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Supply Chain Management
By
Prof. Prasad Kulkarni
© Prof. Prasad Kulkarni, MBA department GIT Belgaum.Change to change otherwise change will change you
Module 1
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Introduction to supply Chain Management
• Supply chain – objectives – importance – decision phases – process view – competitive and supply chain strategies – achieving strategic fit – supply chain drivers – obstacles – framework – facilities – inventory – transportation – information – sourcing – pricing.
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definition
• A supply chain consists of all parties involved directly or indirectly in fulfilling a customer request.
• It includes manufacturer supplier, transporters, warehouses, retailers and customers.
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Supply chain management in HUL
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Objectives
• Objective 1: enhance the supply chain value
Supply chain value is the difference between final worth of product to customer minus costs supply chain incurs in filling the customers request.
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• Objective 2: Increase the supply chain profitability.
Supply chain profitability is the difference between the revenue generated from the customer and the overall cost across the value chain.
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• Objective 3: Maximize the customer satisfaction
• Objective 4: Have product replenishment at right time.
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Importance of supply chain
• Transportation and information infrastructure facilitates effective flow of goods and information.
• Proper management of product, information and fund flows increases the profitability.
• Involving customers in supply chain improves the effectiveness.
• Zero inventory system and JIT reduces the cost of manufacturing.
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[Decision Phases of a Supply Chain ]
• Supply chain strategy or design• Supply chain planning• Supply chain operation
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Supply Chain Strategy or Design
• Decisions about the structure of the supply chain and what processes each stage will perform
• Strategic supply chain decisions– Locations and capacities of facilities– Products to be made or stored at various locations– Modes of transportation– Information systems
• Supply chain design must support strategic objectives• Supply chain design decisions are long-term and
expensive to reverse – must take into account market uncertainty
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Supply Chain Planning
• Definition of a set of policies that govern short-term operations
• Fixed by the supply configuration from previous phase
• Starts with a forecast of demand in the coming year
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Supply Chain Planning
• Planning decisions:– Which markets will be supplied from which
locations– Planned buildup of inventories– Subcontracting, backup locations– Inventory policies– Timing and size of market promotions
• Must consider in planning decisions demand uncertainty, exchange rates, competition over the time horizon
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Supply Chain Operation
• Time horizon is weekly or daily• Decisions regarding individual customer orders• Supply chain configuration is fixed and operating policies
are determined• Goal is to implement the operating policies as effectively
as possible• Allocate orders to inventory or production, set order due
dates, generate pick lists at a warehouse, allocate an order to a particular shipment, set delivery schedules, place replenishment orders
• Much less uncertainty (short time horizon)
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Process View of a Supply Chain
• Cycle view: processes in a supply chain are divided into a series of cycles, each performed at the interfaces between two successive supply chain stages
• Push/pull view: processes in a supply chain are divided into two categories depending on whether they are executed in response to a customer order (pull) or in anticipation of a customer order (push)
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Cycle View of Supply Chains
Customer Order Cycle
Replenishment Cycle
Manufacturing Cycle
Procurement Cycle
Customer
Retailer
Distributor
Manufacturer
Supplier
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Cycle View of a Supply Chain
• Each cycle occurs at the interface between two successive stages
• Customer order cycle (customer-retailer)• Replenishment cycle (retailer-distributor)• Manufacturing cycle (distributor-manufacturer)• Procurement cycle (manufacturer-supplier)• Cycle view clearly defines processes involved and the
owners of each process. Specifies the roles and responsibilities of each member and the desired outcome of each process.
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Push/Pull View of Supply Chains
Procurement,Manufacturing andReplenishment cycles
Customer OrderCycle
CustomerOrder Arrives
PUSH PROCESSES PULL PROCESSES
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Push/Pull View of Supply Chain Processes
• Supply chain processes fall into one of two categories depending on the timing of their execution relative to customer demand
• Pull: execution is initiated in response to a customer order (reactive)
• Push: execution is initiated in anticipation of customer orders (speculative)
• Push/pull boundary separates push processes from pull processes
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Push/Pull View of Supply Chain Processes
• Useful in considering strategic decisions relating to supply chain design – more global view of how supply chain processes relate to customer orders
• Can combine the push/pull and cycle views
– Big Bazaar– Hindustan Unilever.
• The relative proportion of push and pull processes can have an impact on supply chain performance
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Supply Chain Macro Processes in a Firm • Supply chain processes discussed in the
two views can be classified into:– Customer Relationship Management (CRM)– Internal Supply Chain Management (ISCM)– Supplier Relationship Management (SRM)
• Integration among the above three macro processes is critical for effective and successful supply chain management
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Competitive and Supply Chain Strategies• Competitive strategy: defines the set of customer needs
a firm seeks to satisfy through its products and services• Product development strategy: specifies the portfolio of
new products that the company will try to develop
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• Marketing and sales strategy: specifies how the market will be segmented and product positioned, priced, and promoted
• Supply chain strategy: – determines the nature of material procurement, transportation of
materials, manufacture of product or creation of service, distribution of product
– Consistency and support between supply chain strategy, competitive strategy, and other functional strategies is important
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NewProduct
Development
Marketingand
SalesOperations Distribution Service
Finance, Accounting, Information Technology, Human Resources
The Value Chain: Linking Supply Chain and Business
Strategy
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Achieving Strategic Fit
• Strategic fit: – Consistency between customer priorities of competitive strategy
and supply chain capabilities specified by the supply chain strategy
– Competitive and supply chain strategies have the same goals• A company may fail because of a lack of strategic fit or because its
processes and resources do not provide the capabilities to execute the desired strategy
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How is Strategic Fit Achieved?
• Step 1: Understanding the customer and supply chain uncertainty
• Step 2: Understanding the supply chain• Step 3: Achieving strategic fit
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Step 1: Understanding the Customer and Supply Chain
Uncertainty• Identify the needs of the customer
segment being served• Quantity of product needed in each lot• Response time customers will tolerate• Variety of products needed• Service level required• Price of the product• Desired rate of innovation in the product
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Step 1: Understanding the Customer and Supply Chain
Uncertainty• Overall attribute of customer demand• Demand uncertainty: uncertainty of
customer demand for a product• Implied demand uncertainty: resulting
uncertainty for the supply chain given the portion of the demand the supply chain must handle and attributes the customer desires
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Step 1: Understanding the Customer and Supply Chain Uncertainty
• Implied demand uncertainty also related to customer needs and product attributes
• First step to strategic fit is to understand customers by mapping their demand on the implied uncertainty spectrum
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Achieving Strategic Fit
• Understanding the Customer– Lot size– Response time– Service level– Product variety– Price– Innovation
ImpliedDemand
Uncertainty
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Impact of Customer Needs on Implied Demand Uncertainty
Customer Need Causes implied demand uncertainty to increase because …
Range of quantity increases Wider range of quantity implies greater variance in demand
Lead time decreases Less time to react to orders
Variety of products required increases
Demand per product becomes more disaggregated
Number of channels increases Total customer demand is now disaggregated over more channels
Rate of innovation increases New products tend to have more uncertain demand
Required service level increases Firm now has to handle unusual surges in demand
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Levels of Implied Demand Uncertainty
Predictable supply and
demand
Salt at a supermarket
A new communication
device
Highly uncertain supply and demand
Figure 2.2: The Implied Uncertainty (Demand and Supply) Spectrum
Predictable supply and uncertain demand or uncertain supply and predictable demand or somewhat
uncertain supply and demand
An existing automobile
model
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Correlation Between Implied Demand Uncertainty and Other
Attribute Low Implied Uncertainty
High Implied Uncertainty
Product margin Low High
Avg. forecast error 10% 40%-100%
Avg. stockout rate 1%-2% 10%-40%
Avg. forced season-end markdown
0% 10%-25%
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Step 2: Understanding the Supply Chain
• How does the firm best meet demand?• Dimension describing the supply chain is supply chain
responsiveness• Supply chain responsiveness -- ability to
– respond to wide ranges of quantities demanded– meet short lead times– handle a large variety of products– build highly innovative products– meet a very high service level
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Step 2: Understanding the Supply Chain
• There is a cost to achieving responsiveness• Supply chain efficiency: cost of making and delivering the product to
the customer• Increasing responsiveness results in higher costs that lower
efficiency• Second step to achieving strategic fit is to map the supply chain on
the responsiveness spectrum
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Understanding the Supply Chain: Cost-Responsiveness Efficient Frontier
High Low
Low
High
Responsiveness
Cost
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Step 3: Achieving Strategic Fit
• Step is to ensure that what the supply chain does well is consistent with target customer’s needs
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Responsiveness Spectrum
Integratedsteel mill
Dell
Highlyefficient
Highlyresponsive
Somewhatefficient
Somewhatresponsive
Hanesapparel
Mostautomotiveproduction
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Achieving Strategic Fit Shown on the Uncertainty/Responsiveness Map
Implied uncertainty spectrum
Responsive supply chain
Efficient supply chain
Certain demand
Uncertain demand
Responsiveness spectrum Zone of
Strategic Fit
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Step 3: Achieving Strategic Fit
• All functions in the value chain must support the competitive strategy to achieve strategic fit
• Two key points– there is no right supply chain strategy
independent of competitive strategy– there is a right supply chain strategy for a
given competitive strategy
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Comparison of Efficient and Responsive Supply Chains
Efficient Responsive
Primary goal Lowest cost Quick response
Product design strategy Min product cost Modularity to allow postponement
Pricing strategy Lower margins Higher margins
Mfg strategy High utilization Capacity flexibility
Inventory strategy Minimize inventory Buffer inventory
Lead time strategy Reduce but not at expense of greater cost
Aggressively reduce even if costs are significant
Supplier selection strategy Cost and low quality Speed, flexibility, quality
Transportation strategy Greater reliance on low cost modes
Greater reliance on responsive (fast) modes
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Other Issues Affecting Strategic Fit
• Multiple products and customer segments• Product life cycle• Competitive changes over time
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Multiple Products and Customer Segments
• Firms sell different products to different customer segments (with different implied demand uncertainty)
• The supply chain has to be able to balance efficiency and responsiveness given its portfolio of products and customer segments
• Two approaches:– Different supply chains– Tailor supply chain to best meet the needs of each product’s
demand
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Product Life Cycle
• The demand characteristics of a product and the needs of a customer segment change as a product goes through its life cycle
• Supply chain strategy must evolve throughout the life cycle• Early: uncertain demand, high margins (time is important), product
availability is most important, cost is secondary• Late: predictable demand, lower margins, price is important
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Product Life Cycle
• Examples: pharmaceutical firms, Intel• As the product goes through the life cycle,
the supply chain changes from one emphasizing responsiveness to one emphasizing efficiency
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Competitive Changes Over Time
• Competitive pressures can change over time
• More competitors may result in an increased emphasis on variety at a reasonable price
• The Internet makes it easier to offer a wide variety of products
• The supply chain must change to meet these changing competitive conditions
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Expanding Strategic Scope
• Scope of strategic fit – The functions and stages within a supply chain that devise
