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OPER3208-001 Supply Chain Management

OPER3208-001 Supply Chain Management. Fall 2006 Instructor: Prof. Setzler. Simchi-Levi, Chapter 4. Chapter 4: The Value of Information (Simchi-Levi). Introduction Focus: the value of using information technology to help effectively design and manage an integrated SC

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OPER3208-001 Supply Chain Management

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  1. OPER3208-001Supply Chain Management Fall 2006 Instructor: Prof. Setzler

  2. Simchi-Levi, Chapter 4

  3. Chapter 4: The Value of Information (Simchi-Levi) • Introduction • Focus: the value of using information technology to help effectively design and manage an integrated SC • “In modern supply chains, information replaces inventory” • By taking advantage of information the SC can be designed and operated more efficiently and effectively than ever before • Using information effectively makes the SC more complex

  4. Chapter 4: The Value of Information (Simchi-Levi) • Introduction • Information • Helps reduce variability in the SC • Helps suppliers make better forecasts • Enables the coordination of manufacturing and distribution systems and strategies • Enables retailers to better serve their customers by offering tools for locating desired items • Enables retailers to react and adapt to supply problems more rapidly • Enables lead time reductions

  5. Chapter 4: The Value of Information (Simchi-Levi) • The Bullwhip Effect • Suppliers and retailers observed that while demand did not vary much, inventory and back-order levels fluctuated a lot across the SC • For example, • Proctor&Gamble and Pampers diapers • Demand was stable • Supply fluctuated • Bullwhip effect • Variability as you move up the SC

  6. Chapter 4: The Value of Information (Simchi-Levi) • The Bullwhip Effect • Retailer observes customer demand • Retailer places order with wholesaler • Wholesaler receives products from distributor • Distributor places order with factory • Figures shows an increase in variability across supply chain

  7. Chapter 4: The Value of Information (Simchi-Levi) • The Bullwhip Effect • Consider the wholesaler • Wholesaler receives orders from retailer and places orders with its supplier, the distributor • The wholesaler uses forecasting to determine the retailer’s demand

  8. Chapter 4: The Value of Information (Simchi-Levi) • The Bullwhip Effect • Consider the wholesaler • If the wholesaler doesn’t have access to customer demand, he uses past orders placed by the retailer for his forecasting • The retailer’s order variability is higher than the variability of customer demand

  9. Chapter 4: The Value of Information (Simchi-Levi) • The Bullwhip Effect • Consider the wholesaler • The wholesaler must carries more safety stock than the retailer in order to meet the same service level as the retailer

  10. Chapter 4: The Value of Information (Simchi-Levi) • The Bullwhip Effect • Consider the wholesaler • This analysis carries on to the distributor and the factory, resulting in higher inventories at each level (tier) and, as a result, higher costs at each lower level in the chain

  11. Chapter 4: The Value of Information (Simchi-Levi)

  12. Chapter 4: The Value of Information (Simchi-Levi) • The Bullwhip Effect • Widget Example • A single factory supplies a single retailer with widgets • Average annual widget demand is 5,200 units • Orders are delivered from the factory to the store every week • If the variability in orders placed by the store is low • Weekly shipments of about 100 units per week • The factory’s production capacity and weekly shipping capacity is only about 100 units per week

  13. Chapter 4: The Value of Information (Simchi-Levi) • The Bullwhip Effect • Widget Example • If the variability in orders placed by the store is very high • Certain weeks the factory ships 400 units, and some weeks no units at all • It is easy to see that the production and shipping capacity must be much higher and that some weeks capacity is idle • This is not acceptable • Given this situation, the factory could build up inventory during weeks with low demand and supply the excess units during high demand weeks • This will, however, increase inventory holding costs

  14. Chapter 4: The Value of Information (Simchi-Levi) • The Bullwhip Effect • It’s important to develop tools and techniques to control the Bullwhip Effect • i.e., increase in variability in the SC

  15. Chapter 4: The Value of Information (Simchi-Levi) • The Bullwhip Effect • The main factors contributing to the increase in variability in the SC • Demand Forecasting • Lead time • Batch ordering • Price fluctuation • Inflated orders

