to build and the best service costs more to
deliver.
Your choice of a positioning strategy
places strong constraints on the way you make the
tradeoff between efficiency and flexibility in your supply
chain. It is difficult to set and maintain a single, clear
strategy for your supply chain and you shouldn’t
complicate the strategy if you can possibly avoid it.
Some very successful companies use multiple supply
chain strategies.
Exploring Your Options
Once you have decided on a core strategy, you
need to set the scope of the design effort. If your

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company is vertically integrated, so that much of the
supply chain is under your direct control, the scope may
naturally run from your immediate suppliers to your
immediate customers. If not, you will probably need to
include your customers’ customers and your suppliers’
suppliers to achieve major improvements. One test of
reasonableness for the design scope is the degree of
branching. If you only deal with a handful of Tier 1
suppliers, they need to be included in the design. If their
collective supplier base also happens to be small, it may
make sense to bring in the Tier 2 suppliers as well. But at
some point, the fan-out of suppliers will become too
extreme, so that extending the design to include an
additional tier would seriously inflate the number of
parties involved.
Once you have set a rough scope for the design,
you need to decide which companies within that scope
you’d like to have as partners in your efforts to improve
the chain. Supply chain managers generally know who
the key players are, but there may still be some difficult
choices. Here are a few things you might want to look
for:
1. Volume of business – The most obvious
candidates are your largest customers and
suppliers.
2. Value added – The more a supplier or customer
contributes to the quality of your products, the
more important it is to engage them in the design
process.
3. Interdependence – A small customer that depends
on you for custom supplies will be much more
likely to contribute to a successful design than a

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 large one that buys interchangeable parts from
you.
4. Common strategy – If your strategy is based on
efficiency, bring in companies with a proven
ability to operate a lean chain. If your strategy is
based on flexibility, focus on the companies that
thrive on innovation.
5. Willingness to partner – There’s not much point
in working up an integrated design if your trading
partners aren’t predisposed to making the
necessary investment to improve the chain.
Working through the decisions about who would
make the best partners in designing a better supply chain
offers a good opportunity to rethink your own role within
the chain. The starting point for a new design is a
working model of the supply chain as it exists today. A
proven approach to building the conceptual model is to
use a combination of simple diagrams and narratives.
Once the managers in the modeling session agree on how
the current chain works, it’s time for them to look for
opportunities to improve the chain. The purpose of
exploring these alternatives is not to make decisions, but
to choose the options that should be evaluated in the
formal model. Once the managers have completed their
conceptual model and generated a list of options they’d
like to evaluate, technical modelers translate their results
into a mathematical or simulation model. If you want to
explore your options for moving new products through
the chain, the modelers will need demand forecasts, bills
of materials, planned production sites, and similar
information on each new product you are considering.

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Designing the Chain
The strategy is set, the current chain is
diagrammed and described, and the options are on the
table: It’s time to build a formal model of the chain. If
you haven’t already done so, you now have to make the
choice between a mathematical optimizer and a
simulator. A simulator may be a natural step if your
chain is complex and you are still trying to get a handle
on how it all works. Optimizers come in a variety of
forms. They are the core technology underlying
advanced planning and Scheduling (APS) systems, they
are common in stand-alone supply chain design tools and
they can be purchased or even downloaded for free on
the web as plug-in modules for other modeling systems.
Basically an optimizer is a system with a large number
of inputs and a single output, the best design for your
supply chain given the inputs. All but one of the inputs
take the form of constraints, which is optimizer jargon
for mathematical expressions that describe the current
chain and your options for modifying it. The other input
is the objective function, a formula the modelers
construct to reflect your objectives for the design. The
optimizer takes the constraints as inputs and uses a
variant of linear programming to find the design that best
satisfies the objectives, producing the winning design as
its output. Give the modelers the information they need
to prepare the constraints and the objective function, then
review the resulting design with them.
Although, the constraints are all expressed in the
same mathematical form, it is helpful to think of them as
falling into four categories. The demand constraints are
forecasts of how much product has to be delivered in

