SUPPLY CHAIN INTEGRATION

• In inefficient supply chains, material, information and finance do not flow seamlessly across departmental and organizational boundaries.

• This creates inefficiencies in the working of the organization and consequently, profitability of the organization.

• These inefficiencies can be removed only if the flow becomes seamless. That is there is no block at the departmental as well as organizational boundaries.

• This seamless flow is possible only by integrating not only the internal operations but also if the firm manages to integrate itself with the suppliers as well as the end users.

• Supply chain integration means the coordination and re-structuring of organizational elements in such a way that a system is created wherein there is seamless flow of information, material and finance, not only within the organization , but to and from the suppliers and the end users as well.

• Internal Integration :• A typical firm is functionally organized, and material

and information has to go through multiple departments across the internal supply chain.

• As each department is focusing on a narrowly defined local performance, there are many inefficiencies and buffers at the departmental boundaries.

• These give rise to inefficiencies in the organization.

• In order to remove these inefficiencies, firms have to undertake internal integration, which is, finding ways of coordinating the planning and decision making across the organization.

• This can be achieved :• - by centralizing all planning activities. • - decentralizing all planning activities .

• Centralized System :• In this type of system, the planning is done at a

centralized place.• This eliminates some problems arising from

decisions based on local performance measures.• It is ensured that decisions are made from firm’s

performance point of view rather than on individual department’s local performance measures.

• The advantage with centralized system is that optimizing performance at the firm’s level results in better performance.

• The drawback with this system is that it cannot capture the local knowledge and can result in disempowerment of local managers, which in turn will lead to lower levels of innovations in problem solving.

• Decentralized System :• In this type of system, internal supply chains

are divided into large number of customer supplier linkages.

• Here customer service gets priority over local efficiency.

• This ensures that an assured level of service is provided to internal customers in supplier-customer linkages.

• Each system then can manage its operations independently, ensuring that it meets its service requirements.

• When performance measures are aligned, one can coordinate decentralized systems in the internal supply chain.

• The advantage with decentralized system is that it results in higher innovations in problem solving situations and more effective use of local knowledge.

• The disadvantage with decentralized system is that it usually has a longer lead time.

• Since customer service is a function of the load on the system, each link in the system will work out its own lead time based on worst case scenario, rather than on average case scenario.

• This will lead to an increase in lead time.• In case the internal customer insists on a

shorter lead time, the internal supplier will keep a buffer stock. This will again increase costs for the firm.

• Hybrid System :• In this type of system, a few key activities are

centralized and other activities and decisions are decentralized.

• These decentralized activities and decisions are coordinated using supplier-customer linkages.

• This is similar to the concept of synchronous manufacturing.

• In this system, schedules and decisions for bottleneck resources are decided centrally while schedules/decisions for non bottleneck resources are left to local decision makers.

• Buffer inventory is maintained at critical junctures such as bottleneck points and customer service points.

• Non-bottleneck machines serve just bottleneck machines and are measured against internal customer service.

• The disadvantage with hybrid approach is that it is not suitable for multiple products and the product mix varies from time to time.

• In such a situation, the bottleneck keeps on shifting.

• External Integration :• In a well managed supply chain, there should

be a seamless flow of information and material across organizational boundaries.

• In a supply chain, all entities are linked in a buyer-supplier chains.

• In this supply chain, the information is passed on from the buyer to the supplier in the form of orders.

• Most often it is found that this information gets distorted as it passes from the buyer to the supplier.

• This increased volatility results in increased costs for all the members of the chain.

• The reason for this is that each entity in the chain focuses on its short term performance measures.

• The volatility in demand while moving up the supply chain is caused both by buyer practices and by supplier practices.

• In general it is found that demand as seen by the supplier is a much distorted version of demand as seen by the buyer.

• Demand as seen by the supplier is nothing but orders placed by the buyer, which is influenced by buyer and supplier practices.

• Impact of Buyer Practices on Demand Distortions Across the Buyer Supplier Link :

• There are two main reasons why a buyer’s practices result in information and order distortion across a chain:

• 1. Forecast Updating : Every entity in a chain uses order received as an input to the forecasting system and treats that piece of information as a signal for future demand.

