Supply Chain Integration and e- Business Strategies David Simchi-Levi Professor of Engineering Systems Massachusetts Institute of Technology Tel:

©Copyright 2002 D. Simchi-Levi Outline Review –Supply Chain Dynamics A new Supply Chain Paradigm Matching Products with Strategies e-Business Opportunities

©Copyright 2002 D. Simchi-Levi The Dynamics of the Supply Chain Order Size Time Source: Tom Mc Guffry, Electronic Commerce and Value Chain Management, 1998 Customer Demand Customer Demand Retailer Orders Distributor Orders Production Plan

©Copyright 2002 D. Simchi-Levi The Dynamics of the Supply Chain Order Size Time Source: Tom Mc Guffry, Electronic Commerce and Value Chain Management, 1998 Customer Demand Customer Demand Production Plan

©Copyright 2002 D. Simchi-Levi What are the Causes…. Promotional sales Volume and Transportation discounts –Batching Inflated orders Demand Forecast Long cycle times Lack of Visibility to demand information

©Copyright 2002 D. Simchi-Levi Consequences…. Increased safety stock Reduced service level Inefficient allocation of resources Increased transportation costs

©Copyright 2002 D. Simchi-Levi The Bullwhip Effect: Managerial Insights Exists, in part, due to the retailer’s need to estimate the mean and variance of demand. The increase in variability is an increasing function of the lead time. The more complicated the demand models and the forecasting techniques, the greater the increase. Centralized demand information can reduce the bullwhip effect, but will not eliminate it.

©Copyright 2002 D. Simchi-Levi Coping with the Bullwhip Effect in Leading Companies Reduce Variability and Uncertainty - POS - Sharing Information - Year-round low pricing Reduce Lead Times - EDI - Cross Docking Alliance Arrangements –Vendor managed inventory –On-site vendor representatives

©Copyright 2002 D. Simchi-Levi Example: Quick Response at Benetton Benetton, the Italian sportswear manufacturer, was founded in In 1975 Benetton had 200 stores across Italy. Ten years later, the company expanded to the U.S., Japan and Eastern Europe. Sales in 1991 reached 2 trillion. Many attribute Benetton’s success to successful use of communication and information technologies.

©Copyright 2002 D. Simchi-Levi Example: Quick Response at Benetton Benetton uses an effective strategy, referred to as Quick Response, in which manufacturing, warehousing, sales and retailers are linked together. In this strategy a Benetton retailer reorders a product through a direct link with Benetton’s mainframe computer in Italy. Using this strategy, Benetton is capable of shipping a new order in only four weeks, several week earlier than most of its competitors.

©Copyright 2002 D. Simchi-Levi How Does Benetton Cope with the Bullwhip Effect? 1. Integrated Information Systems Global EDI network that links agents with production and inventory information EDI order transmission to HQ EDI linkage with air carriers Data linked to manufacturing 2. Coordinated Planning Frequent review allows fast reaction Integrated distribution strategy

©Copyright 2002 D. Simchi-Levi Distribution Strategies Warehousing Direct Shipping –No DC needed –Lead times reduced –“smaller trucks” –no risk pooling effects Cross-Docking

©Copyright 2002 D. Simchi-Levi Cross Docking In 1979, Kmart was the king of the retail industry with 1891 stores and average revenues per store of $7.25 million At that time Wal-Mart was a small niche retailer in the South with only 229 stores and average revenues about half of those Kmart stores. Ten years later, Wal-Mart transformed itself; it has the highest sales per square foot, inventory turnover and operating profit of any discount retailer. Today Wal-Mart is the largest and highest profit retailer in the world.

©Copyright 2002 D. Simchi-Levi What accounts for Wal-Mart’s remarkable success The starting point was a relentless focus on satisfying customer needs; Wal-Mart goal was simply to provide customers access to goods when and where they want them and to develop cost structures that enable competitive pricing The key to achieving this goal was to make the way the company replenished inventory the centerpiece of its strategy.