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each geographical region. The resource constraints
provide detailed information about the products,
facilities and other elements of your current supply
chain. The objective function represents the quantity you
want to optimize in the design. If you have the modelers
use total cost for the objective function, the optimizer
will analyze all possible configurations to find the design
that meets the expected demand at the lower cost.
Cost is a common choice for the objective
function – It naturally aligns other business objectives.
However, using cost does tend to favor immediate,
operational benefits over longer-term improvements and
it completely ignores the impact of the design on
revenue. The limitations of mathematical optimizers are
neatly complemented by the strengths of simulation
tools. If simulations are so much better in this regard,
why not use them in place of optimizers? Precisely
because they lack the ability to seek out optimal
solutions. That’s why simulations are a complement to
optimizers rather than a replacement. A good way to
combine the two types is to use an optimizer to generate
one or more candidate models, then use a simulator to
stress-test these models under conditions of variability
and nonlinearity.
8.2 MAXIMIZING PERFORMANCE
Increasing Velocity
One of the simplest ways to advance the efficient
frontier is to accelerate the flow of goods across the
chain. Acceleration improves efficiency because
inventory doesn’t stay in the chain as long, which brings
down the costs of holding that inventory. At the same
time, increasing the velocity of inventory enhances

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flexibility because it reduces the time required to change
what’s in the pipeline in response to changing demand.
An obvious way to increase velocity is to switch to a
faster mode of transportation. If you are sending goods
overseas by ship and have the option of using airfreight,
you may be able to realize a net benefit from making the
switch. A much more effective way to increase velocity
is to improve the way the chain handles goods that aren’t
in motion. In short, the better way to increase the
velocity of inventory is not to move it faster when it does
move, but to get it to spend more of its time in motion.
Achieving that goal is much harder than just changing
the transportation mode, you have to conduct systematic
studies of how inventory moves across the chain,
examine each place it stops and look for ways to get it
moving again. To achieve higher velocities, you may
need to reengineer your supply chain operations,
applying the techniques of JIT, lean production and
related disciplines.
You can get a quick sense of where slowdowns
occur just by looking at the size of the queues of raw
materials that build up within facilities, both at the
receiving docks and in from t of individual workstations.
For a more revealing view of how inventory spends its
time, have someone record the time inventory spends in
each location within the chain and plot the results as a
time-in-process chart of the sort. Tracing the movement
of tens of thousands of products through your supply
chain to identify bottlenecks and unproductive
operations can be a daunting task, but this is an area
where technology can greatly ease the burden. Although
the attempt to increase velocity is primarily directed at

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the flow of inventory, there are advantages to be gained
from accelerating the flow of demand and cash as well.
Pooling Risk
The second technique for advancing the efficient
frontier is risk pooling. The idea behind risk pooling is to
combine the management of inventories that would
otherwise be controlled separately so that variability in
demand can be handled with less safety stock. Of course,
a decision to centralize inventories involves more than
just the requirements for safety stock. It might not be
possible to hit your target CSL without holding stock
close to your customers, or the costs of using faster
transportation might be greater than the savings due to
holding less inventory. But risk pooling doesn’t require
that inventories actually be located in the same place. All
it requires is that they be managed as a common pool.
This can be done through a variety of techniques,
including echelon inventory, multisourcing,
transshipment and direct shipment.
Many distribution networks have multiple levels
or echelons. For example, products might move from a
single, central warehouse through several regional
distribution centers and then to a large number of widely
distributed stores. While it is possible for each of these
facilities to manage its inventory independently, this is
rarely done because it is far more efficient to manage
them collectively as an echelon inventory. The total
inventory in an echelon system can be greatly reduced
through risk pooling. If each facility can receive goods
from two or more upstream facilities, then the
inventories of those facilities automatically form a risk
pool that reduces the need for safety stock. Shipping