• Using standard forecasting methods, a manager updates forecasts for future demands.

• But at the same time he also makes allowances for safety stocks.

• Most managers view recently observed demand increase as a signal for growth.

• Thus when a buyer observes an increase in demand, he takes it as a growth in demand and simultaneously also makes allowances for safety stock to deal with uncertainties.

• He therefore places a larger order to the supplier than the demand observed at his end.

• The opposite thing happens when the manager sees a decline in demand.

• This results in extreme fluctuations in the placement of order.

• As a result, the plant manager may assume the market to be highly erratic when in actual practice it is not so.

• 2. Order Batching for Economies of scale : • There are economies of scale both in manufacturing and

purchasing.• Because of high set up costs, a manufacturer may plan to

manufacture the entire month’s demand in one set up.• Similarly, he may buy truckloads of material so as to take

advantage of economies of scale.• So even though demand is seen by the buyer as uniform,

he will place orders on suppliers in batches, resulting in distortions in ordering pattern by the buyer.

• Impact of Supplier Practices on Demand Distortions Across the Buyer-Supplier Link :

• Demand distortions are created by various supplier practices. They are :

• 1. Incentive offered to buyer for Large Size orders : There are mainly three types of incentives :

• - Lot based discounts : These are the discounts offered by suppliers to encourage the buyers to buy in large lots.

• - End-of-period discounts: In order to achieve the period end (monthly, quarterly) targets, marketing people put much more effort at the fag end of the review period.

• At such a time, when the salespeople are falling short of the target, they use up most of their discretionary powers and give maximum discount.

• - Special Price Promotions :These are price discounts and trade promotions during certain periods.

• These deals are usually struck during lean periods.• This kind of incentive system distorts demand in a

big way.• It also gives credence to the belief that without

trade deals one cannot induce dealers to buy more.

• Effect of Supplier Behavior Uncertainty :• While deciding on the order quantity, the buyer keeps

in mind the supplier uncertainty on three counts:• 1. Handling of shortage situations: There are periods

when shortages happen. • In such a situation, the supplier resorts to rationing.• In order to get the required quantity even in times of

rationing, the buyer gives an inflated demand, so that he gets his normal requirement even after rationing.

• 2. Price Fluctuations: If the supplier changes price very frequently, the buyer starts speculating.

• Based on the supplier’s likely price behavior in the future, the buyer will change his order for the current period.

• If he expects a price increase in near future, he will buy more.

• If there is uncertainty in prices, different members of the supply chain like to either increase or decrease stocks to optimize profits.

• 3. Delivery Uncertainty : If the reliability of the supplier is low, the buyer has to keep a higher safety stock.

• This results in distortions in demand.

• The Bull Whip Effect : • There is demand volatility and information

distortion across the buyer supplier link.• This is also true for multi stage supply chain.• When there are multi stages in a supply chain

( as seen in most FMCG companies ) as you move away from the end consumer, demand volatility keeps on increasing.

• An increase in demand variability as one moves up in the chain is referred to as bull whip effect.

• This is because as you move up the supply chain, each member keeps a safety margin and orders more than what is required to take care of the uncertainty.

• This safety margin is the maximum at the manufacturer’s level.

• Therefore it is not uncommon to find 3-6 months inventory stuck up in the distribution channel.

• Causes of Bull whip effect :• 1. Forecast Updating : Each member of the

chain updates forecasts based on orders received at his end and not on the basis of demand raised by the customer.

• 2. Order batching : Each member has his own economies of scale as far as production and transportation is concerned. Due to this firms order in batches as a matter of practice.

• 3. Price fluctuations : Discounts orprice promotions result in forward buying, causing much distortion.

• 4. Shortage Gaming : In a situation of short supplies, the supplier resorts to rationing. Due to this rationing, the buyers inflate their orders thus causing distortions.

• 5. Long lead time : When there is long lead time, each partner is forced to keep large amounts of safety stock, resulting in distortion.

