Designing Effective Supply Chains Chapter 12

What is Supply Chain Design? Designing a firm’s supply chain to meet the competitive priorities of the firm’s operations strategy.

Creating An Effective Supply Chain Identifying external and internal pressures Dynamic sales volumes Customer service and quality expectations Service/product proliferation Emerging markets

Creating an Effective Supply Chain Link Services/Products with External Supply Chain Link Services/Products with Internal Processes Service/Product Processes Supply Chain Link Services/Products with Customers, Suppliers, and Supply Chain Processes Figure 12.1

Supply Chain Efficiency Curve Inefficient supply chain operations Total costs Supply chain performance Area of improved operations Reduce costs New supply chain efficiency curve with changes in design and execution Improve perform-ance Figure 12.2

Service Supply Chain Packaging Flowers: Local/International Arrangement materials FedEx delivery service Local delivery service Internet service Maintenance services Flowers-on-Demand florist Home customers Commercial Figure 12.3

Manufacturing Supply Chain Poland USA Canada Australia Malaysia Tier 3 Raw materials Germany Mexico USA China Tier 2 Components Germany Mexico USA Tier 1 Major subassemblies Manufacturer USA Assembly USA Ireland Distribution centers East Coast West Coast East Europe West Europe Retail Figure 12.4

Measuring Supply Chain Performance Inventory Measures Average aggregate inventory value = + Value of each unit of item B Number of units of item B typically on hand Value of each unit of item A Number of units of item A typically on hand Weeks of supply = Average aggregate inventory value Weekly sales (at cost) Inventory turnover = Annual sales (at cost) Average aggregate inventory value

Example 12.1 The Eagle Machine Company averaged $2 million in inventory last year, and the cost of goods sold was $10 million. The breakout of raw materials, work-in-process, and finished goods inventories is on the following slide. The best inventory turnover in the company’s industry is six turns per year. If the company has 52 business weeks per year, how many weeks of supply were held in inventory? What was the inventory turnover? What should the company do?

Example 12.1 Figure 12.5

Example 12.1 The average aggregate inventory value of $2 million translates into 10.4 weeks of supply and 5 turns per year, calculated as follows: = 10.4 weeks $2 million ($10 million)/(52 weeks) Weeks of supply = = 5 turns/year $10 million $2 million Inventory turns =

Average aggregate inventory value Application 12.1 A recent accounting statement showed total inventories (raw materials + WIP + finished goods) to be $6,821,000. This year’s “cost of goods sold” is $19.2 million. The company operates 52 weeks per year. How many weeks of supply are being held? What is the inventory turnover? Weeks of supply = Average aggregate inventory value Weekly sales (at cost) = = 18.5 weeks $6,821,000 ($19,200,000)/(52 weeks) = 2.8 turns $19,200,000 $6,821,000 Inventory turnover =

Measuring Supply Chain Performance Financial measures Total revenue Cost of goods sold Operating expenses Cash flow Working capital Return on assets (ROA)

SCM Decisions Affecting ROA Total revenue Increase sales through better customer service Cost of goods sold Reduce costs of transportation and purchased materials Operating expenses Reduce fixed expenses by reducing overhead associated with supply chain operations Net income Improve profits with greater revenue and lower costs Return on assets (ROA) Increase ROA with higher net income and fewer total assets Working capital Reduce working capital by reducing inventory investment, lead times, and backlogs Fixed assets Reduce the number of warehouses through improved supply chain design Net cash flows Improve positive cash flows by reducing lead times and backlogs Inventory Increase inventory turnover Total assets Achieve the same or better performance with fewer assets Figure 12.6

Strategic Options for Supply Chain Design Efficient supply chains Make-to-stock (MTS) Responsive supply chains Assemble-to-order (ATO) Make-to-order (MTO) Design-to-order (DTO)

Environments Factor Efficient Supply Chains Responsive Supply Chains Demand Predictable, low forecast errors Unpredictable, high forecast errors Competitive priorities Low cost, consistent quality, on-time delivery Development speed, fast delivery times, customization, volume flexibility, variety, top quality New-service/product introduction Infrequent Frequent Contribution margins Low High Product variety Table 12.1

Supply to forecasted demand Supply Chain Designs Make-to-Stock Strategy Order based on forecast Order based on forecast Customer order Component Supplier Manufacturer Finished Goods Inventory Customer Supply to forecasted demand Supply to forecast Ship to order Figure 12.7