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from more distant facilities takes longer and is more
expensive, so it may not be economically feasible to
support all possible links between warehouses and
regions. The solution to this problem is to divide the
facilities into separate but overlapping risk pools. The
benefits of risk pooling can also be achieved through
transshipment in which the facilities at a given level of
the chain exchange inventory among themselves. This
technique is more expensive than multi-sourcing because
products travel farther on average, but sometimes it’s the
only option.
Yet another way to achieve risk pooling is
through direct shipment, in which one or more links of a
supply chain are bypassed altogether. Risk pooling is an
excellent tool for advancing the efficient frontier because
pooling can be mapped onto any combination of
efficiency and flexibility, depending on your strategy.
Powerful as it is, risk pooling is not a panacea, and the
leverage you can gain from it depends on the nature of
demand. If the demand for a product is highly stable,
then you don’t need much safety stock to begin with, so
there is less to be gained by reducing it. Another caution
regarding this technique is that it can be much harder to
manage than a standard echelon distribution system.
Designing for Supply
In the 1980s there was a major effort among
manufacturing companies to design products that were
easier to build. This effort, known both as design for
manufacturing and concurrent engineering, was a
significant departure from past practices, in which
engineers designed a product and then handed it over to
manufacturing to figure out how to build it. By taking

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manufacturing requirements into account during the
design process, companies that adopted this approach
were able to simplify production, reduce costs and
enhance quality.
Today, design for manufacturing is being pushed
outside the four walls of the factory and applied to entire
supply chains. The new movement called design for
supply takes into account the entire sequence of
operations and movements necessary to convert raw
materials into usable products. Two of the most basic
techniques are simplification and commonality. The goal
of simplification is to reduce the number of alternative
assemblies by eliminating unnecessary options, even if
that increases the cost of components somewhat. A more
ambitious technique is the use of modularity in product
design. Rather than designing each new product from
scratch, engineers design products as assemblies of
pluggable components using existing components
wherever possible. Another advantage of modularization
is that manufacturers can produce the modules of a
product simultaneously rather than building the entire
product sequentially. If designers take modularization far
enough, manufacturers can create a large number of
products from a minimum number of components.
Another important technique is designing
products for convenient packaging. In the case of retail
products, another technique used in design for supply is
making sure that the product will display well in stores.
One further technique is to engage suppliers in the
design of a product. The design-for-supply initiative is
significant in a number of respects, one of which is the
implied shift in the relative importance of manufacturing

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and supply chain management. Historically,
transportation and logistics functions have been
subordinate to manufacturing. Today the roles are being
reversed and manufacturing is being viewed as one
component of a much larger machine, the supply chain.
In the new order of things, the needs and desires of the
manufacturing group are often subordinated to the
requirements of the supply chain as a whole.
This reversal of roles is a natural consequence of
the new competition between supply chains, but it’s a
consequence that few companies have internalized to
date.
Postponing Differentiation
The most exciting innovation in the movement
toward design for supply is a technique variously called
postponement, delayed differentiation or less commonly
freeze-point delay. The basic idea is to build products in
generic form at the plant, ship them to distribution
centers close to their destinations, then perform the final
operations that result in a specific product. The classic
success story for postponement is Hewlett-Packard’s
DeskJet line of printers. There are several advantages of
the postponement technique. First, it allows products to
be specialized to different markets without
compromising economies of scale in production and
transportation. This advantage is vitally important, in
today’s consumer-oriented markets, manufacturers must
offer products in ever-increasing variety, and that’s
undercutting the economies of scale associated with
large production runs. Postponement offers a way out of
this dilemma by allowing the specialization to be done
close to the customer.

