Fundamentals of Supply Chain Management: A Practitioner's Perspective - Rutgers Version [2 ed.] 9781524995737

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Copyright © 2017, 2018 by William McLaury and Eugene Spiegle

ISBN: 978- 1-5249-9573-7 Kendall 1-Iunt Publishing Co111pany has the exclusive rights to reproduce this ,,,ork, to prepare derivative works fron1 this \VOrk, to publicly distribute this ,vork, to publicly perfonn this ,vork and to publicly display this ,vork. All rights reserved. No part of this publication 111ay be reproduced, stored in a retrieval systen1, or trans111itted, in any fonn or by any means, electronic, mechanical, photocopymg, recordmg, or otherwise, \Vithout the prior ,vritten pennission of the copyright O\vner. Published in the United States of An1erica

PLAN CHAPTER 1 - Introduction to Supply Chain Management 3 CHAPTER 2 - Forecasting and Demand Planning 35 CHAPTER 3 - Supply ChainPlanning 63 CHAPTER 4 - Inventory Management 95

SOURCE CHAPTERS - Purchasing Management 139 CHAPTER 6- Strategic Sourcing 165 CHAPTER 7 - Supplier Relationship Management 187

MAKE CHAPTER 8 - Operations Management with LEAN and Six Sigma 213

DELIVER AND RETURN CHAPTER 9 - Logistics: Warehousing, Transportation,and Reverse Logistics 251 CHAPTER 1O- Global Logistics and International Trade 305 CHAPTER 11 - Customer Relationship Management 331 CHAPTER 12 - Supply Chain Management in the Service Industry 355

ENABLE CHAPTER 13 - Project Management 381

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The authors would like to recognize Haiyan Liu and Zachary Ritfell for their contributions to the con1pletion of this 1nanuscript.

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LO

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Associate Professor, Department of Supply Chain l\1anagernent Director, Supply Chain Managernent Undergraduate Prograrn Rutgers Business School Rutgers, the State University of New Jersey

,-villiam McLaury

Bill ,vas the Executive Director, Phanna Supply Chain ,vith Novartis Phannaceuticals for over thirty years before retiring in July 2014 and joining the Rutgers Business School faculty full tune. While with Novartis, Bill held a number of supply chain managen1ent leadership positions ,vith operational responsibility, both locally and globally, including ten years as Regional Head for North A1nerica, and n,•o years as Global Head of Phanna Supply Chain Strategy. He also served as the Novartis representative on the Industry Advisory Board for the Center for Supply Chain Management at the Rutgers Business School for fourteen years, and as the Chairman of that Advisory Board for the last five. He is a rnernber of the American Production and Jnventory Control Society (APICS), the Institute for Supply Managernent (ISM), and the Council of Supply Chain Managen1ent Professionals (CSCMP) " 'here he serves as the Education Chair for the NJ Roundtable. He continues to be a frequent guest speaker at nun1erous industry and academic events. Bill has a Bacl1elor of Science degree iJ1 Supply Chain Managen1ent from BowliJ1g Green State University, a Masters Certificate in Project Management fron1 George Washington University, and a Master of Adrninistrative Sciences degree from Fairleigh Dickinson University. V

Associate Professor, Department of Supply Chain Managen1ent Di rector, Pathways to Partnership Program Rutgers Business School Rutgers, the State University of Ne"' Jersey

Eugene Spiegle Gene was founder and President of the Can1bridge Group, Project 1'>1anagement consulting and organizational develop1nent finn located in Bedininster, Ne\v Jersey. He has an international reputation in project n1anage1uent, conununications; and operations n1anage1nent. He has over forty five years' experience in management, project n1anagement, both line and staff positions, which enables hi1n to deliver practical, co1nn1on sense as ,,,ell as theory-based perspectives. Mr. Spiegle has perforn1ed consulting, conducted training and delivered " 'orkshops for organizations like AT&T, Bechtel, Black & Veatch, Boeing, Chrysler Corporation, City of Los Angeles DP\>V, and U. S. Corp. of Engineers, Datek Online Inc., General Motors, He,vlett Packard, MIT National Labs, Xerox Corporation and the United Nations. Active in 1nany organizations relative to the areas of his expertise, Gene has been a 111e1nber of the Project Management Institute, Society of Manufacturing Engineers, The National Society of Professional Engineers, American Military Engineers, and Association for Quality Perforn1ance. After reliren1ent from the United Nations where he was Director of Projects, Mr. Spiegle served in various positions fro1n President of a finn pioneering and specializing in automated syste1ns to Vice-President of engineering of a Fortune 500 con1pany. Gene holds degrees in psychology and engineering v>'ith an advanced degree in psychology. Mr. Spiegle has been an adjunct faculty in project n1anagement, engineering management, and con11llunications at University of Pittsburgh and University of A.laban1a, The Conference Board of Ne"' York and Battelle Me1norial Institute. He is also the author and designer of Project Manage,nent Guidelines, a process currently utilized by 1nany organizations to manage their projects. Gene's book Ta,ning a Silent Killer- Your Stress \,,as released in May of 2002 follo,ved by Project Managernent - T11e Basics for Success.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Introduction to Supply Chain Management CHAPTER OUTLINE Introduction What IsSupply Chain Management? Supply Chain Management versus Logistics Your Role ina SupplyChain Supply Chain Flow Supply Chain Management in the Service Industry Origins and Evolution of Supply Chain Management The Future of SupplyChain Management Foundation of SupplyChain Management Supply Chain Capabilities Models Managing the Supply Chain through Defined Tasks The Challenge of Supply Chain Management Supply Chain Planning and Execution Benefits of Supply Chain Management Current Trends in Supply Chain Management Summary 3