an integrated strategy with a shared objective– One extreme: each function at each stage develops its
own strategy– Other extreme: all functions in all stages devise a strategy
jointly• Five categories:
– Intracompany intraoperation scope– Intracompany intrafunctional scope– Intracompany interfunctional scope– Intercompany interfunctional scope– Flexible interfunctional scope
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Drivers of Supply Chain Performance
• Facilities– places where inventory is stored, assembled, or fabricated– production sites and storage sites
• Inventory– raw materials, WIP, finished goods within a supply chain– inventory policies
• Transportation– moving inventory from point to point in a supply chain– combinations of transportation modes and routes
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• Information– data and analysis regarding inventory, transportation, facilities
throughout the supply chain– potentially the biggest driver of supply chain performance
• Sourcing– functions a firm performs and functions that are outsourced
• Pricing– Price associated with goods and services provided by a firm to the
supply chain
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A Framework for Structuring Drivers
Competitive Strategy
Supply Chain Strategy
Efficiency Responsiveness
Facilities Inventory Transportation
Information
Supply chain structure
Cross Functional Drivers
Sourcing Pricing
Logistical Drivers
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Facilities
• Role in the supply chain– the “where” of the supply chain– manufacturing or storage (warehouses)
• Role in the competitive strategy– economies of scale (efficiency priority)– larger number of smaller facilities
(responsiveness priority)• Components of facilities decisions
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Components of Facilities Decisions
• Location– centralization (efficiency) vs. decentralization (responsiveness)– other factors to consider (e.g., proximity to customers)
• Capacity (flexibility versus efficiency)• Manufacturing methodology (product focused versus process focused)• Warehousing methodology (SKU storage, job lot storage, cross-docking)• Overall trade-off: Responsiveness versus efficiency
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Inventory
• Role in the supply chain• Role in the competitive strategy• Components of inventory decisions
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Inventory: Role in the Supply Chain
• Inventory exists because of a mismatch between supply and demand
• Source of cost and influence on responsiveness
• Inventory and throughput are “synonymous” in a supply chain
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Inventory: Role in Competitive Strategy
• If responsiveness is a strategic competitive priority, a firm can locate larger amounts of inventory closer to customers
• If cost is more important, inventory can be reduced to make the firm more efficient
• Trade-off
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Components of Inventory Decisions
• Cycle inventory– Average amount of inventory used to satisfy demand between
shipments– Depends on lot size
• Safety inventory– inventory held in case demand exceeds expectations– costs of carrying too much inventory versus cost of losing sales
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• Seasonal inventory– inventory built up to counter predictable variability in demand– cost of carrying additional inventory versus cost of flexible
production
• Overall trade-off: Responsiveness versus efficiency– more inventory: greater responsiveness but greater cost– less inventory: lower cost but lower responsiveness
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Transportation
• Role in the supply chain• Role in the competitive strategy• Components of transportation decisions
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Transportation: Role in the Supply Chain
• Moves the product between stages in the supply chain
• Impact on responsiveness and efficiency• Faster transportation allows greater
responsiveness but lower efficiency• Also affects inventory and facilities
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Transportation: Role in the Competitive Strategy
• If responsiveness is a strategic competitive priority, then faster transportation modes can provide greater responsiveness to customers who are willing to pay for it
• Can also use slower transportation modes for customers whose priority is price (cost)
• Can also consider both inventory and transportation to find the right balance
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Components of Transportation Decisions
• Mode of transportation: – air, truck, rail, ship, pipeline, electronic
transportation– vary in cost, speed, size of shipment, flexibility
• Route and network selection– route: path along which a product is shipped– network: collection of locations and routes
• In-house or outsource• Overall trade-off: Responsiveness versus
efficiency
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Information
• Role in the supply chain• Role in the competitive strategy• Components of information decisions
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Information: Role in the Supply Chain
• The connection between the various stages in the supply chain – allows coordination between stages
• Crucial to daily operation of each stage in a supply chain – e.g., production scheduling, inventory levels
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Information: Role in the Competitive Strategy• Allows supply chain to become more
efficient and more responsive at the same time (reduces the need for a trade-off)
• Information technology• What information is most valuable?
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Components of Information Decisions
• Push (MRP) versus pull (demand information transmitted quickly throughout the supply chain)
• Coordination and information sharing• Forecasting and aggregate planning• Enabling technologies
– EDI, Internet, ERP systems– Supply Chain Management software
• Overall trade-off: Responsiveness versus efficiency
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Sourcing
• Role in the supply chain• Role in the competitive strategy• Components of sourcing decisions
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Sourcing: Role in the Supply Chain
• Set of business processes required to purchase goods and services in a supply chain
• Supplier selection, single vs. multiple suppliers, contract negotiation
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Sourcing: Role in the Competitive Strategy• Sourcing decisions are crucial because
they affect the level of efficiency and responsiveness in a supply chain
• In-house vs. outsource decisions- improving efficiency and responsiveness
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Components of Sourcing Decisions
• In-house versus outsource decisions• Supplier evaluation and selection• Procurement process• Overall trade-off: Increase the supply
chain profits
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Pricing
• Role in the supply chain• Role in the competitive strategy• Components of pricing decisions
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Pricing: Role in the Supply Chain
• Pricing determines the amount to charge customers in a supply chain
• Pricing strategies can be used to match demand and supply
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Sourcing: Role in the Competitive Strategy• Firms can utilize optimal pricing strategies
to improve efficiency and responsiveness• Low price and low product availability; vary
prices by response times• Example 3.7: Amazon
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Components of Pricing Decisions
• Pricing and economies of scale• Everyday low pricing versus high-low
pricing• Fixed price versus menu pricing• Overall trade-off: Increase the firm profits
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Obstacles to Achieving Strategic Fit
• Increasing variety of products• Decreasing product life cycles• Increasingly demanding customers• Fragmentation of supply chain ownership• Globalization• Difficulty executing new strategies
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• MODULE 2• Designing the supply chain network • Designing the distribution network – role of
distribution – factors influencing distribution – design options – e-business and its impact – distribution networks in practice – network design in the supply chain – role of network – factors affecting the network design decisions – modeling for supply chain.
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The Role of Distributionin the Supply Chain
• Distribution: the steps taken to move and store a product from the supplier stage to the customer stage in a supply chain
• Distribution directly affects cost and the customer experience and therefore drives profitability
• Choice of distribution network can achieve supply chain objectives from low cost to high responsiveness
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Factors InfluencingDistribution Network Design
• Distribution network performance evaluated along two dimensions at the highest level:– Customer needs that are met– Cost of meeting customer needs
• Distribution network design options must therefore be compared according to their impact on customer service and the cost to provide this level of service
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Factors InfluencingDistribution Network Design
• Elements of customer service influenced by network structure:– Response time– Product variety– Product availability– Customer experience– Order visibility– Returnability
• Supply chain costs affected by network structure:– Inventories and Transportation– Facilities and handling– Information
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Service and Number of Facilities
Number of Facilities
Response Time
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The Cost-Response Time Frontier
Local FG
Mix
Regional FG
Local WIP
Central FG
Central WIP
Central Raw Material and Custom production
Custom production with raw material at suppliers
Cost
Response Time HiLow
Low
Hi
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Inventory Costs and Numberof Facilities
Inventory Costs
Number of facilities
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Transportation Costs and Number of Facilities
TransportationCosts
Number of facilities
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Facility Costs and Numberof Facilities
FacilityCosts
Number of facilities
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Transportation
Total Costs Related to Number of Facilities
To
tal
Co
sts
Number of Facilities
Inventory
Facilities
Total Costs
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Response Time
Variation in Logistics Costs and Response Time with Number of Facilities
Number of Facilities
Total Logistics Costs
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Design Options for a Distribution Network
• Manufacturer Storage with Direct Shipping• Manufacturer Storage with Direct Shipping
and In-Transit Merge• Distributor Storage with Carrier Delivery• Distributor Storage with Last Mile Delivery• Manufacturer or Distributor Storage with
Consumer Pickup• Retail Storage with Consumer Pickup• Selecting a Distribution Network Design
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Manufacturer Storage withDirect Shipping
Manufacturer
Retailer
Customers
Product FlowInformation Flow
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In-Transit Merge NetworkFactories
Retailer
Product FlowInformation Flow
In-Transit Merge by Carrier
Customers
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Distributor Storage withCarrier Delivery
Factories
Customers
Product FlowInformation Flow
Warehouse Storage by Distributor/Retailer
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Distributor Storage with Last Mile Delivery
Factories
Customers
Product Flow
Information flow
Distributor/Retailer Warehouse
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Manufacturer or Distributor Storage with Customer Pickup (Fig. 4.10)
Factories
Retailer
Pickup Sites
Cross Dock DC
Customers
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E-Business and the Distribution Network
• Impact of E-Business on Customer Service
• Impact of E-Business on Cost• Using E-Business: Dell, Amazon, Peapod,
Grainger
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Distribution Networks in Practice
• The ownership structure of the distribution network can have as big as an impact as the type of distribution network
• The choice of a distribution network has very long-term consequences
• Consider whether an exclusive distribution strategy is advantageous
• Product, price, commoditization, and criticality have an impact on the type of distribution system preferred by customers
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Network Design Decisions
• Facility role• Facility location• Capacity allocation• Market and supply allocation
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Factors InfluencingNetwork Design Decisions
• Strategic • Technological• Macroeconomic• Political• Infrastructure• Competitive• Logistics and facility costs
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A Framework forGlobal Site Location
PHASE ISupply Chain
Strategy
PHASE IIRegional Facility
Configuration
PHASE IIIDesirable Sites
PHASE IVLocation Choices
Competitive STRATEGY
INTERNAL CONSTRAINTSCapital, growth strategy,existing network
PRODUCTION TECHNOLOGIESCost, Scale/Scope impact, supportrequired, flexibility
COMPETITIVEENVIRONMENT
PRODUCTION METHODSSkill needs, response time
FACTOR COSTSLabor, materials, site specific
GLOBAL COMPETITION
TARIFFS AND TAXINCENTIVES
REGIONAL DEMANDSize, growth, homogeneity,local specifications
POLITICAL, EXCHANGERATE AND DEMAND RISK
AVAILABLEINFRASTRUCTURE
LOGISTICS COSTSTransport, inventory, coordination
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Conventional Network
CustomerStore
MaterialsDC
ComponentManufacturin
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VendorDC
Final Assembly
FinishedGoods DC
ComponentsDC
VendorDC Plant
Warehouse
FinishedGoods DC
CustomerDC
CustomerDC
CustomerDC
CustomerStore
CustomerStore
CustomerStore
CustomerStore
VendorDC
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Tailored Network: Multi-Echelon Finished Goods Network
RegionalFinished
Goods DC
RegionalFinished
Goods DC
Customer 1DC
Store 1
NationalFinished
Goods DC
Local DCCross-Dock
Local DC Cross-Dock
Local DCCross-Dock
Customer 2DC
Store 1
Store 2
Store 2
Store 3
Store 3
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Gravity Methods for Location
• Ton Mile-Center Solution– x,y: Warehouse Coordinates
– xn, yn : Coordinates of
delivery location n
– dn : Distance to delivery
location n
– Fn : Annual tonnage to
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Network Optimization Models
• Allocating demand to production facilities
• Locating facilities and allocating capacity
Which plants to establish? How to configure the network?