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 Another benefit of postponement is that it takes
advantage of risk pooling to reduce inventory
requirements. A closely related benefit is that production
can be based on aggregate forecasts, which are always
more accurate than detailed forecasts. In effect, the
postponement technique allows the variations of a
generic product to be pulled through the chain by
immediate demand rather than being pushed down the
chain on the basis of uncertain, item-level forecasts. At
the same time postponement offers an economical way
to increase the level of customization by allowing minor
variations to be determined all the way out to the point of
sale.
Postponement is a form of design for supply.
Like design for supply in general, the postponement
technique can require some difficult organizational
changes. If transforming distribution centers into final
assembly plants isn’t a viable option, postponement can
still be applied within the main plant. Conversely, if the
final configuration process is quite simple or if retailers
have special skills, it’s possible to extend postponement
out to the point of purchase. Postponement offers may
potential benefits, but it’s not without its costs. In
addition to the quality and organizational problems that
can arise when assembly operations are pushed down the
supply chain, the cost of performing these operations
downstream is almost always higher than if they were
performed at the factory.
Postponement works best when two conditions
are met: a large variety of configurations can be derived
from a common base product and the demand across
these configurations is hard to predict. The most

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effective approach is to use postponement selectively
across product lines, applying it only where the
advantages out-weigh the cost. Better still is to apply it
selectively within a product line.
Conclusion
The most critical element in designing the supply
chain is deciding how to make the tradeoff between
flexibility and efficiency. The four techniques to
maximize performance are increasing velocity, pooling
risk, designing for supply and postponing differentiation.
Exercises
1. Discuss about exploring options to identify your
customers.
2. What are the four ways to maximize supply chain
performance? Explain.

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 UNIT – V
Lesson – 9
Objectives
In this lesson you will learn:
 The need for CRM
 Essential components and modules of CRM
 Advantages of using CRM in business

9.1 CUSTOMER RELATIONSHIP MANAGEMENT

INTRODCTION
As businesses increasingly realize that
knowledge (not capital or technology) is their only
sustainable edge, customers their key assets, and channel
relationships their source of adaptability, they are turning
to knowledge management and customer relationship
management with high hopes of withstanding the
complexity, uncertainty, unnatural time scales,
unexpected competitor innovations, shifting markets, and
ambiguity that surround them.
E-Business is defined as the Internet-facilitated
integration of processes, applications, and information
systems to facilitate rapid collaboration, coordination,
and relationship formation across traditional
organizational boundaries. Electronic commerce is a
subset of e-business.
As e-businesses move from once-rewarded
customer acquisition to now-rewarded customer
retention and loyalty, people are thinking about
implementing customer relationship management
(CRM), knowledge management (KM), and channel
relationship management - processes that bring together

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your suppliers, distributors, service providers,
infrastructural partners, business allies, and customers.
Customer Relationship Management is defined as
the process of managing relationships with existing
customers to maximize their loyalty, increase revenues
from them, and retain them while selectively attracting
new customers. Figure 9.1 shows the various elements of
CRM.

Figure 9.1 Elements of CRM

Companies are increasingly nurturing a team of

professionals earmarked to maintain customer
relationship. These customer relationship managers are
required to constantly stay in touch with their set of
customers, resolving their problems and addressing their
needs as and when required. However, if all companies
are doing the same thing, how can your company gain an
edge over the others? Thus companies has to concentrate
on the essentials of a few customer relationship
management ideas that are bound to increase your
customer retention rate.

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9.1.1 Essentials of Customer Relationship
Management
Build a Smart Team
Retaining customers is a difficult task. Make sure
you have the right people as customer relationship
executives. The first step is clearly laying down what
your relationship executives are required to do.
Once you define their roles and responsibilities,
you know the exact set of traits you are looking for while
selecting candidates. While recruiting, the focus in most
cases remains on the technical expertise of the
candidates and soft skills are often neglected. It has been
proven time and again that it is the communication skills
and the attitude of the employees that impact customer
satisfaction.
Make sure that you hire people with strong active
listening skills and troubleshooting abilities as your
customer relationship executives. A soft skill training for
your existing employees is also a good idea to boost their
performance.
Communicate Often
Once you win a customer it is your job to make
sure that the customer is kept aware of the latest updates
in the product and service offerings. Of course, this does
not mean you bombard them with continuous emails and
phone calls. Most people find such tactics quite annoying
and if you do so, chances are that soon your mails will
end up in the spam folder. The key to success here is the
timing. Time your mails and calls such that your
company’s offering and their needs align. Keeping your
company blog active is another easy way to keep

