Supply Chain Management Managing the Supply Chain Key to matching demand with supply Cost and Benefits of inventory Levers for reducing mismatch costs Cycle Inventory and Economies of Scale Safety Inventory and Uncertainty Structuring Supply Chains Centralization & Pooling efficiencies Postponement Accurate Response Palu Gear Movie Rental Business J.A. Van Mieghem/Operations/Supply Chain Mgt

What is Supply Chain Management? Managing supply chain flows and assets to maximize supply chain surplus in a sustainable manner. The Procurement or supply system The Operating System The Distribution System Raw Material supply points Movement/ Transport Storage STORAGE PLANT 1 PLANT 2 PLANT 3 WAREHOUSE MARKETS Manufacturing Finished Goods A B C Key flows in the supply chain are - information, product, and cash (payments up/down SC). It is through these flows that a supply chain fills a customer order. The management of these flows is key to the success or failure of a firm. Give Dell & Compaq example, Amazon & Borders example to bring out the fact that all supply chain interaction is through these flows. Dell: what SC flows are key to Dell’s success? Why? Direct sales, low inventories MTO, merge-in-transit. Information Customers: close contact; match D&S by steering to available stuff, share demand, production schedules with component manufacturers – have steady demand in large assembly plants so suppliers can plan and replenish easily => Dell can keep low comp. inventories. Compaq/HP: what challenges do they face with indirect model? SC surplus = profit: what end customer has paid - total cost expended by supply chain in filling order. Sustainable: SC-wide view. Improve SC surplus for remaining parties. Each remaining party should have viable existence surplus increase at the expense of another. Unsustainable: push inventory to suppliers. SC wide, could be beneficial (aggregation, less value), but what if cost kills supplier. QR. Sustainable: Bullwhip Marks and Spencer. J.A. Van Mieghem/Operations/Supply Chain Mgt

Wal-Mart Financials over time 12 months ending 1/31 of: (Millions USD) 2011 2010 2009 2008 2007 Total Revenue 418,952 408,214 404,374 377,023 348,368 Cost of Revenue, Total 315,287 304,657 304,056 284,137 263,979 Gross Profit 103,665 100,389 97,031 89,684 80,780 SG&A Expense 81,020 79,607 77,520 70,934 63,892 Accounts Receivable - Trade, Net 5,089 4,144 3,905 3,642 2,840 Total Inventory 36,318 33,160 34,511 35,159 33,685 What questions would you ask the Wal-Mart CFO?

Amazon Financials over time 12 months ending 12/31 of: (Millions USD) 2010 2009 2008 2007 2006 Total Revenue 34,204 24,509 19,166 14,835 10,711 Cost of Revenue, Total 26,561 18,978 14,896 11,482 8,255 Gross Profit 7,643 5,531 4,270 3,353 2,456 Total Receivables, Net 1,587 988 827 682 382 Total Inventory 3,202 2,171 1,399 1,200 877 What questions would you ask the Amazon CFO?

The Role of Inventory in the Supply Chain Goal: Match supply and demand Otherwise: Mismatch cost: Overstocking = available amount > demand liquidation, obsolescence, holding Under-stocking = demand > available amount lost sales and resulting lost margin and future sales What are the causes (challenges) driving this mismatch? Notes: J.A. Van Mieghem/Operations/Supply Chain Mgt

Magazine sales at newsstands: as % of copies shipped to newsstands In Style People Vanity Fair Vogue The New Yorker GQ New York Esquire Rolling Stone Us Talk 64.7% 54.5% 45.6% 42.1% 39.9% 39.4% 35.1% 31.0% 28.0% 23.9% 18.0% Data for Oct. 1999 – Oct. 2000

The challenge of increased responsiveness: The challenge of increased responsiveness: A Key to Matching Supply and Demand When would you rather place your bet? A B C D Notes: A: A month before start of Derby B: The Monday before start of Derby C: The morning of start of Derby D: The winner is an inch from the finish line J.A. Van Mieghem/Operations/Supply Chain Mgt

Push/Pull View of Supply Chains Boundary Procurement, Customer order cycle Manufacturing and Replenishment cycles PUSH PROCESSES PULL PROCESSES Process 1 Process 2 Process 3 Process k Process k+1 Process N In this view processes are divided based on their timing relative to the timing of a customer order. Define push and pull processes. They key difference is the uncertainty during the two phases. Give examples at Amazon and Borders to illustrate the two views Customer Order Arrives J.A. Van Mieghem/Operations/Supply Chain Mgt