Key Costs:
• Fixed facility cost• Transportation cost• Production cost• Inventory cost• Coordination cost
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Demand Allocation Model
• Which market is served by which plant?
• Which supply sources are used by a plant?
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Plant Location with Multiple Sourcing
• yi = 1 if plant is located at site i, 0 otherwise
• xij = Quantity shipped from plant site i to customer j
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Plant Location with Single Sourcing
• yi = 1 if plant is located at site i, 0 otherwise
• xij = 1 if market j is supplied by factory i, 0 otherwise
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• MODULE 3 (5 Hours) • Designing and Planning
Transportation Networks. • Role of transportation - modes and their
performance - transportation infrastructure and policies - design options and their trade-offs - Tailored transportation
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Factors AffectingTransportation Decisions
• Carrier (party that moves or transports the product)– Vehicle-related cost– Fixed operating cost– Trip-related cost
• Shipper (party that requires the movement of the product between two points in the supply chain)– Transportation cost– Inventory cost– Facility cost
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Transportation Modes• Trucks
– TL– LTL
• Rail• Air• Package Carriers• Water• Pipeline
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Truckload (TL)
• Average revenue per ton mile (1996) = 9.13 cents
• Average haul = 274 miles• Average Capacity = 42,000 - 50,000 lb.• Low fixed and variable costs• Major Issues
– Utilization– Consistent service– Backhauls
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Less Than Truckload (LTL)
• Average revenue per ton-mile (1996) = 25.08 cents• Average haul = 646 miles• Higher fixed costs (terminals) and low variable costs• Major issues:
– Location of consolidation facilities– Utilization– Vehicle routing– Customer service
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Rail
• Average revenue / ton-mile (1996) = 2.5 cents• Average haul = 720 miles• Average load = 80 tons• Key issues:
– Scheduling to minimize delays / improve service– Off-track delays (at pickup and delivery end) – Yard operations– Variability of delivery times
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Air
• Key issues:– Location/number of hubs– Location of fleet bases/crew bases– Schedule optimization– Fleet assignment– Crew scheduling– Yield management
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Package Carriers• Companies like FedEx, UPS,, that carry small
packages ranging from letters to shipments of about 150 pounds
• Expensive• Rapid and reliable delivery• Small and time-sensitive shipments• Preferred mode for e-businesses• Consolidation of shipments (especially important for
package carriers that use air as a primary method of transport)
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Water
• Limited to certain geographic areas• Ocean, inland waterway system, coastal
waters• Very large loads at very low cost• Slowest• Dominant in global
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Pipeline
• High fixed cost• Primarily for crude petroleum, refined
petroleum products, natural gas• Best for large and predictable demand• Would be used for getting crude oil to a
port or refinery, but not for getting refined gasoline to a gasoline station (why?)
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Intermodal• Use of more than one mode of transportation to move a
shipment to its destination• Most common example: rail/truck• Also water/rail/truck or water/truck• Grown considerably with increased use of containers• Increased global trade has also increased use of intermodal
transportation• More convenient for shippers (one entity provides the
complete service)• Key issue involves the exchange of information to facilitate
transfer between different transport modes
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Design Options for aTransportation Network
• What are the transportation options? Which one to select? On what basis?
• Direct shipping network• Direct shipping with milk runs• All shipments via central DC• Shipping via DC using milk runs• Tailored network
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Trade-offs in Transportation Design
• Transportation and inventory cost trade-off– Choice of transportation mode– Inventory aggregation
• Transportation cost and responsiveness trade-off
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Choice of Transportation Mode
• A manager must account for inventory costs when selecting a mode of transportation
• A mode with higher transportation costs can be justified if it results in significantly lower inventories
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Inventory Aggregation: Inventory vs. Transportation
Cost• As a result of physical aggregation
– Inventory costs decrease– Inbound transportation cost decreases– Outbound transportation cost increases
• Inventory aggregation decreases supply chain costs if the product has a high value to weight ratio, high demand uncertainty, or customer orders are large
• Inventory aggregation may increase supply chain costs if the product has a low value to weight ratio, low demand uncertainty, or customer orders are small
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Trade-offs Between Transportation Cost and Customer Responsiveness
• Temporal aggregation is the process of combining orders across time
• Temporal aggregation reduces transportation cost because it results in larger shipments and reduces variation in shipment sizes
• However, temporal aggregation reduces customer responsiveness
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Tailored Transportation
• The use of different transportation networks and modes based on customer and product characteristics
• Factors affecting tailoring:– Customer distance and density– Customer size– Product demand and value
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Role of IT in Transportation
• The complexity of transportation decisions demands to use of IT systems
• IT software can assist in:– Identification of optimal routes by minimizing
costs subject to delivery constraints– Optimal fleet utilization– GPS applications
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Risk Management in Transportation
• Three main risks to be considered in transportation are:– Risk that the shipment is delayed– Risk of disruptions– Risk of hazardous material
• Risk mitigation strategies:– Decrease the probability of disruptions– Alternative routings– In case of hazardous materials the use of
modified containers, low-risk transportation models, modification of physical and chemical properties can prove to be effective
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• MODULE 4 (6 Hours) • Sourcing and Pricing. • Sourcing – In-house or Outsource – 3rd and 4th PLs –
supplier scoring and assessment, selection – design collaboration – procurement process – sourcing planning and analysis.
• Pricing and revenue management for multiple customers, perishable products, seasonal demand, bulk and spot contracts.
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The Role of Sourcingin a Supply Chain
• Sourcing is the set of business processes required to purchase goods and services
• Sourcing processes include:– Supplier scoring and assessment– Supplier selection and contract negotiation– Design collaboration– Procurement– Sourcing planning and analysis
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Benefits of EffectiveSourcing Decisions
• Better economies of scale can be achieved if orders are aggregated
• More efficient procurement transactions can significantly reduce the overall cost of purchasing
• Design collaboration can result in products that are easier to manufacture and distribute, resulting in lower overall costs
• Good procurement processes can facilitate coordination with suppliers
• Appropriate supplier contracts can allow for the sharing of risk
• Firms can achieve a lower purchase price by increasing competition through the use of auctions
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Supplier Scoring and Assessment
• Supplier performance should be compared on the basis of the supplier’s impact on total cost
• There are several other factors besides purchase price that influence total cost
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Supplier Assessment Factors
• Replenishment Lead Time• On-Time Performance• Supply Flexibility• Delivery Frequency /
Minimum Lot Size• Supply Quality• Inbound Transportation
Cost
• Pricing Terms• Information
Coordination Capability• Design Collaboration
Capability• Exchange Rates,
Taxes, Duties• Supplier Viability
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Supplier Selection- Auctions and Negotiations
• Supplier selection can be performed through competitive bids, reverse auctions, and direct negotiations
• Supplier evaluation is based on total cost of using a supplier
• Auctions:– Sealed-bid first-price auctions– English auctions– Dutch auctions– Second-price (Vickery) auctions
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Contracts and Supply Chain Performance
• Contracts for Product Availability and Supply Chain Profits– Buyback Contracts– Revenue-Sharing Contracts– Quantity Flexibility Contracts
• Contracts to Coordinate Supply Chain Costs
• Contracts to Increase Agent Effort• Contracts to Induce Performance
Improvement
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Contracts for Product Availability and Supply Chain
Profits• Many shortcomings in supply chain performance occur because the buyer and supplier are separate organizations and each tries to optimize its own profit
• Total supply chain profits might therefore be lower than if the supply chain coordinated actions to have a common objective of maximizing total supply chain profits
• Recall Chapter 10: double marginalization results in suboptimal order quantity
• An approach to dealing with this problem is to design a contract that encourages a buyer to purchase more and increase the level of product availability
• The supplier must share in some of the buyer’s demand uncertainty, however
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Contracts for Product Availability and Supply Chain Profits: Buyback Contracts
• Allows a retailer to return unsold inventory up to a specified amount at an agreed upon price
• Increases the optimal order quantity for the retailer, resulting in higher product availability and higher profits for both the retailer and the supplier
• Most effective for products with low variable cost, such as music, software, books, magazines, and newspapers
• Downside is that buyback contract results in surplus inventory that must be disposed of, which increases supply chain costs
• Can also increase information distortion through the supply chain because the supply chain reacts to retail orders, not actual customer demand
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Contracts for Product Availability and Supply Chain Profits: Revenue Sharing Contracts
• The buyer pays a minimal amount for each unit purchased from the supplier but shares a fraction of the revenue for each unit sold
• Decreases the cost per unit charged to the retailer, which effectively decreases the cost of overstocking
• Can result in supply chain information distortion, however, just as in the case of buyback contracts
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Contracts for Product Availability and Supply Chain Profits: Quantity Flexibility Contracts
• Allows the buyer to modify the order (within limits) as demand visibility increases closer to the point of sale
• Better matching of supply and demand• Increased overall supply chain profits if the
supplier has flexible capacity• Lower levels of information distortion than
either buyback contracts or revenue sharing contracts
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Contracts to CoordinateSupply Chain Costs
• Differences in costs at the buyer and supplier can lead to decisions that increase total supply chain costs
• Example: Replenishment order size placed by the buyer. The buyer’s EOQ does not take into account the supplier’s costs.