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customers updated. Also the content of the
communication must be clear and precise.
Let Testimonials Speak
Get customers who are happy doing business
with you to do the talking. Prospects are more likely to
trust your company if they hear someone like them speak
your praise. Internet has made it easy to get feedback and
testimonials. To add some personal touch, you could
organize a face to face gathering of your loyal customers
and apprise them about the recent happenings in the
company. Eventually, ask if they would be willing to be
part of a case study or shoot a short video testimonial.
A lesser expensive way to engage your customers
would be to send them a questionnaire email and build a
case study based on the answers they give. You could
also use social networking to stay in touch with your
community of trusted and loyal customers.
Build a Comprehensive Customer Database
In an era where companies of all sizes are busy
designing customer loyalty programs, handing out
purchase reward points and discount coupons to appease
their customers, it makes perfect sense for you to do the
same. Know as much as you can about your customer.
Their buying cycle, purchase patterns, budgets,
anniversary dates and so on. These details can then be
collated in a sales management software for planning
your communication with them well ahead of time. The
first step for this is of course is to build a detailed
customer database. Keep a record of all the information
available about your customers, be it their birthdays or
their son’s birthday. A simple greeting on their
anniversary or a message congratulating them on the

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new house they purchased can go a long way to make
them feel special.
Lend an Ear
Happy customers who get their issue resolved tell
about 4-6 people about their experience. Companies tend
to lose out on their existing customers because their
complaints were not resolved in time. A quick and
timely redressal of customer grievances will bring in rich
dividends. Make sure that you have a proper mechanism
of lodging queries and complaints in place where your
customers can express their grievances easily.
Regularly monitor for any complaints that are
reported by many and work on a solution. Make sure to
resolve a problem as soon as it crops up. You may lose
out your customers in the long run and they might take it
up on social networks, making the situation far worse.
Keep Track of the Changes
The modern day marketplace is subject to
constant changes. Be it the customer’s requirements, his
preference or the products that your competitors are
offering, everything is constantly changing.
In such an environment, it is advisable to keep
track of new trends and changes so that you can prepare
yourselves. Invest in resources to revise your product
offering and redesign your products to cater to the new
demands.
Keep yourself abreast of new trends so that you
can seize the opportunity to serve your customers before
your competitors make a move. Meeting your customer’s
changing needs, is a strong indicator that the company
cares for them.

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Motivate Your Workforce
Lastly, it’s your employees who make all the
difference when it comes to retaining customers.
Therefore, it is absolutely essential that you instill a
culture of superior customer service and right attitude
amongst your employees.
This is when building a customer centric business
makes a lot of sense. You might have hired professionals
with good communication skills as customer relationship
executive, however, without the right attitude they might
not prove to be effective. Set down key responsibilities
and clear parameters of performance measurement to
enhance their efficiency.
It is true to a great extent that how an employee
treats the customers reflects on how the organization
treats him in the first place. If you can instill a sense of
responsibility and loyalty amongst your employees you
are sure to have more satisfied customers
Avoid False Promises
It is also very important for effective customer
service to avoid making false promise for generation of
sales. Reliability and trust are key for any good
relationship and good customer service is no exception.
If the company promises to deliver a product or service
within a stipulated time, it should be adhered to. If
because of certain unavoidable reason it is not possible,
proper communication is to be done to the customer
explaining the reason and a new date should be
conveyed.
Preferring long-term profit over the immediate one
While servicing the customers, the long-term
value and the profit are to be taken into account. Many

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of the companies have been forgetting all the customer
service initiatives once the sale is made. Companies
should focus on both the older customers and new
customers. They should not leave the older and less
demanding customers which may lead to a loss.