• Remedial Strategies to counter demand distortions :

• There are broadly three kinds of initiatives through which one can minimize distortions in a supply chain –

• - Information sharing across the supply chain• - Aligning incentives across the chain• - Improving operational efficiencies

• Information Sharing Across the Chain :• Normally, order information is the main form

of communication in any supply chain.• Each entity in the supply chain gets the order

from its immediate customer and tries to forecast demand based on this order pattern.

• This order is a distorted version of demand.

• Instead of communicating information about just the orders, if the end customer demand is communicated across the chain, one can reduce the distortions.

• These distortions can be further reduced if the members resort to collaborative forecasting.

• With the help of IT, it is possible to share the information in a cost effective manner across the supply chain.

• Aligning Incentives across the chain : • In a supply chain, the alignment of interest of all the

entities should be such that they behave as a single entity.• When there is alignment of interest, each entity focuses on

the overall rather than local optimization.• Therefore, incentives should be removed that encourage

buyers from buying in bulk and avoid a shortage gaming situation in the chain.

• Firms should remove incentives given to their representatives to improve their short term local performance.

• Improving Operational Efficiencies :• The bull whip effect is caused due to because of long lead

time and order batching.• This can be handled only by increasing efficiencies in the

operations.• By reducing the transaction costs involved in purchasing

and reducing the set up time, one can reduce the batching effect in the chain.

• Similarly, if the partners can work together in creating efficiencies, it can create additional values in the chain and further dampen the bull whip effect.

• Barriers to External Integration :• External integration is more difficult and

demanding as compared to internal integration.

• In internal integration, performance measures can be easily imposed whereas in external integration, the performance measures have to be negotiated so as to make business sense to both the parties.

• In the external integration, unless all the parties agree it may not be possible to find ways in which interest can be aligned.

• Following are the barriers to external integration:

• 1. Difference in objectives leading to conflicts in supply chain :

• There are many situations in which differences can arise

• Manufacturer versus multi-brand retailer : In a competitive market, a manufacturer will want retailer to work with high service level so as to ensure availability of his product.

• But since substitutes in terms of competing brands are available, a multi-brand retailer will want to work with a lower service level so as to reduce his overall costs .

• Supplier competing in the end product market: If a supplier is competing with the buyer in the end product market, it may not be possible to align their interests.

• Excessive focus on quarterly financial performance by member firms : Most firms today are listed and are answerable to their shareholders.

• They have a responsibility to improve shareholder value.

• They are therefore interested in converting finished goods inventory in sales.

• This is done by dumping the inventory to the next partner in chain by giving discounts and credit resulting in lower profits and higher receivables.

• Such decisions lowers performance of all parties in the supply chain in the long run.

• Supplier serving multiple industries : Whenever a supplier serves two or more industries, priorities of a supplier to a specific industry and customer will vary based on the way these industries are performing.

• The supplier will naturally want to serve the industry which is doing well and is more profitable.

• 2. Imbalance in Power leading to focus on value appropriation :

• Even in a situation where there is no conflict of interest between two parties, it is possible that firms may be competing for value appropriation within the chain.

• That is, each firm in the chain may be competing to grab a bigger share.

• Firms may try to focus on capturing a bigger share for themselves rather than creating more value for the chain as a whole.

• Steps in building successful relationships :• Supply chain relationships are based either on

power or trust.• In power based relationships, the stronger party

usually exploits the weaker one and benefits in the short run.

• But since this is not sustainable in the long run, the relationship eventually breaks down and the overall supply chain performance starts going down.

• Research studies have shown that trust based relationships are beneficial in the long run.

• It has been found that successful relationship building involves the following three elements:

• 1. Design relationship with cooperation and trust : At the design stage, it must be ensured that the relationship is a win-win relationship.

• In the initial stages of the relationship both parties may worry that the other may take advantage of the relationship, therefore a formal contract must be signed specifying performance measures and responsibilities.

• 2. Manage and nurture relationship : Once the relationship is designed, during the operations phase, both sides are in a position to evaluate the cost and benefits of relationship.

• This helps parties to revise the conditions of partnership so that it is a fair partnership.

• If both parties work within the spirit of partnership, trust gets built over a period of time.

• 3. Redesign relationship with change in environment : Any relationship operates within a larger economic environment.

• Since the environment keeps on changing with changes in technology and competition, one has to redesign the relationship.