• A quantity discount contract may encourage the buyer to purchase a larger quantity (which would be lower costs for the supplier), which would result in lower total supply chain costs
• Quantity discounts lead to information distortion because of order batching
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Contracts to Increase Agent Effort
• There are many instances in a supply chain where an agent acts on the behalf of a principal and the agent’s actions affect the reward for the principal
• Example: A car dealer who sells the cars of a manufacturer, as well as those of other manufacturers
• Examples of contracts to increase agent effort include two-part tariffs and threshold contracts
• Threshold contracts increase information distortion, however
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Contracts to InducePerformance Improvement
• A buyer may want performance improvement from a supplier who otherwise would have little incentive to do so
• A shared savings contract provides the supplier with a fraction of the savings that result from the performance improvement
• Particularly effective where the benefit from improvement accrues primarily to the buyer, but where the effort for the improvement comes primarily from the supplier
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Design Collaboration• 50-70 percent of spending at a manufacturer is through procurement• 80 percent of the cost of a purchased part is fixed in the design
phase• Design collaboration with suppliers can result in reduced cost,
improved quality, and decreased time to market• Important to employ design for logistics, design for manufacturability• Manufacturers must become effective design coordinators
throughout the supply chain
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The Procurement Process
• The process in which the supplier sends product in response to orders placed by the buyer
• Goal is to enable orders to be placed and delivered on schedule at the lowest possible overall cost
• Two main categories of purchased goods:– Direct materials: components used to make finished goods– Indirect materials: goods used to support the operations of a firm
• Focus for direct materials should be on improving coordination and visibility with supplier
• Focus for indirect materials should be on decreasing the transaction cost for each order
• Procurement for both should consolidate orders where possible to take advantage of economies of scale and quantity discounts
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Product Categorization by Value and Criticality
Critical Items Strategic Items
General Items Bulk Purchase Items
Low
Low
High
High
Value/Cost
Crit
ical
ity
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Sourcing Planning and Analysis
• A firm should periodically analyze its procurement spending and supplier performance and use this analysis as an input for future sourcing decisions
• Procurement spending should be analyzed by part and supplier to ensure appropriate economies of scale
• Supplier performance analysis should be used to build a portfolio of suppliers with complementary strengths– Cheaper but lower performing suppliers
should be used to supply base demand– Higher performing but more expensive
suppliers should be used to buffer against variation in demand and supply from the other source
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Making SourcingDecisions in Practice
• Use multifunction teams• Ensure appropriate coordination across
regions and business units• Always evaluate the total cost of
ownership• Build long-term relationships with key
suppliers
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The Role of Revenue Management in the Supply
Chain• Revenue management is the use of pricing to increase the profit generated from a limited supply of supply chain assets
• Supply assets exist in two forms: capacity and inventory• Revenue management may also be defined as the use of differential
pricing based on customer segment, time of use, and product or capacity availability to increase supply chain profits
• Most common example is probably in airline pricing
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Conditions Under Which Revenue Management Has the Greatest
Effect• The value of the product varies in different market
segments (Example: airline seats)• The product is highly perishable or product waste occurs
(Example: fashion and seasonal apparel)• Demand has seasonal and other peaks (Example:
products ordered at Amazon.com)• The product is sold both in bulk and on the spot market
(Example: owner of warehouse who can decide whether to lease the entire warehouse through long-term contracts or save a portion of the warehouse for use in the spot market)
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Revenue Management forMultiple Customer Segments
• If a supplier serves multiple customer segments with a fixed asset, the supplier can improve revenues by setting different prices for each segment
• Prices must be set with barriers such that the segment willing to pay more is not able to pay the lower price
• The amount of the asset reserved for the higher price segment is such that the expected marginal revenue from the higher priced segment equals the price of the lower price segment
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Revenue Management forMultiple Customer Segments
pL = the price charged to the lower price segment
pH = the price charged to the higher price segment
DH = mean demand for the higher price segment
sH = standard deviation of demand for the higher price segment
CH = capacity reserved for the higher price segment
RH(CH) = expected marginal revenue from reserving more capacity
= Probability(demand from higher price segment > CH) x pH
RH(CH) = pL
Probability(demand from higher price segment > CH) = pL / pH
CH = F-1(1- pL/pH, DH,sH) = NORMINV(1- pL/pH, DH,sH)
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Example : ToFrom Trucking
Revenue from segment A = pA = $3.50 per cubic ft
Revenue from segment B = pB = $3.50 per cubic ft
Mean demand for segment A = DA = 3,000 cubic ft
Std dev of segment A demand = sA = 1,000 cubic ft
CA = NORMINV(1- pB/pA, DA,sA)= NORMINV(1- (2.00/3.50), 3000, 1000)= 2,820 cubic ft
If pA increases to $5.00 per cubic foot, then
CA = NORMINV(1- pB/pA, DA,sA)= NORMINV(1- (2.00/5.00), 3000, 1000)= 3,253 cubic ft
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Revenue Managementfor Perishable Assets
• Any asset that loses value over time is perishable• Examples: high-tech products such as computers and
cell phones, high fashion apparel, underutilized capacity, fruits and vegetables
• Two basic approaches:– Vary price over time to maximize expected revenue– Overbook sales of the asset to account for
cancellations
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Revenue Managementfor Perishable Assets
• Overbooking or overselling of a supply chain asset is valuable if order cancellations occur and the asset is perishable
• The level of overbooking is based on the trade-off between the cost of wasting the asset if too many cancellations lead to unused assets and the cost of arranging a backup if too few cancellations lead to committed orders being larger than the available capacity
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Revenue Managementfor Perishable Assets
p = price at which each unit of the asset is sold
c = cost of using or producing each unit of the asset
b = cost per unit at which a backup can be used in the case of asset shortage
Cw = p – c = marginal cost of wasted capacity
Cs = b – c = marginal cost of a capacity shortage
O* = optimal overbooking level
s* = Probability(cancellations < O*) = Cw / (Cw + Cs)
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Revenue Managementfor Perishable Assets
If the distribution of cancellations is known to be normal with mean mc and standard deviation sc then
O* = F-1(s*, mc, sc) = NORMINV(s*, mc, sc)If the distribution of cancellations is known only as a function
of the booking level (capacity L + overbooking O) to have a mean of m(L+O) and std deviation of s(L+O), the optimal overbooking level is the solution to the following equation:
O = F-1(s*, (m L+O),s(L+O)) = NORMINV(s*, (m L+O),s(L+O))
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Example Cost of wasted capacity = Cw = $10 per dress
Cost of capacity shortage = Cs = $5 per dress
s* = Cw / (Cw + Cs) = 10/(10+5) = 0.667
mc = 800; sc = 400
O* = NORMINV(s*, mc,sc)
= NORMINV(0.667,800,400) = 973
If the mean is 15% of the booking level and the coefficient of variation is 0.5, then the optimal overbooking level is the solution of the following equation:
O = NORMINV(0.667,0.15(5000+O),0.075(5000+O))
Using Excel Solver, O* = 1,115
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Revenue Managementfor Seasonal Demand
• Seasonal peaks of demand are common in many supply chains
• Examples: Most retailers achieve a large portion of total annual demand in December (Amazon.com)
• Off-peak discounting can shift demand from peak to non-peak periods
• Charge higher price during peak periods and a lower price during off-peak periods
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Revenue Management forBulk and Spot Customers
• Most consumers of production, warehousing, and transportation assets in a supply chain face the problem of constructing a portfolio of long-term bulk contracts and short-term spot market contracts
• The basic decision is the size of the bulk contract• The fundamental trade-off is between wasting a
portion of the low-cost bulk contract and paying more for the asset on the spot market
• Given that both the spot market price and the purchaser’s need for the asset are uncertain, a decision tree approach as discussed in Chapter 6 should be used to evaluate the amount of long-term bulk contract to sign
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Revenue Management forBulk and Spot Customers
For the simple case where the spot market price is known but demand is uncertain, a formula can be used
cB = bulk rate
cS = spot market priceQ* = optimal amount of the asset to be purchased in bulkp* = probability that the demand for the asset does not
exceed Q*
Marginal cost of purchasing another unit in bulk is cB. The expected marginal cost of not purchasing another unit in bulk and then purchasing it in the spot market is (1-p*)cS.