9.2 DESIGNING CRM APPLICATION

To achieve success through CRM, a CRM value
chain needs to be designed. By this, data received from
customer could be converted into meaningful
information. These information may help companies
acquire knowledge about the customer and design their
relationship programs to create customer delight. Figure
9.2 shows the CRM value chain.

Figure 9.2 CRM Value Chain

As per the above sequences of activities, initially
data regarding the customers are gathered, then they are
converted into meaningful format depending on the
objective and usability of the company. A compilation of
only those data which have got significance for the
organizational decision making is put forth. A set of
knowledge is then required to be created and the CRM
programme is designed accordingly.
Success of a CRM Programme depends on how well
it is designed and implemented. The CRM process lacks
a standard universally acceptable model. Finding a
standard process for practicing CRM is the key issue for
its success. The following is the process proposed for
effective and successful implementation of CRM in an

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organization. The process goes in the sequence as
follows:
1. Customer segmentation based on CLV: Since all
customers are not equal, segmentation is a must.
But certainly, segmentation is a must. But
certainly, there has to have a basis for
segmentation of customers. In CRM, the
customer’s lifetime value for the company acts as
the most prudent basis for segmentation.
2. Customer profiling: After Segmentation,
customer profiling needs to be conducted and the
basic customer information, tastes, preferences,
buying habits, likings and dislikings and all the
informations of significance about the customers
need to be stored in such a manner that the same
can be used effectively for all the business
customer-interest purposes.
3. Offer customization: After studying the specific
customer requirements, the company’s offers are
so designed that they meet the exclusive needs of
the customers.
4. Matching service cost and revenue: An important
factor needs to be taken care of while designing
the offer is that the offer should in no way be
more that the corresponding benefit coming out
of the customers.
5. Employee participation in CRM design: Another
very critical factor in the design of CRM is
participation of the employees through their
opinion, views and suggestions as it is the
employees only who ultimately have to deal with
the customers and face the implication of the

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 proposed CRM programme. The practicality and
implementability of the programme needs to be
seen from the perspective of employees.
6. Motivating employees for effective
implementation: Since it is the employees only
who are entrusted with the responsibility of
effective implementation of the CRM programme
they need to be adequately motivated.
7. Making CRM an enterprisewide activity: In many
of the organisations, CRM is considered as a
marketing function, hence loses the real benefit.
CRM actually needs to be made and understood
as an enterprisewide activity. All the people of
the organization need to believe that their
existence is because of the customers and their
ultimate reason of existence is betterment of the
customers.
8. Adequate technology support for CRM
implementation: Adequate technology support
also needs to be arranged for successful
implementation of the CRM programmes. These
technological tools include hardwares and CRM
softwares.
9. Consistency testing of CRM programmes:
Organisations start CRM with a bang many
times, but get engaged in the routine activity over
a period of time. A very critical aspect in the
success of CRM programme is its consistency in
practice. A mechanism needs to be devised to
keep checking the system if it is responding as
per the schedule.

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10. CRM practice evaluation: To verify how
successful the implementation of the CRM programmes
is, regular feedback mechanism needs to be devised.
This feedback has to be from the following perspectives:
(i) Customer experience perspective
(ii) Employee participation perspective
This feedback may further be used for restructuring
CRM as per the changing needs of time and changing
requirements of the system.

9.3 VARIOUS MODULES OF CRM APPLICATION

The primary Customer Relation modules which
are important in all types of business is shown in figure
9.3.

Figure 9.3 Modules of CRM

Each of the modules shown in figure 9.3 work

coherently to handle, store, feedback and manage all
customers’ accounts automatically. The system

