OPER3208-001 Supply Chain Management

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

Simchi-Levi, Chapters 5

Chapter 5: Supply Chain Integration (Simchi-Levi) • Introduction • The challenge in SC integration is to coordinate activities across the SC so that the enterprise can improve performance • Reduce cost • Increase service level • Reduce the bullwhip effect • Better utilize resources • Effectively respond to changes in the marketplace • These challenges are only met by coordination of • Production • Transportation • Inventory decisions • Integrating the front-end of the SC (i.e., customer demand), and the back-end of the SC (i.e., production and manufacturing)

Chapter 5: Supply Chain Integration (Simchi-Levi) • Push-Based Supply Chain • Production and distribution decisions are based on long-term forecasts • Demand forecast for manufacturer is based on orders received from the retailer’s warehouse • As discussed in Ch 4, the variability of orders received from retailers and warehouses is much larger than the variability of customer demand—Bullwhip Effect • Increases in variability leads to • Excessive inventories (safety stock) • Larger and more variable production batches • Unacceptable service levels • Product obsolescence • It takes longer for a push-based SC to react to changes in the marketplace, which can lead to • The inability to meet changing demand patterns • The obsolescence of SC inventory

Chapter 5: Supply Chain Integration (Simchi-Levi) • Push-Based Supply Chain • Due to the need for emergency production changeovers, we often find increased transportation costs, high inventory levels, and/or high manufacturing costs

Chapter 5: Supply Chain Integration (Simchi-Levi) • Pull-Based Supply Chain • Production and distribution are demand driven so that they are coordinated with true customer demandrather than forecast demand • In a pure pull system, the firm does not hold any inventory and only responds to specific orders • Pull systems are attractive since they lead to • A decrease in lead times through the ability to better anticipate incoming orders from the retailers • A decrease in inventory at the retailers since inventory levels at these facilities increase with lead times • A decrease in variability in the system and variability faced by manufacturers due to lead-time reduction • Decreased inventory at the manufacturer due to the reduction in variability

Chapter 5: Supply Chain Integration (Simchi-Levi) • Pull-Based Supply Chain • These systems typically have • A significant reduction in system inventory level • Enhanced ability to manage resources • A reduction in system costs (when compared to an equivalent push-based system) • Pull systems are difficult to implement when lead times are too long • Unable to react to demand • Pull systems are more difficult to take advantage of economies of scale in manufacturing and transportation since systems are not planned far ahead in time

Chapter 5: Supply Chain Integration (Simchi-Levi) • Push-Pull Supply Chain • A new SC strategy that takes advantage of the best of the push strategy and the pull strategy • Some stages of the SC (usually the initial stages) operate as a push-based system, the remaining stages operate as a pull-based system • The interface (boundary) between the push-based stages and the pull-based stages is called the push-pull boundary

Chapter 5: Supply Chain Integration (Simchi-Levi) • Push-Pull Supply Chain

Chapter 5: Supply Chain Integration (Simchi-Levi) • Push-Pull Supply Chain • Example 1: Dell Computers uses the push-pull strategy • Manufacturer builds to order • Component inventory is managed based on forecast (push) • Demand for component is an aggregation of demand for all finished goods that use that component • Since aggregate forecasts are more accurate, uncertainty in component demand is much smaller than uncertainty in finished goods • This leads to a reduction in safety stock • Final assembly is in response to specific orders (pull) • The push-pull boundary is at the beginning of the assembly process

Chapter 5: Supply Chain Integration (Simchi-Levi) • Push-Pull Supply Chain • Example 2: Postponement, or delayed differentiation • The firm designs the product and the manufacturing process so that decision can be delayed as long as possible • The manufacturing process starts by producing a generic or family product • The portion of the SC prior to product differentiation is usually operated using a push-based strategy • Since demand for the generic product is an aggregation of demand for all its corresponding end-products, forecasts are more accurate and inventory levels are reduced • The portion of the SC starting from the time of differentiation is pull-based