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Revenue Management forBulk and Spot Customers
If the optimal amount of the asset is purchased in bulk, the marginal cost of the bulk purchase should equal the expected marginal cost of the spot market purchase, or cB = (1-p*)cS
Solving for p* yields p* = (cS – cB) / cS
If demand is normal with mean m and std deviation s, the optimal amount Q* to be purchased in bulk is
Q* = F-1(p*,m,s) = NORMINV(p*,m,s)
© Prof. Prasad Kulkarni, MBA department GIT Belgaum.Change to change otherwise change will change you
Example 15.6
Bulk contract cost = cB = $10,000 per million units
Spot market cost = cS = $12,500 per million units
m = 10 million units
s = 4 million units
p* = (cS – cB) / cS = (12,500 – 10,000) / 12,500 = 0.2
Q* = NORMINV(p*,m,s) = NORMINV(0.2,10,4) = 6.63
The manufacturer should sign a long-term bulk contract for 6.63 million units per month and purchase any transportation capacity beyond that on the spot market
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Using Revenue Managementin Practice
• Evaluate your market carefully• Quantify the benefits of revenue management• Implement a forecasting process• Apply optimization to obtain the revenue
management decision• Involve both sales and operations• Understand and inform the customer• Integrate supply planning with revenue management
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Role of Information Technologyin a Supply Chain
• Information is the driver that serves as the “glue” to create a coordinated supply chain
• Information must have the following characteristics to be useful:– Accurate– Accessible in a timely manner– Information must be of the right kind
• Information provides the basis for supply chain management decisions– Inventory– Transportation– Facility
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Characteristics of UsefulSupply Chain Information
• Accurate• Accessible in a timely manner• The right kind• Provides supply chain visibility
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Use of Information in a Supply Chain
• Information used at all phases of decision making: strategic, planning, operational
• Examples:– Strategic: location decisions– Operational: what products will be
produced during today’s production run
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Use of Information in a Supply Chain
• Inventory: demand patterns, carrying costs, stockout costs, ordering costs
• Transportation: costs, customer locations, shipment sizes
• Facility: location, capacity, schedules of a facility; need information about trade-offs between flexibility and efficiency, demand, exchange rates, taxes, etc.
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Role of Information Technologyin a Supply Chain
• Information technology (IT)– Hardware and software used throughout
the supply chain to gather and analyze information
– Captures and delivers information needed to make good decisions
• Effective use of IT in the supply chain can have a significant impact on supply chain performance
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The Importance of Informationin a Supply Chain
• Relevant information available throughout the supply chain allows managers to make decisions that take into account all stages of the supply chain
• Allows performance to be optimized for the entire supply chain, not just for one stage – leads to higher performance for each individual firm in the supply chain
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The Supply Chain IT Framework
• The Supply Chain Macro Processes– Customer Relationship Management (CRM)– Internal Supply Chain Management (ISCM)– Supplier Relationship Management (SRM)– Plus: Transaction Management Foundation
• Why Focus on the Macro Processes?• Macro Processes Applied to the Evolution
of Software
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Macro Processes in a Supply Chain
(Figure 16.1)
Supplier Relationshi
p Managemen
t (SRM)
Internal Supply Chain
Management (ISCM)
Customer Relationshi
p Managemen
t (CRM)
Transaction Management Foundation (TFM)
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Customer Relationship Management
• The processes that take place between an enterprise and its customers downstream in the supply chain
• Key processes:– Marketing– Selling– Order management– Call/Service center
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Internal Supply Chain Management
• Includes all processes involved in planning for and fulfilling a customer order
• ISCM processes:– Strategic Planning– Demand Planning– Supply Planning– Fulfillment– Field Service
• There must be strong integration between the ISCM and CRM macro processes
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Supplier Relationship Management
• Those processes focused on the interaction between the enterprise and suppliers that are upstream in the supply chain
• Key processes:– Design Collaboration– Source– Negotiate– Buy– Supply Collaboration
• There is a natural fit between ISCM and SRM processes
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The Transaction Management Foundation
• Enterprise software systems (ERP)• Earlier systems focused on automation of
simple transactions and the creation of an integrated method of storing and viewing data across the enterprise
• Real value of the TMF exists only if decision making is improved
• The extent to which the TMF enables integration across the three macro processes determines its value
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The Future of IT in the Supply Chain
• At the highest level, the three SCM macro processes will continue to drive the evolution of enterprise software
• Software focused on the macro processes will become a larger share of the total enterprise software market and the firms producing this software will become more successful
• Functionality, the ability to integrate across macro processes, and the strength of their ecosystems, will be keys to success
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Supply Chain Information Technology in Practice
• Select an IT system that addresses the company’s key success factors
• Take incremental steps and measure value
• Align the level of sophistication with the need for sophistication
• Use IT systems to support decision making, not to make decisions
• Think about the future
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Lack of SC Coordination and the Bullwhip Effect
• Supply chain coordination – all stages in the supply chain take actions together (usually results in greater total supply chain profits)
• SC coordination requires that each stage take into account the effects of its actions on the other stages
• Lack of coordination results when: – Objectives of different stages conflict or– Information moving between stages is distorted
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Bullwhip Effect
• Fluctuations in orders increase as they move up the supply chain from retailers to wholesalers to manufacturers to suppliers
• Distorts demand information within the supply chain, where different stages have very different estimates of what demand looks like
• Results in a loss of supply chain coordination
• Examples: Proctor & Gamble (Pampers); HP (printers); Barilla (pasta)
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The Effect of Lack ofCoordination on Performance
• Manufacturing cost (increases)• Inventory cost (increases)• Replenishment lead time (increases)• Transportation cost (increases)• Labor cost for shipping and receiving (increases)• Level of product availability (decreases)• Relationships across the supply chain (worsens)• Profitability (decreases)• The bullwhip effect reduces supply chain profitability by
making it more expensive to provide a given level of product availability
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Obstacles to Coordination in a Supply Chain
• Incentive Obstacles• Information Processing Obstacles• Operational Obstacles• Pricing Obstacles• Behavioral Obstacles
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Incentive Obstacles
• When incentives offered to different stages or participants in a supply chain lead to actions that increase variability and reduce total supply chain profits – misalignment of total supply chain objectives and individual objectives
• Local optimization within functions or stages of a supply chain
• Sales force incentives
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Information Processing Obstacles
• When demand information is distorted as it moves between different stages of the supply chain, leading to increased variability in orders within the supply chain
• Forecasting based on orders, not customer demand– Forecasting demand based on orders magnifies
demand fluctuations moving up the supply chain from retailer to manufacturer
• Lack of information sharing
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Operational Obstacles
• Actions taken in the course of placing and filling orders that lead to an increase in variability
• Ordering in large lots (much larger than dictated by demand) –
• Large replenishment lead times• Rationing and shortage gaming (common in the
computer industry because of periodic cycles of component shortages and surpluses)
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Pricing Obstacles
• When pricing policies for a product lead to an increase in variability of orders placed
• Lot-size based quantity decisions• Price fluctuations (resulting in forward
buying) – Figure 17.3
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Behavioral Obstacles• Problems in learning, often related to communication in
the supply chain and how the supply chain is structured• Each stage of the supply chain views its actions locally
and is unable to see the impact of its actions on other stages
• Different stages react to the current local situation rather than trying to identify the root causes
• Based on local analysis, different stages blame each other for the fluctuations, with successive stages becoming enemies rather than partners
• No stage learns from its actions over time because the most significant consequences of the actions of any one stage occur elsewhere, resulting in a vicious cycle of actions and blame
• Lack of trust results in opportunism, duplication of effort, and lack of information sharing
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Managerial Levers to Achieve Coordination
• Aligning Goals and Incentives• Improving Information Accuracy• Improving Operational Performance• Designing Pricing Strategies to Stabilize
Orders• Building Strategic Partnerships and
Trust
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Aligning Goals and Incentives
• Align incentives so that each participant has an incentive to do the things that will maximize total supply chain profits
• Align incentives across functions• Pricing for coordination• Alter sales force incentives from sell-in
(to the retailer) to sell-through (by the retailer)
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Improving Information Accuracy
• Sharing point of sale data• Collaborative forecasting and planning• Single stage control of replenishment
– Continuous replenishment programs (CRP)
– Vendor managed inventory (VMI)
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Improving Operational Performance
• Reducing replenishment lead time– Reduces uncertainty in demand– EDI is useful
• Reducing lot sizes– Computer-assisted ordering, B2B exchanges– Shipping in LTL sizes by combining shipments– Technology and other methods to simplify receiving– Changing customer ordering behavior
• Rationing based on past sales and sharing information to limit gaming– “Turn-and-earn”– Information sharing
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Designing Pricing Strategiesto Stabilize Orders
• Encouraging retailers to order in smaller lots and reduce forward buying
• Moving from lot size-based to volume-based quantity discounts (consider total purchases over a specified time period)
• Stabilizing pricing– Eliminate promotions (everyday low pricing, EDLP)– Limit quantity purchased during a promotion– Tie promotion payments to sell-through rather than
amount purchased• Building strategic partnerships and trust – easier to
implement these approaches if there is trust
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Building Strategic Partnerships and Trust in a Supply Chain• Background• Designing a Relationship with
Cooperation and Trust• Managing Supply Chain Relationships
for Cooperation and Trust
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Building Strategic Partnerships and Trust in a Supply Chain
• Trust-based relationship– Dependability– Leap of faith
• Cooperation and trust work because:– Alignment of incentives and goals– Actions to achieve coordination are easier
to implement– Supply chain productivity improves by
reducing duplication or allocation of effort to appropriate stage