Role of Inventory in the Supply Chain Cost Availability Responsiveness Efficiency Notes: S. Chopra/Operations/Supply Chain

Supply Chain Management Managing the Supply Chain Key to matching demand with supply Cost and Benefits of inventory Levers for reducing mismatch costs Cycle Inventory and Economies of Scale Safety Inventory and Uncertainty J.A. Van Mieghem/Operations/Supply Chain Mgt

Palü Gear: Cycle Inventory & Economies of Scale Annual jacket revenues at a Palü Gear retail store are roughly $1M. Palü jackets sell at an average retail price of $325, which represents a mark-up of 30% above what Palü Gear paid its manufacturer. Being a profit center, each store made its own inventory decisions and was supplied directly from the manufacturer by truck. A shipment up to a full truck load, which was about 1500 jackets, was charged a flat fee of $2,200. To exploit economies of scale, stores typically ordered full truck loads. (Palü’s cost of capital is approximately 20%.) What order size would you recommend for a Palü store in current supply network? retailer manufacturer J.A. Van Mieghem/Operations/Supply Chain Mgt

Economies of Scale: Inventory Build-Up Diagram R: Annual demand rate, Q: Number of wind breakers per replenishment order Number of orders per year = R/Q. Average number of wind breakers in inventory = Q/2 . Inventory Inventory Profile: # of wind breakers in inventory over time. Q -R = Demand rate Q/2 “cycle stock” Time t J.A. Van Mieghem/Operations/Supply Chain Mgt

Accurate Response to Scale Economies: Economic Order Quantity EOQ Total annual costs H Q/2: Annual holding cost S R /Q:Annual setup cost Order Size Q Fixed cost per order The order quantity that minimizes total supply chain cost is: Annual unit demand Annual unit holding cost J.A. Van Mieghem/Operations/Supply Chain Mgt

Optimal Economies of Scale: For a Palü Gear retailer R = 3077 units/ year C = $ 250 / unit r = 0.20/year S = $ 2,200 / order Unit annual holding cost = H = 0.20/yr x $250 = $50/yr Optimal order quantity = Q = sqrt(2 x 3077 x 2200/50) = 520 Number of orders per year = R/Q = 5.9 Time between orders = Q/R = 0.17yr = 8.8weeks Annual order cost = (R/Q)S = $13,008.87/yr Average inventory I = Q/2 = 260 Annual holding cost = (Q/2)H =$13,008.87/yr Average flow time T = I/R = 0.084 yr = 4.4weeks J.A. Van Mieghem/Operations/Supply Chain Mgt

Costs associated with batches Order Costs (S) Setup/Changeover of process Transportation Receiving Holding costs (H) Physical holding cost Cost of capital Cost of obsolescence

Learning Objectives: Batching & Economies of Scale Increasing batch size Q of order (or production) increases average inventories (and thus flow times). Average inventory for a batch size of Q is Q/2. The optimal batch size minimizes supply chain costs by trading off setup cost and holding cost and is given by the EOQ formula. To reduce batch size, one must reduce setup cost (time). Economies of scale are manifested by the square-root relationship between QEOQ and (R, S): If demand increases by a factor of 4, it is optimal to increase batch size by a factor of 2 and produce (order) twice as often. To reduce batch size by a factor of 2, setup cost has to be reduced by a factor of 4. J.A. Van Mieghem/Operations/Supply Chain Mgt

Demand uncertainty and forecasting: How good is “your forecast?” Year Demand Forecast 1994 323 1995 258 ? 1996 303 ? 1997 304 ? 1998 284 ? 1999 285 ?  The numbers in the updated slide are the batting averages for Ken Griffey Jr, who played for the Seattle Mariners until the end of the 1999 season. The story is as follows: At the end of 1999 Griffey demanded a trade to the Cincinatti Reds, who had to decide how much he was worth. He was offered $117 m for 9 years, presumably on the belief that he would once again break .300. As Marty noted this morning, the industry average is about .260, and breaking .300 consistently puts you in Hall of Fame contention. Griffey started off the year 2000 with the Reds very badly, with injuries, but managed to pull off a respectable .271 for the 2000 season. Respectable, yes, but worth $117 million?? This of course goes along with the example, in that forecasts are usually off and people tend to overestimate. Griffey has much more name recognition with non-sports fans than Danny Tartabull. By the way, Ken Griffey Jr is also known as "Junior." His father, Ken Griffey, was also a star. A very timely update - the Reds just put Ken Griffey Jr. on the disabled list (DL). He has a partially torn left hamstring. Hamstring injuries are, like diamonds, potentially forever! This example just keeps getting better! The Mariners (Griffey's former team), by the way, despite losing to Chicago, are the first team to get 20 wins before May. J.A. Van Mieghem/Operations/Supply Chain Mgt