Chapter 5: Supply Chain Integration (Simchi-Levi) • Identifying the Appropriate Supply Chain Strategy • Figure 5.2 provides a framework for matching SC strategies with products and industries

Chapter 5: Supply Chain Integration (Simchi-Levi) • Identifying the Appropriate Supply Chain Strategy • Everything else being equal, higher demand uncertainty leads to a preference for managing the SC based on realized demand: a pull strategy • Smaller demand uncertainty leads to an interest in managing the SC based on a long-term forecast: a push strategy • Everything else being equal, the higher the importance of economies of scale in reducing cost, the greater the value of aggregating demand, and the greater the importance of managing the SC based on long-term forecast, a push-based strategy • If economies of scale are not important aggregation does not reduce cost, so a pull-based strategy makes more sense

Chapter 5: Supply Chain Integration (Simchi-Levi) • Identifying the Appropriate Supply Chain Strategy • Box 1 represents industries (i.e., products) such as computer industry (e.g., Dell uses the pull-based strategy) • Box 3 represents product in the grocery industry such as beer, pasta, and soup (a push-based retail strategy is appropriate) • Demand is stable • Boxes 1 & 3 represent situations in which it is relatively easy to identify an efficient SC strategy

Chapter 5: Supply Chain Integration (Simchi-Levi) • Identifying the Appropriate Supply Chain Strategy • Boxes 2 & 4: There is a mismatch between the strategies suggested by the two attributes • Uncertainty “pulls” the SC towards one strategy, while economies of scale “push” the SC in a different direction • Box 4 represents products such as high-volume/fast-moving books and CDs. • Both traditional push strategies and innovative push-pull strategies may be appropriate • Depends on specific costs and uncertainties • Discussed further in Section 5.4

Chapter 5: Supply Chain Integration (Simchi-Levi) • Identifying the Appropriate Supply Chain Strategy • Boxes 2 & 4: There is a mismatch between the strategies suggested by the two attributes • Box 2 represents products and industries such as the furniture industry • Offers a large number of similar products distinguished by shape, color, fabric, etc • Need to distinguish between the production and the distribution strategies • Production strategy has to follow a pull-based strategy since it is impossible to make production decisions based on long-term forecasts • On the other hand, the distribution strategy needs to take advantage of economies of scale in order to reduce transportation cost • The SC strategy followed by furniture manufacturers is a pull-push strategy

Chapter 5: Supply Chain Integration (Simchi-Levi) • Implementing a Push-Pull Strategy • There are many ways to implement a push-pull strategy, depending on the location of the push-pull boundary • Dell locates the push-pull boundary at the assembly point • Furniture manufacturers locate the boundary at the production point

Chapter 5: Supply Chain Integration (Simchi-Levi) • Implementing a Push-Pull Strategy • Push strategy • Demand uncertainty is relatively small and managing this portion based on long-term forecast is appropriate • Service level is not an issue, so the focus can be on cost minimization • Low demand uncertainty and economies of scale in production and/or transportation • Long lead times and complex SC structures, including product assembly at various levels • Cost minimization is achieved by better utilizing resources such as production and distribution capacity while minimizing inventory, transportation, and production costs • Pull strategy • Uncertainty is high, and it is important to manage this portion based on realized demand • High uncertainty, and a short cycle time • Focus is on service level • High service level is achieved by deploying a flexible and responsive SC • A SC that can adapt quickly to changes in customer demand

Chapter 5: Supply Chain Integration (Simchi-Levi) • Implementing a Push-Pull Strategy • Different processes need to be used in different portions of the SC • The focus in the pull part of the SC is on service level, order fulfillment processes are typically applied • The focus of the push part of the SC is on cost and resource utilization, SC planning processes are used to develop effective strategies for a given planning horizon (e.g., a few weeks, or months)

Chapter 5: Supply Chain Integration (Simchi-Levi) • Implementing a Push-Pull Strategy • Table 5-1 summarizes the characteristics of the push and pull portions of the SC