– Greater information sharing results
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Trust in the Supply Chain
• Table 17.2 shows benefits• Historically, supply chain relationships are based on
power or trust• Disadvantages of power-based relationship:
– Results in one stage maximizing profits, often at the expense of other stages
– Can hurt a company when balance of power changes
– Less powerful stages have sought ways to resist
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Building Trust into aSupply Chain Relationship
• Deterrence-based view– Use formal contracts– Parties behave in trusting manner out of self-
interest• Process-based view
– Trust and cooperation are built up over time as a result of a series of interactions
– Positive interactions strengthen the belief in cooperation of other party
• Neither view holds exclusively in all situations
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Building Trust into aSupply Chain Relationship
• Initially more reliance on deterrence-based view, then evolves to a process-based view
• Co-identification: ideal goal• Two phases to a supply chain
relationship– Design phase– Management phase
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Designing a Relationshipwith Cooperation and Trust
• Assessing the value of the relationship and its contributions
• Identifying operational roles and decision rights for each party
• Creating effective contracts• Designing effective conflict resolution
mechanisms
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Assessing the Value of the Relationship and its
Contributions• Identify the mutual benefit provided• Identify the criteria used to evaluate the
relationship (equity is important)• Important to share benefits equitably• Clarify contribution of each party and
the benefits each party will receive
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Identifying Operational Roles and Decision Rights for Each
Party• Recognize interdependence between parties
– Sequential interdependence: activities of one partner precede the other
– Reciprocal interdependence: the parties come together, exchange information and inputs in both directions
• Sequential interdependence is the traditional supply chain form
• Reciprocal interdependence is more difficult but can result in more benefits
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Effects of Interdependence on Supply Chain Relationships
Org
an
iza
tio
n’s
D
ep
end
en
ce
High
Low
Partner’s Dependence
Low High
Partner Relatively Powerful
Organization Relatively Powerful
High Level of Interdependence
Effective Relationship
Low Level of Interdependenc
e
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Creating Effective Contracts
• Create contracts that encourage negotiation when unplanned contingencies arise
• It is impossible to define and plan for every possible occurrence
• Informal relationships and agreements can fill in the “gaps” in contracts
• Informal arrangements may eventually be formalized in later contracts
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Designing Effective Conflict Resolution Mechanisms
• Initial formal specification of rules and guidelines for procedures and transactions
• Regular, frequent meetings to promote communication
• Courts or other intermediaries
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Managing Supply Chain Relationships for Cooperation and
Trust• Effective management of a relationship
is important for its success• Top management is often involved in
the design but not management of a relationship
• -- process of alliance evolution• Perceptions of reduced benefits or
opportunistic actions can significantly impair a supply chain partnership
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Achieving Coordination in Practice
• Quantify the bullwhip effect• Get top management commitment for coordination• Devote resources to coordination• Focus on communication with other stages• Try to achieve coordination in the entire supply chain
network• Use technology to improve connectivity in the supply
chain• Share the benefits of coordination equitably
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Role of Forecasting in a Supply Chain
• The basis for all strategic and planning decisions in a supply chain
• Used for both push and pull processes• Examples:
– Production: scheduling, inventory, aggregate planning
– Marketing: sales force allocation, promotions, new production introduction
– Finance: plant/equipment investment, budgetary planning
– Personnel: workforce planning, hiring, layoffs• All of these decisions are interrelated
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Characteristics of Forecasts
• Forecasts are always wrong. Should include expected value and measure of error.
• Long-term forecasts are less accurate than short-term forecasts (forecast horizon is important)
• Aggregate forecasts are more accurate than disaggregate forecasts
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Forecasting Methods
• Qualitative: primarily subjective; rely on judgment and opinion
• Time Series: use historical demand only– Static – Adaptive
• Causal: use the relationship between demand and some other factor to develop forecast
• Simulation– Imitate consumer choices that give rise to demand– Can combine time series and causal methods
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Components of an ObservationObserved demand (O) =
Systematic component (S) + Random component (R)
Level (current deseasonalized demand)
Trend (growth or decline in demand)
Seasonality (predictable seasonal fluctuation)
• Systematic component: Expected value of demand• Random component: The part of the forecast that deviates from the systematic component• Forecast error: difference between forecast and actual demand
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Time Series ForecastingQuarter Demand Dt
II, 1998 8000III, 1998 13000IV, 1998 23000I, 1999 34000II, 1999 10000III, 1999 18000IV, 1999 23000I, 2000 38000II, 2000 12000III, 2000 13000IV, 2000 32000I, 2001 41000
Forecast demand for thenext four quarters.
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Time Series Forecasting
0
10,000
20,000
30,000
40,000
50,000
97,2
97,3
97,4
98,1
98,2
98,3
98,4
99,1
99,2
99,3
99,4
00,1
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Forecasting Methods
• Static • Adaptive
– Moving average– Simple exponential smoothing– Holt’s model (with trend)– Winter’s model (with trend and
seasonality)
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Basic Approach toDemand Forecasting
• Understand the objectives of forecasting• Integrate demand planning and forecasting• Identify major factors that influence the demand
forecast• Understand and identify customer segments• Determine the appropriate forecasting technique• Establish performance and error measures for the
forecast
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Time Series Forecasting Methods
• Goal is to predict systematic component of demand– Multiplicative: (level)(trend)(seasonal factor)– Additive: level + trend + seasonal factor– Mixed: (level + trend)(seasonal factor)
• Static methods• Adaptive forecasting
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Static Methods
• Assume a mixed model:
Systematic component = (level + trend)(seasonal factor)
Ft+l = [L + (t + l)T]St+l
= forecast in period t for demand in period t + l
L = estimate of level for period 0
T = estimate of trend
St = estimate of seasonal factor for period t
Dt = actual demand in period t
Ft = forecast of demand in period t
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Static Methods
• Estimating level and trend• Estimating seasonal factors
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Estimating Level and Trend
• Before estimating level and trend, demand data must be deseasonalized
• Deseasonalized demand = demand that would have been observed in the absence of seasonal fluctuations
• Periodicity (p) – the number of periods after which the
seasonal cycle repeats itself– for demand at Tahoe Salt (Table 7.1,
Figure 7.1) p = 4
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Time Series Forecasting (Table 7.1)
Quarter Demand Dt
II, 1998 8000III, 1998 13000IV, 1998 23000I, 1999 34000II, 1999 10000III, 1999 18000IV, 1999 23000I, 2000 38000II, 2000 12000III, 2000 13000IV, 2000 32000I, 2001 41000
Forecast demand for thenext four quarters.
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Time Series Forecasting(Figure 7.1)
0
10,000
20,000
30,000
40,000
50,000
97,2
97,3
97,4
98,1
98,2
98,3
98,4
99,1
99,2
99,3
99,4
00,1
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Estimating Level and Trend
• Before estimating level and trend, demand data must be deseasonalized
• Deseasonalized demand = demand that would have been observed in the absence of seasonal fluctuations
• Periodicity (p) – the number of periods after which the
seasonal cycle repeats itself– for demand at Tahoe Salt (Table 7.1,
Figure 7.1) p = 4
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Deseasonalizing Demand
[Dt-(p/2) + Dt+(p/2) + S 2Di] / 2p for p even
Dt = (sum is from i = t+1-(p/2) to t+1+(p/2))
S Di / p for p odd
(sum is from i = t-(p/2) to t+(p/2)), p/2 truncated to lower integer
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Deseasonalizing Demand
For the example, p = 4 is even
For t = 3:
D3 = {D1 + D5 + Sum(i=2 to 4) [2Di]}/8
= {8000+10000+[(2)(13000)+(2)(23000)+(2)(34000)]}/8
= 19750
D4 = {D2 + D6 + Sum(i=3 to 5) [2Di]}/8
= {13000+18000+[(2)(23000)+(2)(34000)+(2)(10000)]/8
= 20625
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Deseasonalizing DemandThen include trend
Dt = L + tT
where Dt = deseasonalized demand in period t
L = level (deseasonalized demand at period 0)
T = trend (rate of growth of deseasonalized demand)
Trend is determined by linear regression using deseasonalized demand as the dependent variable and period as the independent variable (can be done in Excel)
In the example, L = 18,439 and T = 524
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Time Series of Demand(Figure 7.3)
0
10000
20000
30000
40000
50000
1 2 3 4 5 6 7 8 9 10 11 12
Period
Dem
an
d
Dt
Dt-bar
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Estimating Seasonal Factors
Use the previous equation to calculate deseasonalized demand for each period
St = Dt / Dt = seasonal factor for period t
In the example,
D2 = 18439 + (524)(2) = 19487 D2 = 13000
S2 = 13000/19487 = 0.67
The seasonal factors for the other periods are calculated in the same manner
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Estimating Seasonal Factors (Fig. 7.4)
t Dt Dt-bar S-bar1 8000 18963 0.42 = 8000/189632 13000 19487 0.67 = 13000/194873 23000 20011 1.15 = 23000/200114 34000 20535 1.66 = 34000/205355 10000 21059 0.47 = 10000/210596 18000 21583 0.83 = 18000/215837 23000 22107 1.04 = 23000/221078 38000 22631 1.68 = 38000/226319 12000 23155 0.52 = 12000/23155
10 13000 23679 0.55 = 13000/2367911 32000 24203 1.32 = 32000/2420312 41000 24727 1.66 = 41000/24727
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Estimating Seasonal FactorsThe overall seasonal factor for a “season” is then
obtained by averaging all of the factors for a “season”
If there are r seasonal cycles, for all periods of the form pt+i, 1<i<p, the seasonal factor for season i is
Si = [Sum(j=0 to r-1) Sjp+i]/r
In the example, there are 3 seasonal cycles in the data and p=4, so
S1 = (0.42+0.47+0.52)/3 = 0.47
S2 = (0.67+0.83+0.55)/3 = 0.68
S3 = (1.15+1.04+1.32)/3 = 1.17
S4 = (1.66+1.68+1.66)/3 = 1.67
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Estimating the Forecast
Using the original equation, we can forecast the next four periods of demand:
F13 = (L+13T)S1 = [18439+(13)(524)](0.47) = 11868
F14 = (L+14T)S2 = [18439+(14)(524)](0.68) = 17527
F15 = (L+15T)S3 = [18439+(15)(524)](1.17) = 30770
F16 = (L+16T)S4 = [18439+(16)(524)](1.67) = 44794
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Adaptive Forecasting
• The estimates of level, trend, and seasonality are adjusted after each demand observation
• General steps in adaptive forecasting• Moving average• Simple exponential smoothing• Trend-corrected exponential smoothing (Holt’s
model)• Trend- and seasonality-corrected exponential
smoothing (Winter’s model)
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Basic Formula forAdaptive Forecasting
Ft+1 = (Lt + lT)St+1 = forecast for period t+l in period t
Lt = Estimate of level at the end of period t
Tt = Estimate of trend at the end of period t
St = Estimate of seasonal factor for period t
Ft = Forecast of demand for period t (made period t-1 or earlier)
Dt = Actual demand observed in period t
Et = Forecast error in period t
At = Absolute deviation for period t = |Et|
MAD = Mean Absolute Deviation = average value of At
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General Steps inAdaptive Forecasting
• Initialize: Compute initial estimates of level (L0), trend (T0), and seasonal factors (S1,…,Sp). This is done as in static forecasting.