Demand uncertainty and forecasting: Key Facts about Forecasting Forecasts should capture all available knowledge: historical data, “market intelligence,” etc. (Point) Forecasts are usually (always?) wrong A good forecast has at least 2 numbers: it includes a measure of forecast error or variability, e.g., standard deviation s Operational response = The longer the forecast horizon, the less accurate the forecast The forecast horizon must at least be as large as the lead time Demand during shorter lead times has less variability Aggregate forecasts tend to be more accurate Pooled demand has less “relative variability” (s /mean) J.A. Van Mieghem/Operations/Supply Chain Mgt

Learning Objectives safety inventory and uncertainty Safety stock is a hedge against uncertainty Need more safety stock when there is an increase in service level, demand variability or forecast error, delivery lead time, delivery lead time variability. J.A. Van Mieghem/Operations/Supply Chain Mgt

Supply Chain Management Managing the Supply Chain Key to matching demand with supply Cost and Benefits of inventory Levers for reducing mismatch costs Cycle Inventory and Economies of Scale Safety Inventory and Uncertainty Structuring Supply Chains Centralization & Pooling efficiencies Postponement Accurate Response Palu Gear Movie Rental Business J.A. Van Mieghem/Operations/Supply Chain Mgt

Structuring Drivers of Supply Chain Performance to Improve Matching of Supply and Demand Demand with Supply Transportation Inventory Information Facilities J.A. Van Mieghem/Operations/Supply Chain Mgt

Structuring Inventory for Accurate Response System A (Decentralized) System B (Centralized) Notes: How do both systems compare? J.A. Van Mieghem/Operations/Supply Chain Mgt

Actions to improve supply chain profitability: Actions to improve supply chain profitability: Various possibilities to pool: Aggregation Actions Physical centralization Information centralization Specialization Substitution Commonality Postponement Multiple locations Information centralization: Wal-Mart, The Gap, mail order Product substitution: Dell, Category Management Multiple products J.A. Van Mieghem/Operations/Supply Chain Mgt

Accurate Response using Speed Principle: Long term forecasts are less accurate than short term forecasts. Action: Shorten time of information and physical flows Reduce replenishment lead time Reduce supply uncertainty or replenishment lead time uncertainty Increase reorder frequency or go to continuous review Speed, however, comes at a cost! J.A. Van Mieghem/Operations/Supply Chain Mgt

Global Dual Sourcing Mexico-China? You are a $10B high-tech US manufacturer of wireless transmission components, about 20SKUs. Intense global competition put pressure on margins and working capital You have two assembly plants, one in China and another in Mexico, that supply a warehouse in McAllen, TX. How can you best manage this existing global network? Emphasize that you have an existing global network (or at least have the option to change already identified locations. We shall not discuss how to find locations and related setup costs.) The two key questions we want to address: you may have an existing SKU that is: 1. offshored to a low cost location; should you bring it back? 2. sourced locally; should you offshore it? Or you may have a new SKU in the pipeline… A good tool to analyze those decisions is TLC—how many of you found it better to use China for the SKUs in mini-case 6? How did you compute TLC? insight.kellogg.northwestern.edu Global Dual Sourcing Strategies Should you source your carbon fiber bicycle frames from Mexico or China? Based on the Research of Gad Allon And Jan A. Van Mieghem Do no copy nor poste on the Internet.

Digital Tech & Social Media to improve information The value of early information and forecast updating Even for stable products, clickstream tracking of non-transactional websites can improve holding and backlogging costs by 5% (Huang & Van Mieghem 2011) 500 1000 1500 2000 2500 3000 3500 4000 Actual total sales: Each data point represents the forecast and the actual season sales for a particular item (at the style-color level). Updated Forecast after observing 20% of sales Initial Forecast Updated Forecast after observing 80% of sales insight.kellogg.northwestern.edu From Web Visits to Firm Orders: Analyzing web visitor click data to streamline sales efforts Based on the research of Tingliang Huang And Jan A. Van Mieghem

Movie Rental Business

Summary: Improved Matching of Supply and Demand Notes: S. Chopra/Operations/Supply Chain