©Copyright 2002 D. Simchi-Levi What accounts for Wal-Mart’s remarkable success? This was obtained by using a logistics technique known as cross-docking. Here goods are continuously delivered to Wal-Mart’s warehouses where they are dispatched to stores without ever sitting in inventory. This strategy reduced Wal-Mart’s cost of sales significantly and made it possible to offer everyday low prices to their customers.

©Copyright 2002 D. Simchi-Levi Characteristics of Cross-Docking: Goods spend at most 48 hours in the warehouse, Avoids inventory and handling costs, Wal-Mart delivers about 85% of its goods through its warehouse system, compared to about 50% for Kmart, Stores trigger orders for products.

©Copyright 2002 D. Simchi-Levi System Characteristics: Very difficult to manage, Requires linking Wal-Mart’s distribution centers, suppliers and stores to guarantee that any order is processed and executed in a matter of hours, Wal-Mart operates a private satellite- communications system that sends point-of- sale data to all its vendors allowing them to have a clear vision of sales at the stores

©Copyright 2002 D. Simchi-Levi System Characteristics: Need a fast and responsive transportation system: Wal-Mart has a dedicated fleet of 2000 trucks that serve their 19 warehouses This allows them to –ship goods from warehouses to stores in less than 48 hours –replenish stores twice a week on average.

©Copyright 2002 D. Simchi-Levi Distribution Strategies

©Copyright 2002 D. Simchi-Levi Supply Chain Integration - Dealing with Conflicting Goals Lot Size vs. Inventory Inventory vs. Transportation Lead Time vs. Transportation Product Variety vs. Inventory Cost vs. Customer Service

©Copyright 2002 D. Simchi-Levi The Future is Not What it Used to Be –Reduce cost –Increase Profit –Increase service level –Increase flexibility A new Business Model e-

©Copyright 2002 D. Simchi-Levi Reality is Different….. Peapod Example –Founded 1989 –140,000 members, largest on-line grocer –Revenue tripled to $73 million in 1999 –1st Quarter of 2000: $25M Sales, Loss: $8M Amazon.com Example –Founded in 1995; 1st Internet purchase for most people –1996: $16M Sales, $6M Loss –1999: $1.6B Sales, $720M Loss –2000: $2.7B Sales, $1.4B Loss –Last quarter of 2001: $50M Profit Total debt: $2.2B

©Copyright 2002 D. Simchi-Levi Reality is Different…. Dell Example: –Dell Computer has outperformed the competition in terms of shareholder value growth over the eight years period, , by over 3,000% (see Anderson and Lee, 1999)

©Copyright 2002 D. Simchi-Levi Reality is Different…. Cisco Example: –Cisco’s Internet based business model has been instrumental in our ability to quadruple in size from fiscal 1994 to fiscal 1998 ($1.3B to over $8B), hire approximately 1000 new employees per quarter and saving $560M annually in business expenses (Peter Solvik, CIO Cisco)

©Copyright 2002 D. Simchi-Levi e-Business is a collection of business models and processes motivated by Internet technology, and focusing on improving the extended enterprise performance –e-commerce is part of e-Business –Internet technology is the driver of the business change –The focus is on the extended enterprise: Intra-organizational Business to Consumer (B2C) Business to Business (B2B) The Business Model e-

©Copyright 2002 D. Simchi-Levi A new Supply Chain Paradigm A shift from a Push System... –Production decisions are based on forecast …to a Push-Pull System

©Copyright 2002 D. Simchi-Levi From Make-to-Stock Model…. Configuration Assembly Suppliers

©Copyright 2002 D. Simchi-Levi Demand Forecast The three principles of all forecasting techniques: –Forecasts are always wrong –The longer the forecast horizon the worst is the forecast –Aggregate forecasts are more accurate The Risk Pooling Concept

©Copyright 2002 D. Simchi-Levi A new Supply Chain Paradigm A shift from a Push System... –Production decisions are based on forecast …to a Push-Pull System

©Copyright 2002 D. Simchi-Levi Push-Pull Supply Chains Push-Pull Boundary PUSH STRATEGYPULL STRATEGY Low Uncertainty High Uncertainty The Supply Chain Time Line Customers Suppliers

©Copyright 2002 D. Simchi-Levi A new Supply Chain Paradigm A shift from a Push System... –Production decisions are based on forecast …to a Push-Pull System –Parts inventory is replenished based on forecasts –Assembly is based on accurate customer demand

