Introduction to

Supply Chain Dynamics

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Lesson Objectives
• Recap of courses to date
• Knowledge level setting
• Refresh of basic concepts
• What happens when reality strikes!
• Real-world challenges
• Agenda for SC3x Course
• Introduction to Supply Chain Complexity
• What it is, why we care, and where it comes from
• How to manage (mitigate or embrace) complexity

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Recap of SCx Courses to Date

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MicroMasters Credential in SCM
SC0x Supply Chain Analytics

SC1x Supply Chain Fundamentals

SC2x Supply Chain Design

SC3x Supply Chain Dynamics

SC4x Supply Chain Systems & Technology

Final Capstone Exam

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Key Concepts SC0x SC Analytics
• Objective:
• Be familiar with and comfortable using the core analytical methods
most common in supply chain management
• Deterministic Methods
• Classic optimization
• Linear programming
• Integer (and mixed integer) programming
• Stochastic Methods
• Probability distributions and models
• Statistics (descriptive and inferential)
• Discrete event simulation

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Key Concepts SC1x SC Fundamentals
• Objective:
• Understand the basic models and trade-offs involved in demand forecasting,
inventory management, and transportation planning.
• Demand Forecasting
• Time series (moving average, exponential smoothing, etc.)
• Causal analysis (regression)
• New product forecasting
• Inventory Management
• Deterministic (economic order quantity EOQ) vs. Stochastic (single period,
continuous/periodic review) demand models
• Inventory types (safety, cycle, pipeline, etc.)
• Performance metrics (cycle service level, item fill rate)
• Transportation Planning
• Mode choice (total landed cost)
• Impact of lead time (mean and variability)

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Key Concepts SC2x SC Design
• Objective:
• Understand why and how to design the three primary flows of supply
chains: physical, financial, and information.
• Physical Flow Design
• Facility Location Models (continuous and discrete)
• Network models (transportation, transshipment, network flow)
• Financial Design
• Translating supply chain actions into financial terms
• Activity based costing
• Working capital
• Discounted Cash Flow Analysis
• Information Flow Design
• Working with suppliers: procurement, auctions, risk sharing
• Coordinating manufacturing: production planning, BOM, MRP/DRP

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MicroMasters Credential in SCM
SC0x Supply Chain Analytics

SC1x Supply Chain Fundamentals

SC2x Supply Chain Design

SC3x Supply Chain Dynamics

SC4x Supply Chain Systems & Technology

Final Capstone Exam

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When Reality Strikes

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Examples of Reality Striking Back
• When the low cost solution is expensive!
• ShopCo Transportation sourcing circa 2000
• National truckload procurement event
circa 2000

post-2002

Lessons:
• We are not living in a “steady state” world!
• Need to take potential disruptions into
account!

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 Examples of Reality Striking Back
• When the “right” location isn’t right!
• Supply chain network design finds
optimal locations based on costs . . .

Lessons:
• There is more to location than proximity.
• Taxes, customs, and duties can often
outweigh supply chain costs!
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Supply Chain Complexity

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Supply Chain Complexity
• There is a general consensus that . . .
• supply chains are complex,
• they are only getting more complex, and
• complexity adds costs to a supply chain,
• Therefore, we should look to mitigate or minimize
complexity.

However, perhaps we should understand exactly

what complexity is!

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Accounting Complexity
Product Complexity Customer Complexity
• Small batch sizes • Customized products
• Long set-up times • Short lead times
• Unique components • Unpredictable orders
• Special tests/inspections • Extensive technical support
• Extensive material handling • Extensive post-sales support
• Special vendors • Special tests or requirements

high
overcosted

volume traditional
costs

undercosted
low
low high
complexity

Source: “Introduction to Activity-Based Costing,” Robert S. Kaplan, Harvard Business

School Publishing, July 5, 2001. (Product Number: 197076) 15
What is complexity?

“I know it when I see it”

Justice Potter Stewart, in Jacobellis v. Ohio
regarding possible obscenity in a movie.