• Forecast: Forecast demand for period t+1 using the general equation
• Estimate error: Compute error Et+1 = Ft+1- Dt+1
• Modify estimates: Modify the estimates of level (Lt+1), trend (Tt+1), and seasonal factor (St+p+1), given the error Et+1 in the forecast
• Repeat steps 2, 3, and 4 for each subsequent period
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Moving Average• Used when demand has no observable trend or
seasonality• Systematic component of demand = level• The level in period t is the average demand over the last
N periods (the N-period moving average)• Current forecast for all future periods is the same and is
based on the current estimate of the level
Lt = (Dt + Dt-1 + … + Dt-N+1) / N
Ft+1 = Lt and Ft+n = Lt
After observing the demand for period t+1, revise the estimates as follows:
Lt+1 = (Dt+1 + Dt + … + Dt-N+2) / N
Ft+2 = Lt+1
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Moving Average Example
From Tahoe Salt example (Table 7.1)
At the end of period 4, what is the forecast demand for periods 5 through 8 using a 4-period moving average?
L4 = (D4+D3+D2+D1)/4 = (34000+23000+13000+8000)/4 = 19500
F5 = 19500 = F6 = F7 = F8
Observe demand in period 5 to be D5 = 10000
Forecast error in period 5, E5 = F5 - D5 = 19500 - 10000 = 9500
Revise estimate of level in period 5:
L5 = (D5+D4+D3+D2)/4 = (10000+34000+23000+13000)/4 = 20000
F6 = L5 = 20000
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Simple Exponential Smoothing
• Used when demand has no observable trend or seasonality• Systematic component of demand = level• Initial estimate of level, L0, assumed to be the average of all historical
data
L0 = [Sum(i=1 to n)Di]/n
Current forecast for all future periods is equal to the current estimate of the level and is given as follows:
Ft+1 = Lt and Ft+n = Lt
After observing demand Dt+1, revise the estimate of the level:
Lt+1 = aDt+1 + (1-a)Lt
Lt+1 = Sum(n=0 to t+1)[a(1-a)nDt+1-n ]
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Simple Exponential Smoothing Example
From Tahoe Salt data, forecast demand for period 1 using exponential smoothing
L0 = average of all 12 periods of data
= Sum(i=1 to 12)[Di]/12 = 22083
F1 = L0 = 22083
Observed demand for period 1 = D1 = 8000
Forecast error for period 1, E1, is as follows:
E1 = F1 - D1 = 22083 - 8000 = 14083
Assuming a = 0.1, revised estimate of level for period 1:
L1 = aD1 + (1-a)L0 = (0.1)(8000) + (0.9)(22083) = 20675
F2 = L1 = 20675
Note that the estimate of level for period 1 is lower than in period 0
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Trend-Corrected Exponential Smoothing (Holt’s Model)
• Appropriate when the demand is assumed to have a level and trend in the systematic component of demand but no seasonality
• Obtain initial estimate of level and trend by running a linear regression of the following form:
Dt = at + b
T0 = a
L0 = b
In period t, the forecast for future periods is expressed as follows:
Ft+1 = Lt + Tt
Ft+n = Lt + nTt
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Trend-Corrected Exponential Smoothing (Holt’s Model)
After observing demand for period t, revise the estimates for level and trend as follows:
Lt+1 = aDt+1 + (1-a)(Lt + Tt)
Tt+1 = b(Lt+1 - Lt) + (1-b)Tt
a = smoothing constant for level
b = smoothing constant for trend
Example: Tahoe Salt demand data. Forecast demand for period 1 using Holt’s model (trend corrected exponential smoothing)
Using linear regression,
L0 = 12015 (linear intercept)
T0 = 1549 (linear slope)
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Holt’s Model Example (continued)
Forecast for period 1:F1 = L0 + T0 = 12015 + 1549 = 13564Observed demand for period 1 = D1 = 8000E1 = F1 - D1 = 13564 - 8000 = 5564Assume a = 0.1, b = 0.2L1 = aD1 + (1-a)(L0+T0) = (0.1)(8000) + (0.9)(13564) =
13008T1 = b(L1 - L0) + (1-b)T0 = (0.2)(13008 - 12015) + (0.8)
(1549) = 1438F2 = L1 + T1 = 13008 + 1438 = 14446F5 = L1 + 4T1 = 13008 + (4)(1438) = 18760
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Trend- and Seasonality-Corrected Exponential Smoothing
• Appropriate when the systematic component of demand is assumed to have a level, trend, and seasonal factor
• Systematic component = (level+trend)(seasonal factor)• Assume periodicity p• Obtain initial estimates of level (L0), trend (T0), seasonal
factors (S1,…,Sp) using procedure for static forecasting
• In period t, the forecast for future periods is given by:
Ft+1 = (Lt+Tt)(St+1) and Ft+n = (Lt + nTt)St+n
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Trend- and Seasonality-Corrected Exponential Smoothing (continued)
After observing demand for period t+1, revise estimates for level, trend, and seasonal factors as follows:
Lt+1 = a(Dt+1/St+1) + (1-a)(Lt+Tt)
Tt+1 = b(Lt+1 - Lt) + (1-b)Tt
St+p+1 = g(Dt+1/Lt+1) + (1-g)St+1
a = smoothing constant for level
b = smoothing constant for trend
g = smoothing constant for seasonal factor
Example: Tahoe Salt data. Forecast demand for period 1 using Winter’s model.
Initial estimates of level, trend, and seasonal factors are obtained as in the static forecasting case
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Trend- and Seasonality-Corrected Exponential Smoothing Example (continued)
L0 = 18439 T0 = 524 S1=0.47, S2=0.68, S3=1.17, S4=1.67
F1 = (L0 + T0)S1 = (18439+524)(0.47) = 8913
The observed demand for period 1 = D1 = 8000
Forecast error for period 1 = E1 = F1-D1 = 8913 - 8000 = 913
Assume a = 0.1, b=0.2, g=0.1; revise estimates for level and trend for period 1 and for seasonal factor for period 5
L1 = a(D1/S1)+(1-a)(L0+T0) = (0.1)(8000/0.47)+(0.9)(18439+524)=18769
T1 = b(L1-L0)+(1-b)T0 = (0.2)(18769-18439)+(0.8)(524) = 485
S5 = g(D1/L1)+(1-g)S1 = (0.1)(8000/18769)+(0.9)(0.47) = 0.47
F2 = (L1+T1)S2 = (18769 + 485)(0.68) = 13093
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Measures of Forecast Error
• Forecast error = Et = Ft - Dt
• Mean squared error (MSE)
MSEn = (Sum(t=1 to n)[Et2])/n
• Absolute deviation = At = |Et|
• Mean absolute deviation (MAD)
MADn = (Sum(t=1 to n)[At])/n
s = 1.25MAD
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Measures of Forecast Error
• Mean absolute percentage error (MAPE)
MAPEn = (Sum(t=1 to n)[|Et/ Dt|100])/n
• Bias• Shows whether the forecast consistently under- or
overestimates demand; should fluctuate around 0
biasn = Sum(t=1 to n)[Et]
• Tracking signal• Should be within the range of +6• Otherwise, possibly use a new forecasting method
TSt = bias / MADt
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Forecasting Demand at Tahoe Salt
• Moving average• Simple exponential smoothing• Trend-corrected exponential smoothing• Trend- and seasonality-corrected
exponential smoothing
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Forecasting in Practice
• Collaborate in building forecasts• The value of data depends on where you
are in the supply chain• Be sure to distinguish between demand
and sales
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Collaborative Planning, Forecasting And Replenishment (CPFR)
• Initiatives that have attempted to create efficiency and effectiveness through integration of supply chain activities and processes have been identified as quick response, electronic data interchange (EDI), short cycle manufacturing, vendor managed inventory (VMI), continuous replenishment planning (CRP) and efficient consumer response (ECR).
• CPFR has become recognized as a breakthrough business model for planning, forecasting and replenishment. Using this approach, retailers, transport providers, distributors and manufacturers can utilize available internet-based technologies to collaborate from operational planning through execution. CPFR simplifies and streamlines overall demand planning.
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CPFR Business Model
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• Development of CPFR came from an effort by Wal Mart and one of its suppliers, Warner-Lambert Company, particularly with regard to its Listerine brand product. In addition to rationalizing inventories of specific line items and addressing out-of-stock occurrences, these two companies collaborated to increase their forecasting accuracy, so as to have just the right amount of inventory where it was needed, when it was needed.
• CPFR emphasizes a sharing of consumer purchasing data among and between trading partners for the purpose of helping to govern supply chain activities. In this manner, CPFR creates a significant, direct link between the consumer and the supply chain.
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• The CPFR initiative begins with the sharing of marketing plans between trading partners. Once an agreement is reached on the timing and planned sales of specific products, and a commitment is made to follow that plan closely, the plan is then used to create a forecast, by stock-keeping unit, by week, and by quantity. The planning can be for thirteen, twenty-six, or fifty two weeks.
