Chapter 12

1. Chapter 12 Supply Chain Management and Multiechelon Inventories

2. Supply Chain Management SCM is the management of materials and information accross the entire supply chain, from suppliers to component producers to final assemblers to distribution (warehouses and retailers) and ultimately to the consumer. Also includes after sale service and returns and recycling.

3. Supply Chain Management Outside suppliers Component producers Recycle Final assembly Warehouse Warehouse Retailers Customers Customers

4. Why Much Interest in SCM? People realized that actions taken by one member of the chain can influence the profitability of all others in the chain. Competition now: as part of a supply chain against other supply chains rather than as a single firm against other individual firms. Firms having streamlined their operations now improve through better coordination with their suppliers and customers.

5. Bullwhip Effect Variability of orders increases in moving up the supply chain from consumer to grocery store to distribution center to central warehouse to factory  bullwhip effect. The cost of this variability is high: • Inefficient use of resources • High transportation costs • High inventory costs

6. Example of the Bullwhip Effect in Supply Chains

7. Bullwhip Effect The factors that help to create bullwhip effect: • Demand signal processing: ordering more when demand increases. • Rationing game: order more than actual forecast when there is shortage. • Order batching: fixed costs  batching of orders. • Manufacturer price variations: encourages bulk orders. Large orders followed by small orders Increased variability at upstream locations

8. Bullwhip Effect To mitigate the bullwhip effect: Increased communication about consumer demand via EDI (electronic data interchange) and EDLP (everyday low pricing-to eliminate forward buying of bulk orders).

9. Research on SCM • New product development • Late customization (even at retailer level) Ex: HP and Benetton • Design for recycling or disassembly • Inventory and production management • Mode of transportation

10. Supply Chain Management The focus of this chapter is from the perspective of inventory management; specifically multi-echelon systems. Dependent demand situation: demand at the central warehouse is dependent on the demand and stocking decisions at the branches. Outside suppliers 3rd echelon Central warehouse 2nd echelon Branch warehouse Branch warehouse 1st echelon Retailers Customers Customers

11. Structural Decisions • Where to locate factories, warehouses and retail sites? • How many of these to have? • Their capacities? • When and how much should the capacities be expanded or contracted? • Which facilities should produce/distribute which products? • Modes of transportation?

12. Coordination Decisions Taken after structural decisions. • Inventory stocking and replenishment decisions centrally or in a decentralized fashion? • Inventory at a central warehouse? • Where should inventory be deployed? • How to allocate an insufficient amount of stock?

13. Deterministic Demand • An idealization • Lead times are known and fixed

14. Deterministic Demand Sequential Stocking Points with Level Demand Central warehouse Retailer warehouse Retailer outlet Raw material Finished product ........ Secondary operation Finishing operation Primary operation

15. Deterministic Demand Focusing on two stages only. Demand occurs at the retailer. Warehouse Retailer

16. Deterministic Demand Notation D: deterministic, constant demand at the retailer AW: fixed cost of replenishment at warehouse AR: fixed cost of replenishment at retailer vW, vR: unit variable cost at warehouse and retailer, respectively (vR>vw since value is added) QW, QR: replenishment quantities at warehouse and retailer, respectively r: carrying charge QW=n.QRn=1, 2, 3, ...

17. Deterministic Demand Retailer inventory level QR Time

18. Deterministic Demand Inventory at the warehouse does not follow the usual sawtooth pattern, since withdrawals are of size QR. The determination of average inventory levels become complicated. We use a different concept  echelon stock. Echelon stock (of echelon j): number of units in the system that are at or have passed through echelon j but not yet been committed to outside customers. When backorders are permitted, echelon stock can be negative.

19. Deterministic Demand Warehouse inventory level QW echelon inventory of the warehouse item actual physical inventory Time

20. Deterministic Demand Echelon stock has a sawtooth pattern. • Easy to compute the average value of an echelon stock. However, multiplying each average echelon stock by vR and summing them up is not correct. The reason is that the same physical units of stock can appear in more than one echelon inventory. • Value any specific echelon inventory at only the value added at that particular echelon.