US Supreme Court Justice Potter Stewart

1915 - 1985

By Robert S. Oakes [Public domain], via Wikimedia Commons 16

What is complexity?
• Complicated versus Complex
• Two types of complexity (Senge 1990)
• Detail Complexity:
Distinct number of processes or parts within the system
• Dynamic Complexity:
Unpredictability of response of the system due to interactions

A system is complex if it “is made up of a large

number of parts that interact in a non-simple way.”

Herbert Simon 1962

Source: Bozarth et al, “Impact of Supply Chain Complexity on manufacturing Plant

Performance,” JOM 2009. 17
Complexity Drivers

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What are the drivers of SC Complexity?
less complex

1. Numerousness
2. Variety/Diversity
3. Interconnections/Interactions
4. Opacity of Interactions
5. Dynamic Effects

more complex

Source: Mitchell, “Complexity – A Guided Tour” Oxford Press2009.

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Why do we care?
• Complexity is not introduced for complexity’s sake
• Drivers of complexity = Drivers of profitability
• Drivers of profitability
• Increase revenue per unit
• Increase the number of customers
• Increase number of units sold
• Decrease cost per unit

• Implicit to every strategy or action intended to

improve profitability is a hidden cost of complexity!

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Profitability Drivers = Complexity Drivers

Revenue/Unit
Numerousness
# Customers
strategy Variety/Diversity
or action
# Units
Interactions
Cost/Unit

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Example: Introduce new packaging format

Revenue/Unit
Numerousness
# Customers
Variety/Diversity
# Units
Interactions
Cost/Unit

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Example: Open a joint DC for online and
traditional retail replenishment

Revenue/Unit
Numerousness
# Customers
Variety/Diversity
# Units
Interactions
Cost/Unit

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Where does complexity enter the supply chain?

Most complexity enters from the ends!

customers and market

research & marketing

source make deliver
development & sales

Desire for unique Desire for a wide

solutions and diverse product
portfolio.

Adapted from Scheiter et al, “How much does complexity really cost?” A.T. Kearney 2007.
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Identifying where complexity lies
Map the complexity “fingerprint”
• Identify the potential complexity drivers
• Count total number used
• Count number that account for 80% EBIT

Technologies

Customers
Complexity Drivers ➔

Brands
SKUs
Package
Total Number 10 Types
33 892 65 2,200
Number in 80% EBIT 2 17 197 41 214
Percentage 20% 52% 22 63% 10%
%

Adapted from Scheiter et al, “How much does complexity really cost?” A.T. Kearney 2007.
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Complexity Reduction at Novartis

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Complexity Example: Novartis
• Novartis ~ 2010
• Global healthcare company based in Basel Switzerland
• Four Divisions: Pharmaceuticals, Sandoz, Vaccines & Diagnostics, and
Consumer Health
• Annual Revenue ~ $50.6 billion
• Pharmaceuticals Division (Pharma)
• Annual Revenue of ~$30 billion with > 60,000 full time associates
• 32 production sites (Europe, North America, South America, and Asia)
• 140 country markets
• ~13,000 finished product SKUs
• Complexity Reduction Initiative (2010)

Source: Leiter, Kevin, “Assessing and Reducing Product Portfolio Complexity in the
Pharmaceutical Industry,” MIT Thesis 2011. 27
Complexity Example: Novartis
• Underlying Complexity Drivers
• Country Markets – SKUs were generally country specific
• Multiple dosage forms (film-coated tablets, pre-filled syringes, etc.) & strengths
• Multiple pack sizes and formats
• Regulatory requirements - Same product produced at two plants creates two
SKUs
• Difficulty in retiring products – some required by regulation others due to mergers
• Need to reduce SKUs . . . but which ones?
• Segmentation analysis (sales by SKU)
• Managerial judgment call on strategic SKUs
100
Percentage of
Sales Value

50 Percentage of
65% 13% 6% 14% 2% Inventory
0
0 20 40 60 80 100
Percentage of SKUs

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Complexity Example: Novartis
Step #1. Redundant Product Rationalization
• Bottoms up approach 100