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Order Fulfillment and Order Management • Three critical elements of collaborative planning are
collaborative demand planning, joint capacity planning, and synchronized order fulfillment. This type of planning improves quality of the demand signal for the entire supply chain through a constant exchange of information from one end to the other that goes well beyond traditional practices.
• The Order-Management system represents the principal means by which buyers and sellers communicate information relating to individual orders of product. Effective order management is a key to operational efficiency and customer satisfaction.
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Collaborative PlanningCollaborative demand planning
Joint Capacity planning
Synchronized Order fulfillment
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Order Management Functions• Receive order• Enter order – manual/electronic• Verify and check order for accuracy • Check credit• Check inventory availability• Process back order• Acknowledge order• Modify order• Suspend order• Check pricing and promotion• Identify shipping point• Generate picking documents• Originate shipment• Inquire order status• Deliver order• Measure service level• Measure quality of service
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Order and Replenishment Cycles
• When referring to outbound-to-customer shipments, we typically use the term order cycle. The term replenishment cycle is used more frequently when referring to the acquisition of additional inventory, as in materials management. Basically one firm’s order cycle is another’s replenishment cycle.
Major components of Order Cycle
Order placement
Order processing
Order preparation
Order shipment
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• Order Placement – Order-placement time can vary significantly, from taking days or weeks to being instantaneous. Company experiences indicate that improvements in order-placement systems and processes offer some of the greatest opportunities for significantly reducing the length and variability of the overall order. Significant increases were projected for Internet facilitated resources such as E-marketplace, Extranets and E-mail.
• Order Processing – The order-processing function usually involves checking customer credit, transferring information to sales records, sending the order to the inventory and shipping areas, and preparing shipping documents.
• Order Preparation – Depending on the commodity being handled and other factors, the order-preparation process sometimes may be very simple and performed manually or, perhaps, may be relatively complex and highly automated.
• Order Shipment – Shipment time extends from the moment an order is placed upon the transport vehicle for movement, until the moment it is received and unloaded at the buyer’s location.
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Customer Service• Having the right product, at the right time, in
the right quantity, without damage or loss, to the right customer is an underlying principle of logistics systems that recognizes the importance of customer service.
• Another aspect of customer service that deserves mention is the growing consumer awareness of the price/quality ratio and the special needs of today’s consumers, who are time conscious and who demand flexibility.
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The Traditional Logistics/Marketing Interface
Product
Price
Place/Customer service levels
Promotion
Inventory carrying costs
Lot quantity costs
Order processing and information
costs
Warehousing costs
Transportation costs
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Defining Customer Service• Customer service is a process for providing competitive
advantage and adding benefits to the supply chain in order to maximize the total value to the ultimate customer.
• According to marketers, there are three levels of product:
1. The core benefit or service, which constitutes what the buyer is really buying.
2. The tangible product, or the physical product or service itself;
3. The augmented product, which includes benefits that are secondary to, but an integral enhancement to, the tangible product the customer is purchasing. Logistical customer service, installation warranties and after-sale service are examples of augmented product features.
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Examples of the various forms that customer service may take include the following:
1. Revamping a billing procedure to accommodate a customer’s request.
2. Providing financial and credit terms.
3. Guaranteeing delivery within specified time periods.
4. Providing prompt and congenial sales representatives.
5. Extending the option to sell on consignment.
6. Providing material to aid in a customer’s sales presentation.
7. Installing the product.
8. Maintaining satisfactory repair parts inventories.
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Levels of Customer Service• Customer service as an activity – This level treats
customer service as a particular task that a firm must accomplish to satisfy the customer’s needs. Order processing, billing and invoicing, product returns and claims handling are all typical examples of this level of customer service.
• Customer service as performance measures – This level emphasizes customer service in terms of specific performance measures, such as the percentage of orders delivered on time and complete and the number of orders processed within acceptable time limits.
• Customer service as a philosophy – This level elevates customer service to a firm-wide commitment to providing customer satisfaction through superior customer service by laying emphasis on quality and quality management.
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Elements of Customer ServiceCustomer service has multifunctional interest for a
company; but, from the point of view of the logistics function, we can view customer service as having four traditional dimensions:
• Time – The time factor is usually order cycle time, particularly from the perspective of the seller looking at customer service. On the other hand, the buyer usually refers to the time dimension as the lead time, or replenishment time.
• Dependability – Dependability can be more important than lead time. The customer can minimize its inventory level if lead time is fixed.
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1. Cycle time – A seller who can assure the customer of a given level of lead time, plus some tolerance, distinctly differentiates its product from that of its competitor. The seller that provides a dependable lead time permits the buyer to minimize the total cost of inventory, stockouts, order processing and production scheduling.
2. Safe delivery – If goods arrive damaged or are lost, the customer cannot use the goods as intended. A shipment containing damaged goods aggravates several customer cost centers – inventory, production and marketing.
3. Correct orders – An improperly filled order forces the customer to reorder, if the customer is not angry enough to buy from another supplier. If a customer who is an intermediary in the marketing channel experiences a stockout, the stockout cost also directly affects the seller.
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• Communications – The two logistics activities vital to order-filling are the communication of customer order information to the order-filling area and the actual process of picking out of inventory the items ordered. In the order information stage, the use of EDI or Internet-enabled communications can reduce errors in transferring order information from the order to the warehouse receipt.
• Convenience – Convenience is another way of saying that the logistics service level must be flexible. Basically, logistics requirements differ with regard to packaging, the mode and carrier the customer requires, routing and delivery times.
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Performance Measures for Customer Service
Element Brief Description
Typical Measurement UnitProduct
availability
Order cycle time
Distribution system flexibility
Usually defined as percent in stock (target performance level) in some base unit (i.e. order, product, dollars)
Elapsed time from order placement to order receipt. Usually measured in time units and variation from standard or target order cycle
% availability in base units
Speed and consistency
Ability of system to respond to special and/or unexpected needs of customer.
Response time to special requests
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Distribution system information
Ability of firm’s information system to respond in timely and accurate manner to customer’s requests for information
Speed, accuracy and message detail of response
Distribution system malfunction
Efficiency of procedures and time required to recover from distribution system malfunction (i.e. errors in billing, shipping, damage , claims).
Response and recovery time requirements
Postsale product support
Efficiency in providing product support after delivery, including technical, information, spare parts, or equipment modification, as appropriate.
Response time, quality of response
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Expected cost of stockoutsA principal benefit of inventory availability and,
hence of customer service is to reduce the incidence of stockouts. Once we develop a convenient way to calculate the costs of a stockout, we can use stockout probability information to determine the expected stockout cost. Last, we can analyse alternative customer service levels directly by comparing the expected cost of stockouts with the revenue enhancing benefits of customer service.
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Effects of stockouts• A stockout occurs when desired quantities of
finished goods are not available when and where a customer needs them. When a seller is unable to satisfy demand with available inventory, one of four possible events may occur:
1. The customer waits until the product is available
2. The customer back orders the product
3. The seller loses a sale
4. The seller loses a customer
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Back Order
A company having to back order an item that is out of stock will incur expenses for special order processing and transportation.
The extra order processing traces the back order’s movement , in addition to the normal processing for regular replenishments.
The customer usually incurs extra transportation charges because a back order is typically a smaller shipment and often incurs higher rates.
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Lost sales
Most firms find that although some customers may prefer a back order, others will turn to alternative supply sources.
Most companies have competitors who produce substitute products; and when one source does not have an item available, the customer will order that item from another source. In such cases, the stockout has caused a lost sale.
The seller’s direct loss is the loss of profit on the item that was unavailable when the customer wanted it.
Thus, a seller can determine direct loss by calculating profit on one item and multiplying it by the number the customer ordered. For eg. If the order was for 100 units and the profit is Rs. 10 per unit, the loss is Rs 1000.
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Lost Customer• The customer permanently switches to
another supplier. A supplier who loses a customer loses a future stream of income.
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Determining the Expected Cost of Stockouts
• The first step is to identify a stockout’s potential consequences. These include a back order, a lost sale, and a lost customer. The second step is to calculate each result’s expense or loss of profit and then to estimate the cost of a single stockout.
• Assume : 70% of all stockouts result in a back order, and a back order requires extra handling costs of Rs. 6; 20% results in a lost sale for the item, and this loss equals Rs. 20 in lost profit margin; and 10% result in a lost customer, or a loss of Rs. 200.
• Overall impact :
70% of Rs 6 = Rs. 4.20
20% of Rs. 20 = Rs 4
10% of Rs. 200 = Rs 20
Total estimated cost per stockout = Rs 28.20
A firm should carry additional inventory to protect against stockouts only as long as carrying the additional inventory costs less than Rs. 28.20.
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Channels of Distribution• A channel of distribution consists of one or
more companies or individuals who participate in the flow of goods, services, information and finances from the producer to the final user or consumer. This encompasses a variety of intermediary firms, including those that we classify as wholesalers or retailers.
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Types of ChannelsManaging distribution channels requires firms to
coordinate and integrate logistics and marketing activities in a manner consistent with overall corporate strategy.
• Logistical channel refers to the means by which products flow physically from where they are available to where they are needed.
• Marketing channels refers to the means by which necessary transactional elements are managed. (e.g. customer orders, billing, accounts receivable etc.)
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Logistical and Marketing Channels
Logistical channel Marketing Channel
Supplier
Transportation
Manufacturer
Transportation
Distribution center
Transportation
Retail store
Consumer
E-Procurement
National account sales
Wholesaler/Distributor
Retail customer
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Example of channels of distribution for the food products manufacturing industry
Food Manufacturing firms
Food Service distributors
Grocery wholesalers
Food brokers
Internet (direct)
Restaurants
Specialty (airlines
etc.) Retail chains
(local and regional)
Retail groce
rs
Institutional
buyers
Retail chains
Internet
retailer
Consumers of manufactured food products