21. Deterministic Demand i a b c

22. Deterministic Demand

23. Deterministic Demand

24. Deterministic Demand

25. Deterministic Demand Multiechelon Stocking Points with Time-Varying Demand D(j): demand in period j (known and varies over time). Carrying cost is incurred on period ending inventories. 2-stage serial process.

26. Deterministic Demand An approach is to use one of the procedures of Ch. 6 sequentially echelon by echelon. For ex: Silver-Meal heuristic could be used to schedule replenishments for the retailer  a pattern of requirements for the warehouse to be used as input to the Silver-Meal heuristic to plan the replenishments of the warehouse. This approach ignores interdependency of the two echelons; i.e. while determining the replenishment quantities at the retailer level, the cost implications at the warehouse are not taken into account.

27. Deterministic Demand To deal with this deficiency, a procedure is developed that can still be applied sequentially, but that captures the essence of the cost interdependencies.

28. Deterministic Demand

29. Probabilistic Demand Raises several new issues and creates extreme modelling complexities in a multiechelon inventory situation.

30. A multiechelon situation with single-stage information flow Supplier 3 weeks Information (orders) Replenishment Central warehouse 1 week Information (orders) Replenishment Branch warehouse Replenishment 1 week Information (orders) Retailer Demands Sales Customers

31. Probabilistic Demand If we use methods of Ch.5-Ch.7, each echelon would make its replenishment decision on its own cost factors, service considerations, predicted demand (forecasts based on historical demand that is observed from the next stocking point downstream), replenishment lead time from the next stocking point upstream, independently.

32. Probabilistic Demand Flaws of this system: • The lead time may change depending on the inventory level of the next stocking point upstream. • It ignores cost implications at one echelon of using certain ordering logic at another level. • Even if end customer demand is fairly smooth, the orders placed farther up the line become progressively larger and less frequent (bullwhip effect).

33. Probabilistic Demand Under decentralized control, such as an order point system, the central warehouse would have to carry a large safety stock to protect against these infrequent demands, even when end-item usage shows little variability. If a centralized control system is used, prompt and reliable communication of demand and inventory status at every echelon is needed. The number of independent decision variables increase rapidly.

34. Probabilistic Demand Other complicating factors: • How do we define service in a multiechelon situation?Normally, service is measured at the lowest echelon. SS at a particular echelon affects stockouts at other echelons. We have to avoid unnecessary duplication of SS. • If the branch warehouse places an order of size Qb on the central warehouse, what if Qb>IC (on hand)? Is partial shipment made? Or does the system wait until the entire order can be shipped? • What about the possibility of an emergency shipment directly from the central warehouse to the retailer? • In a more complicated multiechelon structure, transshipments between points at the same echelon may be possible. • One central warehouse supplies several different stocking points at the next echelon.

35. Probabilistic Demand Two dimensions are useful: • Local vs. global information • Centralized vs. decentralized control • Local information: Each location sees demand only in the form of orders that arrive from the locations it directly supplies. It has visibility of only its own inventory status, the demand and so on. • Global information: The decision maker has visibility of the demand, costs and inventory status of all locations in the system. • Centralized control: Attempts to jointly optimize the entire system (push systems). • Decentralized control: Decisions are made independently by separate locations (pull systems).

36. Probabilistic Demand The best solutions are obtained by using global information and centralized control. In the case of decentralized control and local information, use the methods of Ch. 5-8.

37. The Serial Situation Global information and centralized control. Two stages: Warehouse and retailer Assumptions: • External demand occurs only at retailer and is stationary. Forecast errors are normally distributed. • Deterministic lead times LW and LR. • (s,Q) system with parameters: sW and sR: reorder points at WH and retailer QW and QR: order quantites at WH and retailer QR and QW=n.QR are predetermined by the procedure in deterministic demand/level demand section.

38. Decision Rule Select sR such that

39. Decision Rule Select sW such that