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inherently automates and governs the overall customer
relation operations structurally.
Marketing
The Marketing process is in effect the front door to
any business organization. This Marketing module
guides and automates the process of sustaining existing
customers, developing new customers/markets, surveys,
follow-up, meeting customers, etc. It uses the customer
information system for analyzing and maintaining
existing customers, and also stores records of potential
customers, the demographics of potential markets, and
survey analysis results. Coupled with the Marketing
Calendar, this module enables close follow-up for each
customer every time, and together with the personal
information profile, arms marketing personal with the
leverage of the most up to date customer information,
accessible with a touch of a button. Potential customers
are also alerted with reminders for follow up. The system
ensures that NO potential business is left un-explored.
Enquiries can be automatically replied with an interim
message, followed by a formal reply by marketing
personnel. The typical sub-modules included within this
module are:
 Marketing Calendar
 Customer Trigger System
 Reminder System
 Field Reporting
 Marketing Analysis
 Promotion & Feedback Analysis
 Customer Account Information - Order
Management

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Customer Information System
The Customer Information System is common to all
types of business organizations, whether in the
manufacturing, service, trading, food industry, or
community sector. This information primarily contains
customer contact information, company profile, personal
profile, historical queries, events, business dealings,
feedbacks, etc. The sub-modules attached includes:
 Company Information
 Contacts Information
 Transaction & Queries
 Event Log & Trigger
 Category & Profile
Sales
The Sales process ensures all parts ordered,
arrive at the customer site at the correct time, with the
correct quality, mix and correct cost. This system also
addresses any customer enquiry, provides tracking
information for customer and schedules. Using
information of customers from the Customer Information
System and Marketing analysis, reports and other
information; this Sales module automatically tracks and
triggers personnel for follow up, generates the required
paperwork, and can report periodically on performances.
The typical sub-modules included are:
 Acknowledgement system
 Distribution System
 Trader / 3rd Party
 Customer Enquiry Support System
 Escalation / Cancellation
 Trafficking & Packaging
 Freight / Insurance / Warehousing

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  Tax & Clearance
 Order Processing
Order Fulfillment
The Order Fulfillment process is the process of
scheduling and planning for the delivery of goods and
services to the customer. This system obtains
information from the Customer Information, Marketing,
Shipping, system constraints, stocks, and other inputs in
order to start a Lot/Form flow. The method and schedule
for delivery is predetermined by the system, given the
various inputs, constraints, stocks, personnel, etc. This
system is designed to trigger for automated close-loop
follow-up, in order to ensure all orders are fulfilled
within the specified pre-defined window times. This
system will also trigger other sub-modules for
acknowledgement, feedback, transportation, delivery
methods, etc. The typical sub-modules included are:
 Delivery Configuration
 Distribution Channel
 Constraint Management
 Scheduling & Planning
 Acknowledgement
Returns & Claims
The Returns & Claims module addresses the product
or services returns and claims, due to error in quality,
quantity, mix, unsatisfactory or wrong services,
damages, shelf life expired, product discontinued etc.
The system provides the supervisor information of
events, orders, etc; and also provides a feedback to the
organization as to all claims request from customers.
Where rectifications or repairs need to be made, this
system will route products or services through the

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correct configuration model and re-initiate the supply
chain. Where replacement parts needs to be delivered,
the system will route request accordingly with different
priorities. This system is integral in the process of
customer satisfaction. The typical sub-modules included
are:
 Claims Form
 Returns Form
 Defect Tracking
 Product Expiry / Discontinued
 Stock Rotation
 Reclassification
 Re-order Form
Report & Survey
The Report & Survey module provides the feedback
mechanism as to the performance of not only the whole
customer relation, but also the business in general. This
module includes automated feedback forms, survey
results, custom “report-cards”, delivery & performance
reports, auditable event records; as a means for
management of customer relation strategic decision
making. The typical sub-modules included are:
 Customer Audit / Feedback
 Internal Supply Report
 External Survey Report
 Event Chain Report

9.4 ADVANTAGES OF CRM

Implementing a CRM strategy is advantageous to
both small-scale and large-scale business ventures. If
you want to find out what are the benefits of using CRM