  16. Chapter 4: The Value of Information (Simchi-Levi) • The Bullwhip Effect • The main factors contributing to the increase in variability in the SC • Demand Forecasting • An inventory policy used at each stage of the SC is the min-max inventory policy • The facility monitors inventory and when the inventory level is less than a set number (i.e., the reorder point), the facility raises inventory level up to a maximum target level (i.e., the order-up-to level) • Typically, the reorder point = average demand during lead time + safety stock • Average demand during lead time (a.k.a. the mean) • Safety stock is a multiple of the standard deviation of demand during lead time

  17. Chapter 4: The Value of Information (Simchi-Levi) • The Bullwhip Effect • The main factors contributing to the increase in variability in the SC • Demand Forecasting • A very common forecasting method is a forecast smoothing technique which uses past data to estimate the average demand (mean) and demand variability (standard deviation) • As more data is collected, the estimates of the mean and standard deviation are modified • Safety stock and the order-up-to level strongly depend on these estimates • Changing these values changes order quantities and therefore increases variability

  18. Chapter 4: The Value of Information (Simchi-Levi) • The Bullwhip Effect • The main factors contributing to the increase in variability in the SC • Lead time • Increases in variability are magnified by increases in lead time • To calculate safety stock and the reorder point the average and standard deviation of daily demand are multiplied by lead time and added together • Therefore, longer lead times and even a small change in the estimate of demand variability could result in a significant change in safety stock and reorder level, leading to significant change in order quantities

  19. Chapter 4: The Value of Information (Simchi-Levi) • The Bullwhip Effect • The main factors contributing to the increase in variability in the SC • Batch ordering • If the retailer uses batch ordering then the wholesaler will observe a large order, followed by several periods of no orders, followed by another large order, etc • The wholesaler sees distorted and highly variable patterns of orders

  20. Chapter 4: The Value of Information (Simchi-Levi) • The Bullwhip Effect • The main factors contributing to the increase in variability in the SC • Batch ordering • Why use batch ordering? • If there is a fixed ordering cost • Transportation costs (wanting a full truck load)

  21. Chapter 4: The Value of Information (Simchi-Levi) • The Bullwhip Effect • The main factors contributing to the increase in variability in the SC • Price fluctuation • If prices fluctuate, retailers often try to stock up when prices are low

  22. Chapter 4: The Value of Information (Simchi-Levi) • The Bullwhip Effect • The main factors contributing to the increase in variability in the SC • Inflated orders • If a retailer or distributor suspects that a product might be in short supply in the future, they will sometimes order more than needed with the expectation of only receiving part of the amount ordered • When shortage is over, the retailer will go back to normal ordering patterns, leading to distortions and variations within the SC

  23. Chapter 4: The Value of Information (Simchi-Levi) • Quantifying the Bullwhip Effect • It is helpful to be able to quantify the increase in variability that occurs at every stage of the SC • Demonstrate the magnitude of increase in variability • Show the relationship between the forecast technique, the lead time, and the increase in variability

  24. Chapter 4: The Value of Information (Simchi-Levi) • Quantifying the Bullwhip Effect • Consider a two stage SC (a retailer and a manufacturer) • There is a fixed lead time (L) for the retailer • If the retailer places an order in period t, then they will receive their order in period t + L • The retailer checks his inventory each period and decides how much to order to bring his inventory up to some set value

  25. Chapter 4: The Value of Information (Simchi-Levi) • Quantifying the Bullwhip Effect • Order-up-to level = L * AVG + z * STD * (L)0.5 • AVG = average daily demand (a.k.a. the mean) • STD = standard deviation of daily demand (a.k.a. variation in demand) • z = safety factor chosen to ensure that the probability of stockouts during lead time is equal to some specified service level

  26. Chapter 4: The Value of Information (Simchi-Levi) • Quantifying the Bullwhip Effect • AVG and STD must be calculated from past demand data • Note that the order-up-to point may change according to changes in the current AVG and STD • Order-up-to point in period t, yt, is estimated from demand as

  27. Chapter 4: The Value of Information (Simchi-Levi) • Quantifying the Bullwhip Effect • Suppose the retailer uses the moving average forecasting method • For each period the retailer estimates mean demand as an average of p previous observations of demand • Standard deviation is estimated in a similar manner • If Di represents the customer demand in period i, then