50

• Identify redundant profits by product 0

0 20 40 60 80 100

• Match true customer requirements and align to products

Identify
Create Document/
Assess and Monitor Key
Cross Set Revise
Existing Remove Performance
Functional Objectives Global
Portfolio Redundant Indicators
Team Reqt’s
SKUs

Repeat Bi-Annually
Notes & Comments
• Reduced SKUs by 30% with no sales loss
• Reduced number of SKUs led to better forecasting
• Very resource intensive initiative
• Required buy-in by heads of finance & marketing
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 Complexity Example: Novartis
Step #2. Tail End Pruning
• Top-down approach 100

50

• Identify and remove lowest volume and 0

0 20 40 60 80 100

least profitable products

Define Define Identify Approve

Set
Objectives Evaluation Tail End Trimming
Baseline
and Goals Criteria Products Proposals

Repeat Annually

Notes & Comments

• Devil is in the details and the tail always regenerates!
• What level of detail makes sense? Measure by SKU by Brand by Drug . . .
• Two approaches considered:
• MILP – when high quality data is available
• Criteria Threshold – when data is imperfect

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Complexity Example: Novartis
Results of Complexity Reduction Initiative (2010)
• Approximately 1100 SKUs pruned
• 43 complete brands were pruned!
• Inventory savings of $22 M

Learnings
• Process requires senior support
from marketing and operations
• It is not a single shot exercise –
must be scheduled and repeated
• Redundancy removal can lead to other benefits
• These initiatives complement new product introduction processes

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Portfolio Rationalization
at Hewlett Packard

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Hewlett Packard – circa 2008

• More than a billion customers in 170 countries

• Wide variety of product lines and SKUs
• > 2,000 Laser Printers
• >15,000 Server SKUs
• > 8 million Laptop & Desktop configurations
• Multiple sales channels with variety of order cycle times
• Shorter overall product lifecycles
• New products constantly introduced
• Marketing decision based on marginal revenue improvement
• Minimal supply chain input on costs

Source: Ward et al.: HP Transforms Product Portfolio Management with Operations

Research Interfaces 40(1), pp. 17–32, ©2010 INFORMS 34
Portfolio Rationalization
• Portfolio Rationalization Project
• Focus on Personal Systems Group (PSG)
• Configurable PC products
• Low per SKU costs – but high underlying costs
• Orders must ship 100% complete
• One component short kills the entire order
• Leads to long and unpredictable Order Cycle Time (OCT)

• Two Simultaneous Initiatives

1. New Product ROI Screening
– keeping overly complex products out
2. Revenue Coverage Optimization
– for pruning existing products

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New Product Introduction Process (Stage-Gate)

Gate 1 Gate 2 Gate 3 Gate 4 Gate 5

Stage 2
Stage 1 Stage 3 Stage 4 Stage 5 Stage 6
Scoping &
Discovery & Build Development Test &
Pre-
Idea Business Validate Commercialize
Technical
Generation Case
Evaluation

100 68 47 33 28 24
Forecast Forecast
Forecast Forecast Firm Forecast Forecast Unit
Market Market Sales Unit Unit Sales Sales By
Revenue Revenue Revenue Sales Location
Potential Potential Potential

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New Product Screening
Challenges
• Both volume and variety are distinct cost drivers for new products
• Traditional Activity Based Costing (ABC) approach ignores complexity
Approach
• Create a “Complexity-Adjusted Margin” to use in new product decisions

Complexity ROI = (
Incremental Margin − Variable Complexity Costs)
(Fixed Complexity Costs)
Variable Complexity Costs Fixed Complexity Costs
Low Volume of a SKU drives costs High SKU variety drives costs
• Volume discounts for procurement • Resource costs (R&D, testing, etc.)
• Excess costs (obsolescence, storage, etc.) • External cash outlays (tooling, etc.)
• Shortage costs (expedite, lost sales, etc.) • Indirect impacts (mfg switching, returns etc.)