Chapter 5: Supply Chain Integration (Simchi-Levi) • Implementing a Push-Pull Strategy • Notice that the push portion and the pull portion of the SC interact only at the push-pull boundary • This is the point along the SC time line where there is a need to coordinate the two SC strategies • Typically through buffer inventory • This inventory takes a different role in each portion • In the push portion, buffer inventory at the boundary is part of the output generated by the tactical planning process • In the pull portion, buffer inventory represents the input to the fulfillment process • The interface between the push portion and the pull portion of the SC is forecast demand • Forecast demand is based on historical data obtained from the pull portion • Forecast is used to drive the SC planning process and determines the buffer inventory

Chapter 5: Supply Chain Integration (Simchi-Levi) • Demand-Driven Strategies • Need to integrate demand information into the SC planning process • Information is generated by applying 2 different processes • Demand Forecast: Historical demand data is used to develop long-term estimates of expected demand • Demand Shaping: The firm determines the impact of various marketing plans such as promotion, pricing discounts, rebates, new product introduction, and product withdrawal on demand forecasts

Chapter 5: Supply Chain Integration (Simchi-Levi) • Demand-Driven Strategies • The forecast is not completely accurate • An important output from the demand-forecast and demand-shaping processes is an estimate of the accuracy of the forecast • Forecast error • Measured according to its standard deviation • High demand forecast error has a detrimental impact on SC performance • Resulting in lost sales, obsolete inventory, and inefficient utilization of resources

Chapter 5: Supply Chain Integration (Simchi-Levi) • Demand-Driven Strategies • Can the firm employ SC strategies to increase forecast accuracy and decrease forecast error? • Select the push-pull boundary so that demand is aggregated over one or more of the following dimensions • Demand aggregated across products • Demand aggregated across geography • Demand aggregated across time • Use market analysis and demographic and economic trends to improve forecast accuracy • Determine the optimal assortment of products by store so as to reduce the number of SKUs competing in the same market • Incorporate collaborative planning and forecasting processes with your customers so as to achieve a better understanding of market demand, impact of promotions, pricing events, and advertising

Chapter 5: Supply Chain Integration (Simchi-Levi) • Demand-Driven Strategies • At the end of the demand planning process, the firm has a demand forecast by SKU by location • The next step is to analyze the SC to see if it can support these forecasts • This process is called supply and demand management • It involves matching supply and demand by identifying a strategy that minimizes total production, transportation, and inventory costs, or a strategy that maximizes profits • The firm also needs to determine the best way to handle volatility and risks in the SC

Chapter 5: Supply Chain Integration (Simchi-Levi) • The Impact of the Internet on Supply Chain Strategies • The direct-business model employed by industry giants such as Dell Computers and Amazon.com enables customers to order products over the Internet • Allows companies to sell their products without relying on third-party distributors • Business-to-business e-commerce promises convenience and cost reductions • e-commerce is predicted to skyrocket from $43 billion in 1998 to $1.3 trillion in 2003

Chapter 5: Supply Chain Integration (Simchi-Levi) • The Impact of the Internet on Supply Chain Strategies • The Internet and the emerging e-business models have produced expectations that many SC problems will be resolved merely by using these new technology and business models • e-business strategies were supposed to reduce cost, increase service level, and increase flexibility and profits • In reality, these expectations have frequently gone unmet, as many new e-businesses have not been successful • The downfall of some of the highest-profile Internet businesses has been attributed to their logistics strategies

Chapter 5: Supply Chain Integration (Simchi-Levi) • The Impact of the Internet on Supply Chain Strategies

Chapter 5: Supply Chain Integration (Simchi-Levi) • What is E-Business • E-business • A collection of business models and processes motivated by Internet technology and focusing on improvement of extended enterprise performance • E-commerce • The ability to perform major commerce transactions electronically

Chapter 5: Supply Chain Integration (Simchi-Levi) • What is E-Business • E-commerce is only part of e-business • Internet technology is the force behind the business change • The focus in e-business is on the extended enterprise, intra-organizational, business-to-consumer (B2C), and business-to-business (B2B) transactions • Many companies recognize that the Internet can have a huge impact on SC performance • The Internet can help move away from traditional push strategies • Initially the move was toward a pull strategy, but eventually many companies ended up with a push-pull SC

