Supply Chain Management Fall, 2004 Dr. Lu Note 2 Supply Chain Basics Supply Chain Management Fall, 2004 Dr. Lu Note 2

Outline The supply chain processes Service metrics Performance drivers Cycle view and pull push view Service metrics Average lead time, fill rate Performance drivers Inventory, transportation, information and facility Basic facts and their implications in SCM Economy of scale, risk pooling and information principle Introduction to the beer game

SCM Is Hot The competition becomes between a supply chain to another chain The Increased complexity of supply chain Emergence of global supply chain More demanding customers Shorter production lifecycles Outsourcing, decentralized control and more… Feasibilities radical improvement in information technology and communication capabilities

Cycle View of Supply Chain Processes Customer Customer Order Cycle Retailer Replenishment Cycle Distributor Manufacturing Cycle Manufacturer Procurement Cycle Supplier

Customer order cycle Customer arrival Customer order entry Customer order fulfillment Customer order receiving

Replenishment cycle Retail order trigger Retail order entry Retail order fulfillment Retail order receiving

Manufacturing cycle Order arrival from the distributor, retailer, or customer Production scheduling Manufacturing and shipping Receiving at the distributor, retailer, or customer

Push/Pull View of Supply Chains Procurement, Manufacturing and Replenishment cycles Customer Order Cycle PUSH PROCESSES PULL PROCESSES Customer Order Arrives

Supply Chain Service Metrics Average lead time Percentage of demand met immediately from stock (fill rate) Percentage of orders filled within a prespecified time window Percentage of orders filled correctly

Supply Chain Cost Ordering/transaction costs Inventory costs Ordering processing equipment, labor Inventory costs Capital, obsolescence, insurance, storage Transportation Truck, airfreight, shipping, labor Facilities Warehouses, retail space Taxes and tariffs

Drivers of Supply Chain Performance Inventory Facility Transportation Information

Inventory Inventory is the raw materials, work in process and the finished products within a supply chain Provides good service to the customer The higher inventory means higher fill rate Helps to take advantages of economies of scale in production and distribution Inventory can be used as a tool to reduce cost It incur cost Cost of space, equipment, labor Cost of insurance, tax Cost of perished, damaged goods Cost of obsolescence Cost of capital

Inventory the Evil

Nordstrom Target high-end customer They are willing to pay premium price for high service level Stock high inventory to provide high service level High inventory cost can be justified by the high price

Transportation Transportation moves the products from one stage to another stage Modes of transportation Air, truck, Rail, Pipeline, Electronic transportation In house or outsource the transportation Outsource usually can reduce cost, however, flexibility is restrict Overall trade-off Responsiveness or efficiency

Facilities Facilities is where of the inventory are stored and transported to and from Decision about facilities Location Capacity Overall trade-off Responsiveness and efficiency

Information Information is critical in today’s SCM Coordination needs the information sharing The demand information, status of inventory, status of the supply… Good decision need to be based on the good information Forecast need to be based on good information

Major Tradeoffs in Decision Making Inventory costs vs. transportation Frequent shipments are expensive, but reduce inventory Inventory vs. service level More inventory provides better service, but is more costly Inventory vs. information Better information (more accurate demand forecast and more reliable supplier deliveries) reduces inventory, but requires efforts and investments

Challenges Future is always uncertain Demand uncertainty Supply variability The existence lead times worsen the situation Transportation from one location to another Production time Order processing time While inventory can serve as a buffer to cope with the above difficulties, it is costly Opportunity cost of capital Maintenance, obsolescence, etc. Different players with different objectives

Obstacles Increasing variety of product Decreasing product cycle Customer is more demanding Globalization

SCM Tactics for the Challenge Future is always uncertain demand forecasting mechanism to reduce the variability of the demand at some cost The existence lead times worsen the situation Information technology, e-business While inventory can serve as a buffer to cope with the above difficulties, it is costly Inventory management Different players with different objectives Supply chain coordination

Basic Facts (1) There exists fixed costs Production set-up, facility construction/equipment purchasing, transportation cost Fixed costs implies economies of scale Order more will reduce the average fixed cost per item

Economies of Scale When there is fixed cost in producing or purchasing, the more one produces or purchases, the less the per unit cost will be Implications for SCM A central warehouse realizes economies of scale in consolidated purchasing Fewer large warehouses leads to lower total overhead cost relative to many smaller warehouse Outsource activities that are not core competence of economy and utilize someone else’s economy of scale