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for your business, then read further to know the key
points.
Improved customer relations
One of the prime benefits of using a CRM is
obtaining better customer satisfaction. By using this
strategy, all dealings involving servicing, marketing, and
selling your products to your customers can be carried
out in an organized and systematic way. You can also
praovide better services to customers through improved
understanding of their issues and this in turn helps in
increasing customer loyalty and decreasing customer
agitation.In this way, you can also receive continuous
feedback from your customers regarding your products
and services. It is also possible that your customers
recommend you to their acquaintances, when you
provide efficient and satisfactory services.
Facilitates discovery of new customers
CRM systems are useful in identifying potential
customers. They keep track of the profiles of the existing
clientele and can use them to determine the people to
target for maximum clientage returns. New customers
are an indication of future growth. However, a growing
business utilizing CRM software should encounter a
higher number of existing customers versus new
prospects each week. Growth is only essential if the
existing customers are maintained appropriately even
with recruitment of new prospects.
Increase customer revenues
By using a CRM strategy for your business you
will be able to increase the revenue of your company to a
great extent. Using the data collected, you will be able to
popularize marketing campaigns in a more effective

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way. With the help of CRM software, you can ensure
that the product promotions reach a different and brand
new set of customers, and not the ones who had already
purchased your product, and thus effectively increase
your customer revenue.
Maximize upselling and cross-selling
A CRM system allows up-selling which is the
practice of giving customers premium products that fall
in the same category of their purchase. The strategy also
facilitates cross selling which is the practice of offering
complementary products to customers, on the basis of
their previous purchases. This is done by interacting with
the customers and getting an idea about their wants,
needs, and patterns of purchase. The details thus
obtained will be stored in a central database, which is
accessible to all company executives. So, when an
opportunity is spotted, the executives can promote their
products to the customers, thus maximizing up-selling
and cross selling.
Better internal communication
Following a CRM strategy helps in building up
better communication within the company. The sharing
of customer data between different departments will
enable you to work as a team. This is better than
functioning as an isolated entity, as it will help in
increasing the company’s profitability and enabling
better service to customers.
Optimize marketing
With the help of CRM, you will be able to
understand your customer needs and behavior, thereby
allowing you to identify the correct time to market your
product to the customers. CRM will also give you an

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idea about the most profitable customer groups, and by
using this information you will be able to target similar
prospective groups, at the right time. In this way, you
will be able to optimize your marketing resources
efficiently. You can also be ensured that you don’t waste
your time on less profitable customer groups.
Helps the sales team in closing deals faster
A CRM system helps in closing faster deals by
facilitating quicker and more efficient responses to
customer leads and information. Customers get more
convinced to turn their inquiries into purchases once they
are responded to promptly. Organizations that have
successfully implemented a CRM system have observed
a drastic decrease in turnaround time.
Makes call centers more efficient
Targeting clients with CRM software is much
easier since employees have access to order histories and
customer details. The software helps the organization’s
workforce to know how to deal with each customer
depending upon their recorded archives. Information
from the software can be instantly accessed from any
point within the organization.
CRM also increases the time the sales personnel spend
with their existing customers each day. This benefit can
be measured by determining the number of service calls
made each day by the sales personnel. Alternatively, it
could also be measured through the face – to – face
contact made by the sales personnel with their existing
customers.
Enhances customer loyalty
CRM software is useful in measuring customer
loyalty in a less costly manner. In most cases, loyal

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customers become professional recommendations of the
business and the services offered. Consequently, the
business can promote their services to new prospects
based on testimonials from loyal customers.
Testimonials are often convincing more than presenting
theoretical frameworks to your future prospects. With
CRM, it could be difficult pulling out your loyal
customers and making them feel appreciated for their
esteemed support.
Conclusion
It is important for the companies to realize the
importance of Customer Relationship Management in
their sustained success. They first need to understand
what CRM is and how it affects their chances of
survival. They need to also understand what factors
determine the level of customer satisfaction. This
process may act as a benchmark for most of the service
companies to use with slight customization.
Exercises
1. Explain any five essentials of customer relationship
management.
2. What are the steps to design a CRM application?
3. Elaborate on the various modules of CRM application.
4. What are the advantages of CRM? Explain.

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