  28. Chapter 4: The Value of Information (Simchi-Levi) • Quantifying the Bullwhip Effect • The above equations imply that the retailer will recalculate the mean and standard deviation of demand every period, in which case the target inventory level will also change every periods • The change in variability can therefore be quantified • Calculate the variability faced by the manufacturer and compare it to the variability faced by the retailer

  29. Chapter 4: The Value of Information (Simchi-Levi) • Quantifying the Bullwhip Effect • If the variance of demand seen by the retailer is Var(D), then the variance of the orders placed by the retailer to the manufacturer, Var(Q), relative to the variance of customer demand satisfies

  30. Chapter 4: The Value of Information (Simchi-Levi) • Quantifying the Bullwhip Effect • Figure 407 shows the lower bound on the increase in variability as a function of p for various values of L • When p is large and L is small, the bullwhip effect due to forecasting error is negligible • When p is small and L is large, the bullwhip effect is magnified

  31. Chapter 4: The Value of Information (Simchi-Levi) • Quantifying the Bullwhip Effect • Suppose retailer estimates mean based on last 5 observations, p = 5 • Suppose L = 1 • Variance of the orders placed by the retailer to the manufacturer will be at least 40% larger than the variance of the customer demand seen by the retailer

  32. Chapter 4: The Value of Information (Simchi-Levi) • Quantifying the Bullwhip Effect • Now, suppose retailer estimates mean based on last 10 observations, p = 10 • Suppose L = 1 • Variance of the orders placed by the retailer to the manufacturer will be at least 1.2% larger than the variance of the customer demand seen by the retailer • Note: That by increasing the number of observations the variability can be significantly reduced 1.2

  33. Chapter 4: The Value of Information (Simchi-Levi) • The impact of centralized information on the Bullwhip Effect • One way to reduce the Bullwhip Effect is to centralize demand information within the SC • If demand information were centralized then actual demand data could be used for forecasting instead of orders received from previous stages which can be significantly more than actual demand • Focus: The value of sharing information within the SC • Distinguish two types of SCs • Centralized demand information • Decentralized demand information

  34. Chapter 4: The Value of Information (Simchi-Levi) • The impact of centralized information on the Bullwhip Effect • Centralized demand information • Retailer observes demand • Forecasts mean demand using a moving average with p observations • Places order to wholesaler • Wholesaler • Receives retailer’s order along with forecast mean demand • Uses forecast to determine target inventory level, and then places order to distributor • Distributor • Receives order along with retailers forecast mean demand • Uses forecast to determine target inventory level, and then places order to factory

  35. Chapter 4: The Value of Information (Simchi-Levi) • The impact of centralized information on the Bullwhip Effect • Centralized demand information • Each facility in the SC receives the retailer’s forecast mean demand and uses this mean demand to order-up-to inventory amounts • Centralized information: • Demand information • Forecasting technique • Inventory policy

  36. Chapter 4: The Value of Information (Simchi-Levi) • The impact of centralized information on the Bullwhip Effect • Centralized demand information • The variance of the orders placed by the kth stage of the SC, Var(Qk), relative to the variance of the customer demand, Var (D), is

  37. Chapter 4: The Value of Information (Simchi-Levi) • The impact of centralized information on the Bullwhip Effect • Centralized demand information • Suppose Li is the lead time between stage i and stage i + 1 • If lead time from the time the retailer places the order to the time the wholesaler is 2 weeks, then L1 = 2 • If lead time from wholesaler to distributor is 2 weeks, then L2 = 2 • If lead time from distributor to factor is 2 weeks, then L3 = 2 • Therefore, the total lead time from retailer to factor is = L1 + L2 + L3 = 6 weeks, where k = 3

  38. Chapter 4: The Value of Information (Simchi-Levi) • The impact of centralized information on the Bullwhip Effect • Centralized demand information • The variance of the orders placed by a given stage of a SC is an increasing function of the total lead time between that stage and the retailer • Variance of the orders becomes larger as we move up the SC

  39. Chapter 4: The Value of Information (Simchi-Levi) • The impact of centralized information on the Bullwhip Effect • Decentralized demand information • There is no sharing of information • The wholesale must use the retailer’s past order data to determine demand mean and then target inventory level • Assume the wholesaler uses a moving average with p observations (retailer data) • Wholesaler places order with distributor • The distributor must use the wholesaler’s past order data to determine demand mean and then target inventory level • Assume the distributor uses a moving average with p observations (wholesaler’s data) • Distributor places order with factory