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New Product Screening
• Calculating Complexity Costs
• Used regression and ABC analysis on history
• Demand Variability = f(Demand Volume)
• Probability of Returns = f(Number of SKUs offered)

• Implementation
• Formed cross functional team (SC, Finance, Mkt) to validate approach
• Reach consensus on reasonable rather than exact cost models
• Created user friendly tool to assess Complexity ROI for new products
• Incorporated spreadsheet into New Product Screening Process

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 Revenue Coverage Optimization
Challenges
• Existing products may no longer be profitable, but examining
products in isolation misses dependencies and interrelationships
Approach
• Create optimization tool that maximizes the value of the active portfolio by
pruning existing products based on two metrics
• Order Coverage – Percentage of a given set of past orders that could be completely
filled from the portfolio
• Revenue (Margin) Coverage – Revenue (margin) of its covered orders as a percentage
of the total revenue from the data set.
• Answers the question: If I could only have 100 products, which should I choose?

100
Cumulative Percentage of

80 RCO
Revenue Covered

Heuristic (Revenue)
60

40

20

0
0 200 400 600 800 1000 1200
Number of SKUs 39
Portfolio Rationalization Project Results
• “Hard” benefits
• Over $500 M saved since 2005
• Product adoption rate improved from 18% to 85%
• LaserJet SKU count reduced by 40% in 3 years (2006-9)
• RCO eliminated 3,300 of 11,000 SKUs from HPs Business Critical
Systems division
• “Softer” benefits
• Shift from revenue to margin focused management
• Higher customer satisfaction
• Less confusion for sales and customers
• Higher forecasting accuracy
• Better organizational efficiency – forcing different areas of the
organization to talk with common language

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Embracing Complexity?

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When should complexity be embraced?
• Value Destroying
• Does the cost of complexity outweigh the value?
• Does it introduce greater confusion to the customer?

• Value Creating
• Is the cost of the complexity less than the increase in value to the
customer?
• Does the added complexity provide potentials for flexibility?
• Does the added complexity create a competitive advantage?

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Embracing Complexity?
• What industry has:
• Very small batch sizes,
• Long set up times with very short
desired lead times,
• Highly customized products (no two are
alike),
• Unpredictable order frequency, and
• Many many very small customers.

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Small Format Printing
• Current industry (US)
• ~30,000 firms in the printing industry (NAICS 323)
• Small job shops (~50% of firms have ≤4 employees)
• Fragmented and serving local markets
• Traditional process for business cards
• Relatively high design costs & time
• High switch over and set up costs between runs
• Individual card runs – requires high minimum orders
• Rough printing costs
• $10-$20 per thousand square inches (MSI)
• Business cards are 2” x 3.5” so 500 cards ≈ 3.5 MSI =$35

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 Embracing Complexity
• Vistaprint (and Cimpress)
• Founded in 1995 – profitable in 2001 – IPO 2005
• On line small format printing for micro-businesses
• Mass Customization Platform Custom
• Complete online design & order Made

Unit Cost
• Integrated Production Processes
• Large scale, high speed plants
• Software ties design to production
• Automated sorting, aggregation, Mass
Mass
and organizing of jobs for gang run Produced
Customized

Production Run Size

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Embracing Complexity
• Mass customization leadership:
Build a competitive moat based on scale advantage
• Also uses a "minefield of patents"
• Initial patents filed in France in 2000
• Over 100 patents worldwide
• Example; VistaBridge - Patent 6,992,794

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Key Points from Lesson

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Key Points from Lesson
• Real life challenges
• Supply Chain Complexity
• Drivers
• Numerousness
• Variety/Diversity
• Interconnections/Interactions
• Opacity of Interactions
• Dynamic Effects
• Reducing Complexity
• SKU count is major driver – focus on entry and exit
• Cross functional team and repeatable process
• Embracing Complexity
• Competitive advantage if done right
• Need to align supply chain and other functions to support

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Questions, Comments, Suggestions?
Use the Discussion!

“Dexter & Wilson – neither complex nor complicated”

Yankee Golden Retriever Rescued Dog
(www.ygrr.org) caplice@mit.edu
ctl.mit.edu