©Copyright 2002 D. Simchi-Levi ….to Assemble-to-Order Model Configuration Assembly Suppliers

©Copyright 2002 D. Simchi-Levi Business models in the Book Industry From Push Systems... –Barnes and Noble...To Pull Systems –Amazon.com, And, finally to Push-Pull Systems –Amazon.com, 1999-present 7 warehouses, 3M sq. ft.,

Direct-to-Consumer:Cost Trade-Off

©Copyright 2002 D. Simchi-Levi Industry Benchmarks: Number of Distribution Centers Sources: CLM 1999, Herbert W. Davis & Co; LogicTools Avg. # of WH Pharmaceuticals Food CompaniesChemicals - High margin product - Service not important (or easy to ship express) - Inventory expensive relative to transportation - Low margin product - Service very important - Outbound transportation expensive relative to inbound

©Copyright 2002 D. Simchi-Levi Business models in the Grocery Industry From Push Systems... –Supermarket supply chain...To Pull Systems –Peapod, Stock outs 8% to 10% And, finally to Push-Pull Systems –Peapod, 1999-present Dedicated warehouses Stock outs less than 2%

©Copyright 2002 D. Simchi-Levi Business models in the Grocery Industry Key Challenges for e-grocer: –Transportation cost Density of customers –Very short order cycle times Less than 12 hours –Difficult to compete on cost Must provide some added value such as convenience

©Copyright 2002 D. Simchi-Levi Less than 300,000 shoppers Source: D. Ratliff

©Copyright 2002 D. Simchi-Levi A New Type of Home Grocer grocerystreet.com –On-line window for retailers –The on-line grocer picks products at the store –Customer can pick products at the store or pay for delivery

©Copyright 2002 D. Simchi-Levi e-Business in the Retail Industry Brick-&-Mortar companies establish Virtual retail stores –Wal-Mart, K-Mart, Barnes and Noble Use a hybrid approach in stocking –High volume/fast moving products for local storage –Low volume/slow moving products for browsing and purchase on line Channel Conflict Issues

©Copyright 2002 D. Simchi-Levi E-Fulfillment Requires a New Logistics Infrastructure

©Copyright 2002 D. Simchi-Levi Wal-Mart’s e-fulfillment Strategy Wal-Mart has always prided itself in its in-house distribution operations. Thus, it was a huge surprise when the company announced that it plans to hire an outside firm to handle order fulfillment and warehousing for it’s on- line store Wal-Mart.com, which the retailer launched in the fall of Filling orders behind the scenes of Wal-Mart’s cyberstore is Fingerhut Business Services. Fingerhut will provide Internet order fulfillment, warehousing, shipment, payment processing, customer service and merchandise returns.

©Copyright 2002 D. Simchi-Levi E-Fulfillment Is it a new concept? What is the difference between on-line and catalogue selling? Consider for instance Land’s End which has both channels

©Copyright 2002 D. Simchi-Levi Matching Supply Chain Strategies with Products Pull Push Pull Push I Computer II IVIII Demand uncertainty (C.V.) Delivery cost Unit price L H HLHL Economies of Scale

©Copyright 2002 D. Simchi-Levi Locating the Push-Pull Boundary

©Copyright 2002 D. Simchi-Levi Organizational Skills Needed Raw Material Customers Pull Push Low Uncertainty Long Lead Times Cost Minimization Resource Allocation High Uncertainty Short Cycle Times Service Level Responsiveness

©Copyright 2002 D. Simchi-Levi e-Business Opportunities: Reduce Facility Costs –Eliminate retail/distributor sites Reduce Inventory Costs –Apply the risk-pooling concept Centralized stocking Postponement of product differentiation Use Dynamic Pricing Strategies to Improve Supply Chain Performance

©Copyright 2002 D. Simchi-Levi e-Business Opportunities: Supply Chain Visibility –Reduction in the Bullwhip Effect Reduction in Inventory Improved service level Better utilization of Resources –Improve supply chain performance Provide key performance measures Identify and alert when violations occur Allow planning based on global supply chain data