Standardized Component Supply Chain Designs Assemble-to-Order Strategy Customer order Order based on forecast Supply as needed Customer Component Supplier Standardized Component Inventory Fabrication Assembly Supply to Forecasted Demand Supply as needed Figure 12.8

Design Features Factor Efficient Supply Chains Responsive Supply Chains Operation strategy Make-to-stock or standardized services or products; emphasize high volumes Assemble-to-order, make-to-order, or customized service or products; emphasize variety Capacity cushion Low High Inventory investment Low; enable high inventory turns As needed to enable fast delivery time Lead time Shorten, but do not increase costs Shorten aggressively Supplier selection Emphasize low prices, consistent quality, on-time delivery Emphasize fast delivery time, customization, variety, volume flexibility, top quality Table 12.2

Supply Chain Design Link to Processes Job Small Batch Large Batch Line Continuous Flow Process Efficient Supply Chain Responsive Supply Chain Increasing supply chain flexibility Increasing service/product volume Service/Product Characteristics Figure 12.9 Customized Standardized

What is Mass Customization? A strategy whereby a firm’s highly divergent processes generate a wide variety of customized services or products at reasonably low costs.

Mass Customization Competitive advantages Managing customer relationships Eliminating finished goods inventory Increasing perceived value of services or products Supply chain design for mass customization Assemble-to-order strategy Modular design Postponement Channel Assembly

Outsourcing Processes Paying suppliers and distributors to perform processes and provide needed services and materials Offshoring A supply chain strategy that involves moving processes to another country Next-Shoring A supply chain strategy that involves locating processes in close proximity to customer demand or product R&D

Outsourcing Decision Factors Comparative Labor Costs Rework and Product Returns Logistics Costs Tariffs and Taxes Market Effects Labor Laws and Unions Internet Energy Costs Access to Low Cost Capital Supply Chain Complexity

Outsourcing Potential Pitfalls Pulling the Plug too Quickly Technology Transfer Process Integration

Outsourcing Processes Vertical integration Backward integration Forward integration Make-or-buy decision

Example 12.2 Thompson manufacturing produces industrial scales for the electronics industry. Management is considering outsourcing the shipping operation to a logistics provider experienced in the electronics industry. Thompson’s annual fixed costs of the shipping operation are $1,500,000, which includes costs of the equipment and infrastructure for the operation. The estimated variable cost of shipping the scales with the in-house operation is $4.50 per ton-mile. If Thompson outsourced the operation to Carter Trucking, the annual fixed costs of the infrastructure and management time needed to manage the contract would be $250,000. Carter would charge $8.50 per ton-mile. What is the break-even quantity?

Example 12.2 Fm – Fb 1,500,000 – 250,000 cb – cm Q = 8.50 – 4.50 = = 312,500 ton-miles

Solved Problem A firm’s cost of goods sold last year was $3,410,000, and the firm operates 52 weeks per year. It carries seven items in inventory: three raw materials, two work-in-process items, and two finished goods. The following table contains last year’s average inventory level for each item, along with its value. Category Part Number Average Level Unit Value Raw materials 1 15,000 $ 3.00 2 2,500 5.00 3 3,000 1.00 Work-in-process 4 5,000 14.00 5 4,000 18.00 Finished goods 6 2,000 48.00 7 1,000 62.00 a. What is the average aggregate inventory value? b. How many weeks of supply does the firm maintain? c. What was the inventory turnover last year?

Solved Problem Part Number Average Level Unit Value Total Value a. 1 15,000  $ 3.00 = 2 2,500 5.00 3 3,000 1.00 4 5,000 14.00 5 4,000 18.00 6 2,000 48.00 7 1,000 62.00 Average aggregate inventory value $ 45,000 12,500 3,000 70,000 72,000 96,000 62,000 $360,500

Average aggregate inventory value Average aggregate inventory value Solved Problem b. Average weekly sales at cost = $3,410,000/52 weeks = $65,577/week Weeks of supply = Average aggregate inventory value Weekly sales (at cost) = = 5.5 weeks $360,500 $65,577 c. Inventory turnover = Annual sales (at cost) Average aggregate inventory value = = 9.5 turns $3,410,000 $360,500