Chapter 5: Supply Chain Integration (Simchi-Levi) • The Grocery Industry • A typical supermarket employs a push-based strategy where inventory at the warehouses and stores is based on a forecast • Peapod • On-line grocer • Founded 11 years ago • Idea: establish a pure pull strategy with no inventory and no facilities • Customers ordered groceries, Peapod would pick the products at a nearby supermarket • There were significant service problems since stockout rates were very high (about 8 to 10%) • Peapod changed its business model to a push-pull strategy by setting up a number of warehouses; stockout rates are now less than 2% • The push part is the portion of the Peapod SC prior to satisfying customer demand and the pull part starts from a customer order • Since Peapod warehouse covers a large geographical area, clearly larger than the one covered by an individual supermarket, demand is aggregated over may customers and locations, resulting in better forecasts and inventory reduction

Chapter 5: Supply Chain Integration (Simchi-Levi) • The Grocery Industry • Most on-line grocery stores have failed • No current on-line grocers have the density of customers that will allow them to control transportation costs • Response time is very short, typically within 12 hours in a tight delivery window • On-line groceries • Low level of demand uncertainty for many products • High economies of scale in transportation cost • A Push-based strategy is more appropriate

Chapter 5: Supply Chain Integration (Simchi-Levi) • The Book Industry • Barnes and Noble had a typical push supply chain • When Amazon.com was established about 6 years ago • SC was a pure pull system with no warehouses and no stock • Ingram Book Group supplied most of Amazon’s customer demand • Ingram Book can aggregate across many customers and suppliers and take advantage of economies of scale • As volume and demand increased, two issues are clear • Amazon.com’s service level was affected by Ingram Book’s distribution capacity, which was shared by many booksellers • During peak holiday demand, Amazon.lcom could not meet its service level goals • Using Ingram Book allowed Amazon.com to avoid inventory costsbut significantly reduced profit margins • As demand increased, Amazon.com’s ability to aggregate across large geographical areas allowed the company to reduce uncertainties and inventory costs by itself, without using a distributor

Chapter 5: Supply Chain Integration (Simchi-Levi) • The Book Industry • Barnes and Noble had a typical push supply chain • Amazon.com changed its Barnes and Noble’s philosophy • Has several warehouses around the country where most of the titles are stocked • Inventory at the warehouses is managed based on a push strategy • Demand is satisfied based on individual requests, a pull strategy

Chapter 5: Supply Chain Integration (Simchi-Levi) • The Retail Industry • The retail industry was late to respond to competition from virtual stores and to recognize the opportunities provided by the Internet • As many brick-and-mortar companies are adding an Internet shopping component to their offering • Click-and-mortar giants Wal-Mart, Kmart, Target, and Barnes and Noble, etc. • These retailers recognize the advantage they have over pure Internet companies • They already have the distribution and warehousing infrastructure in place • They have established virtual retail stores, serviced by their existing warehousing and distribution structures

Chapter 5: Supply Chain Integration (Simchi-Levi) • The Retail Industry • Click-and-mortar firms have changed their approach to stocking inventory • High-volume, fast-moving products, whose demand can be accurately matched with supply based on long-term forecasts, are stocked in stores • Low-volume, slow-moving products are stocked centrally for on-line purchasing • The low-volume products have highly uncertain demand levels, and therefore require high levels of safety stock • Centralized stocking reduces uncertainties by aggregating demand across geographical locations, and therefore reduce inventory levels • **These retailers use a push strategy for high volume, fast-moving products and a push-pull strategy for low volume, slow-moving products

Chapter 5: Supply Chain Integration (Simchi-Levi) • The Retail Industry • The move from brick-and-mortar to click-and-mortar is not an easy one, and may require skills that the brick-and-mortar companies don’t have