Basic Facts (2) There exists variation and hence risk Demand, processes Variation degrades system performance and there exists an effect of risk pooling When variation reduces, with same cost, the service level can be improved

Risk Pooling Demand variability is reduced if one aggregates demand across locations because it is more likely that high demand from one customer can be offset by low demand from another customer We also call it “the square root effect” Let D=D1+D2+…+Dn, where Di is the demand in location i, when Di are independent and var(Di)=σ2, then var(D)=nσ2

Implication of Risk Pooling in SCM Centralized inventory enjoys the risk pooling effect and therefore requires less investment This is another reason why we see central warehouses Delaying product differentiation reduces the inventory of common components and/or standardized semi-productions Since it pools the risk of demand fore different products Postpone, Dell’s ATO system

Implication of Risk Pooling in SCM Examples: demand is i.i.d. we have two items, the transportation time from the warehouse to the retailer store is negligible 2 1 1 2

Examples: ATO demand is i.i.d. we have two items The product is AB or AC We have two components for either A, B or C 1 2 1 1 1

Basic Facts (3) Information accumulates over time Observe demand, quality, etc. More information helps make better decisions

Information Uncertainty is largely due to lack of information, so more information helps to increases the predictability of the environment and therefore helps to make better decision Implication in the SCM A central warehouse in effect delays the inventory allocation decision to a later point, at which better allocations can be made using more accurate estimation of the local demand and the stock levels in each stores Delayed customization utilizes this fact too Centralized decisions are better than the local decisions: VMI is an implication of this idea; Inventive schemes should be created so that to induce an decentralized system to act like a centralized system: coordination

Implication of Information The magic of relocating Demand is i.i.d. Re-allocate 20 === 10 10 10 10 10 10 10 10 10 10 10 10 -20 10 -20 -20

Purpose Experience first hand the flow of materials through a distribution system. Understand what is happening in each stage Understand the information distortion

The Beer Game Manufacturer Beers Distributor Wholesaler Retailer Orders Customers

Four Players on a Team Factory Distributor Wholesaler Retailer Orders Delay Factory Distributor Wholesaler Retailer Orders Material

Beer Game Four players without communication Manufacturer Distributor Retailer Four players without communication Event sequence in each stage: Receives Beer (after Shipping Delay) Receives Orders from Downstream Ships Beer Downstream to meet Orders Orders Beer from Upstream (the only decision) Wholesaler

Parameters Unsatisfied demand is fully backlogged (all demand is to be satisfied) No capacity constraints Parameters Ordering lead time is two weeks for each stage Inventory cost/week is $1.00 Backlog cost/week is $2.00 Objective function: Minimize Total Supply Chain Cost Total Cost = Sum of Costs at all four Stages

Playing the Game Cost – Inventory & Stockout Goal – Minimize Costs Delays No Communication within the Team Two decisions each period – How much to ship? How much to order? Must click on “Submit Button” to enter decision. Play a few rounds to get the hang of it…

Game Tasks Plot your Weekly Orders Plot your Inventory and Backlog Plot your Guess on Consumer Demand Pattern Calculate Total Cost at your Stage Sum Costs over all Four Stages

Playing Game Group name:ust_001, ust_002,…,ust_009,ust_010 The retailer will create the game names The other players choose to join in the game When there are four players, the first player (retailer) will start the game and place order There are some initial shipments between all the stages and at the stages Make decision based on your own information!

How to Start the Game Go to the website: Choose Start or Join http://www.masystem.com/beergame Choose Start or Join The retailer choose start and the other players choose join Choose your role: the first player choose the retailer The retailer starts the game The game will last for 52 weeks You can end it earlier

Discussion What, if anything, is unrealistic about this game? Is reality more complicated or less complicated? Why are there delays between each stages? What happened? Variance in Orders Inventory/Shortages – Feast or Famine What was the actual demand at the retailer? Did you find yourself “blaming” the person upstream for your problems? What commonalities do you see in the graphs for the different teams? What pattern do you see? What is the cost of this? What are the reasons that such patterns are seen in the supply chain?

Summary An process view of supply chain Drivers for the performance of supply chain Challenges in supply chain management Some basics and principles Next week Achieving strategic fit and scope Discuss of beer game