  40. multiply Chapter 4: The Value of Information (Simchi-Levi) • The impact of centralized information on the Bullwhip Effect • Decentralized demand information • The variance of the orders placed by the kth stage of the SC, Var(Qk), relative to the variance of customer demand, Var(D) satisfies • Notice that the formula looks similar to the formula shown for the centralized model, however here the variance increase multiplicatively at each stage of the supply chain • Again the variance of the orders becomes larger as you move up the SC • Orders placed by the wholesaler are more variable than orders placed by the retailer

  41. Chapter 4: The Value of Information (Simchi-Levi) • The impact of centralized information on the Bullwhip Effect • Managerial Insights on the value of centralized info • We have learned that for both centralized and decentralized systems that the farther we move up the SC the variance of the order quantities becomes larger • The difference in the two types of SCs is in terms of how much the variability grows as we move from one stage to another • Centralized SC • Orders grow additively in the total lead time • Decentralized SC • Orders grow multiplicatively • Leads to significantly higher variability than a centralized SC • Conclusion: Centralizing demand information can significantly reduce the bullwhip effect

  42. Chapter 4: The Value of Information (Simchi-Levi) • The impact of centralized information on the Bullwhip Effect • Managerial Insights on the value of centralized info

  43. Chapter 4: The Value of Information (Simchi-Levi) • The impact of centralized information on the Bullwhip Effect • Managerial Insights on the value of centralized info • It is important to point out that the bullwhip effect exists even when demand information is completely centralized and all stages of the SC use the same forecasting technique and inventory policy

  44. Chapter 4: The Value of Information (Simchi-Levi) • Methods for coping with the Bullwhip Effect • Reducing uncertainty • Reducing variability • Lead-time reduction • Strategic partnership

  45. Chapter 4: The Value of Information (Simchi-Levi) • Methods for coping with the Bullwhip Effect • Reducing uncertainty • By providing centralized demand information • Even if each stage uses the same demand data, each may use different forecasting methods and different buying practices, both of which may contribute to the Bullwhip Effect • Bullwhip Effect can not be complete eliminated

  46. Chapter 4: The Value of Information (Simchi-Levi) • Methods for coping with the Bullwhip Effect • Lead-time reduction • If the variability of customer demand seen by the retailer, the variability of demand seen by the wholesaler will also be reduced, although not eliminated • The retailer could eliminate price promotions, and thereby eliminate many dramatic swings in demand • Everyday low pricing strategy • More stable (less variable) customer demand

  47. Chapter 4: The Value of Information (Simchi-Levi) • Methods for coping with the Bullwhip Effect • Lead-time reduction • Lead times serve to magnify the increase in variability due to demand forecasting • Lead time typically includes two components • Order lead times (i.e., the time it takes to produce and ship the item) • Can be reduced through the use of cross-docking • Information lead time (i.e., the time it takes to process an order) • Can be reduced through the use of electronic data interchange (EDI)

  48. Chapter 4: The Value of Information (Simchi-Levi) • Methods for coping with the Bullwhip Effect • Strategic partnership • Change the way information is shared and inventory is managed within a SC • Possibly eliminating the impact of the Bullwhip Effect • For example, vendor managed inventory (VMI) • The manufacturer manages the inventory of its product at the retailer outlet • With VMI the manufacturer doesn’t rely on retailer orders • This avoids the Bullwhip Effect entirely

  49. Chapter 4: The Value of Information (Simchi-Levi) • Effective forecasts • Information leads to more effective forecasts • The more factors that predictions of future demand can take into account, the more accurate the predictions • Typically, retailers look at past sales data to forecast future demand • However, future demand could be influenced by pricing, promotions, and new product availability • If this info were available to the forecaster the resulting forecast would be more accurate

  50. Chapter 4: The Value of Information (Simchi-Levi) • Effective forecasts • Many SCs are moving toward cooperative forecasting systems • Sophisticated information systems • Iterative forecasting process • Participants in the SC collaborate to arrive at an agreed-upon forecast • This implies that all components of the SC share and use the same forecasting tool, leading to a decrease in the Bullwhip Effect

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