Chapter 5: Supply Chain Integration (Simchi-Levi) • Impact on Transportation and Fulfillment • The Internet and the associated new SC paradigms introduce a shift in fulfillment strategies: from cases and bulk shipments to single items and smaller-size shipments, and from shipping to a small number of stores to serving highly geographically dispersed customers • This shift has also increased the importance and the complexity of reverse logistics

Chapter 5: Supply Chain Integration (Simchi-Levi) • Impact on Transportation and Fulfillment • Table 5-2 summarizes the impact of the Internet on fulfillment strategies

Chapter 5: Supply Chain Integration (Simchi-Levi) • Impact on Transportation and Fulfillment • New developments in SC strategies are good news for the parcel and LTL industries • Both push-pull systems rely on individual (e.g., parcel) shipments rather than bulk shipments • Especially true in the business-to-customer area (a.k.a. B2C e-fulfillment) • Another impact of e-fulfillment on the transportation industry is the significant increase inreverse logistics • In the B2C arena, e-fulfillment means that the supplier needs to handle many returns, each of which consists of a small shipment • On-line retailers need to build customer trust through generous return terms

Chapter 5: Supply Chain Integration (Simchi-Levi) • Impact on Transportation and Fulfillment • E-fulfillment logistics requires short lead time, the ability to serve globally dispersed customers, and the ability to reverse the flow easily from B2C and C2B • Only parcel shipping can do all that • One important advantage of the parcel industry is the existence of an excellent information infrastructure that enables real-time tracking • The future looks promising for the parcel shipping industry and for those carriers and consolidators who work to modify their own systems in order to integrate it with their customers’ SC

Chapter 5: Supply Chain Integration (Simchi-Levi) • Distribution Strategies • Typically, three distinct outbound distribution strategies are utilized: • Direct shipment • Items are shipped directly from the supplier to the retail stores without going through distribution centers • Warehousing • Classic strategy in which warehouses keep stock and provide customers with items as required • Cross-docking • Items are distributed continuously from suppliers through warehouses to customers • Warehouses rarely keep the items more than 10 to 15 hours

Chapter 5: Supply Chain Integration (Simchi-Levi) • Direct shipment • Bypass warehouses and distribution centers • Employing direct shipment, the manufacturer or supplier delivers goods directly to retail stores • The advantages • The retailer avoids the expenses of operating a distribution center • Lead times are reduced

Chapter 5: Supply Chain Integration (Simchi-Levi) • Direct shipment • Disadvantages: • Risk-pooling effects are negated because there is no central warehouse • The manufacturer and distributor transportation costs increase because it must send smaller trucks to more locations • Direct shipment is common when the retail store requires fully loaded trucks, which implies that the warehouse does not help in reducing transportation cost • Sometimes, the manufacturer is reluctant to be involved with direct shipping but may have no choice in order to keep the business • Also prevalent in the grocery industry, where lead times are critical because of perishable goods

Chapter 5: Supply Chain Integration (Simchi-Levi) • Cross-Docking • A strategy that Wal-Mart made famous • Warehouses function as inventory coordination points rather than as inventory storage points • Goods arrive at warehouses from the manufacturer, are transferred to vehicles serving the retailers, and are delivered to the retailers as rapidly as possible • This system limits inventory cost and decreases lead time by decreasing storage time

Chapter 5: Supply Chain Integration (Simchi-Levi) • Distribution Strategies • Few major retailers utilize one of these strategies exclusively • Different approaches are used for different products, making it necessary to analyze the SC and determine the appropriate approach to use for a particular product or product family

Chapter 5: Supply Chain Integration (Simchi-Levi) • Distribution Strategies • What are the factors that influence distribution strategies? • Customer demand and location • Service level • Transportation costs • inventory costs • Both transportation and inventory costs depend on shipment size, but in opposite ways • Increasing lot sizes reduces delivery frequency and enables the shipper to take advantage of price breaks in shipping volume, which reduces transportation costs • Large lost sizes increase inventory cost per item because items remain in inventory for a longer period of time

OPER3208-001 Supply Chain Management