INTRODUCTION

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The discipline of supply chain 1nanagen1ent is dyna1nic and evolving. Innovation, technology, the internet, and the escalation of globalization, a1nong other things, have contributed to the ongoing and rapid evolution of the field. In addition, pressure is being applied to supply chains by fluctu ating de1nand, changing custon1er expectations, reduced product lifecycles, speed to n1arket, and increased complexity. All of these factors intensify the need to understand and examine ho,v we 1nanage our supply chains. This text ,viii explore supply chains and the funda1nentals of ho"' supply chains are managed in an effort to in1prove our understanding. The An1erican Production and lnventory Control Society (APlCS), the premier professional association for supply chain and operations 1nanagen1ent, defines a supply chain as "the global nehvork used to deliver products and services fron1 ra,\• materials to customers through an engineered flo,v of infonnation, physical distribution, and cash."' In sin1pler tenns, a supply chain is everything that happens to a product on the journey fro1n "concept to consumer:• There are different ways to set up and operate a supply chain depending on the type of product or service a co1npany provides. A co1npany 1nay even operate multiple supply chain setups sitnultaneously if the con1pany's product port folio is broad or co1nplex. Regardless of the specific set up, supply cl1ains are generally described as spannit1g fron1 end to end (i.e., fron1 your supplier's suppliers, to your suppliers on one end, through your organization's operations, and out to your customers, and to your custo1ner's custo111ers, on the opposite end). Most supply cl1ait1s follo,v the basic Supply Chain Operations Research (SCOR) 1nodel sho,vn in figure I.I. SCOR Model, Council of Supply Chain Management Professionals (CSCMP) Plan ➔ Source ➔ Make ➔ Deliver ➔ [ f-

4

Return), and Enable

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

The n1odel depicts the relationships and linkages bet ween the trading partners that form a supply chain. Companies iili\!l ,vhat they n1ake. source the 1naterials, n1ake the products, and deliver them to the marketplace. Companies rnay also have to handle return of products back through the supply chain. \"'11ether you are a supplier, a n1anufacturer, or a custon1er, you're likely doing each of these activities. If you are a n1anufacturer, as sho,vn in the rniddle of figure I. I, you have suppliers on one side that n1ust n1ake the products or n1aterials that you need, and they likely have sources of ra"' n1aterials to support their production. Si1nilarly, you as the rnanufacturer are a supplier to yow· custo1ners. You n1ake the products that your custo1ners ,vant. If yow· custon1ers are not the end conswners of the product, they are also suppliers to their custo1ners who ,viii ultiinately consun1e the product. Suppliers and custon1ers can be internal (i.e., part of your organization) or external to your organization, and many companies have both internal and external suppliers and customers. In addition to the functions of plan, source, make, deliver, and (potentially) return, ,vhich each of the trading partners n1ust execute, supply chains are also typically enabled through various types of processes and technologies (e.g., systen1s soft,vare and hard\\•are). This text "'ill use the SCOR n1odel as an outline to describe all of the functions, processes, and activities involved in managing a supply chain. To better understand this model, follo,ving is a description and quick overview of each 1najor function. The first phase of the rnodel is "Plan." Planning establishes the pararneters ,vithin '"hich the supply chain ,vill operate. Co1npanies need a strategy for 1nanaging all of the resow·ces necessary to addTess how a product or service v,ill be created and delivered to n1eet the needs of their custon1ers. Planning includes the deternunation of n1arketing and distribution channels, pron1otions, quantities, tuning, inventory and replenishment policies, and production policies. Part of supply chain planniI1g is developing 1netrics to n1onitor the supply chain so that it is efficient and cost effective and also delivers lugh quality and value to the custon1ers it serves. PLAN:

The next phase of the n1odel is "Source:• SouTcing is the process of identifyi11g the suppliers that provide the products/n1aterials and services needed for the supply chain to deliver the finished product(s) desired by the custon1er(s). This phase involves not only identifying reliable suppliers but also building a strong relationship ,vith those suppliers. Supply chain n1anagers must also develop pricing, shipping, delivery, and payment processes "'ilh suppliers and create metrics for monitoring and improving the performance of the buying process over tin1e and potentially supplier perforn1ance as ,veil. SOURCE:

MAKE: The third phase of the 1nodel is "Make:• Make or n1a11ufacturing is the series of operations performed to convert n1aterials into a finished product. This is the step where the finished product is 1nanufactured, tested, packaged, and scheduled for delivery. Quality management is an important aspect of the manufacturillg process. Aspects such as LEAN Manufacturing and Six Sigma are introduced in the "Make" process. This is the most metric-intensive portion of the supply chain, ,vhere con1panies are able to rneasure quality levels, production output, and "'orker productivity. el~\J>kt 1: Introduction to Supply Chain Management

s

D ELIVER: The fourth phase of the model is "Deliver:' Also known as the logistics phase, this is the

part of supply chain managen,ent that oversees the planning and execution of both the forward and reverse flo,v of goods and related information betv.•een various points in the supply chain to rneet custon1er require1nents. During the deliver phase, corupanies coordinate the receipt of orders fron1 custon1ers, develop a netv.•ork of warehouses, pick carriers to transport products to custon1ers, and set up an invoicing system to receive payments, among other aspects. RETURN: The fifth phase of the model is "Return:' Also kno,vn as reverse logistics, this is the part

of supply chain 1nanagen1ent that deals v.•ith planning and controlling the process of 1noving goods specifically frorn the point of conswnption back to the point of origin for repair, redan1ation, remanufacture, recycling, or disposal. As this process quite literally goes against the nonnal outbound fiov, of products to the market, this can be a problematic part of the supply chain for many con1panies. Supply chain rnanagers have to create a responsive and flexible nenvork for receiving defective and excess products back frorn their custorners and supporting custon1ers ,vho have questions and problems with delivered products. It is often an unwanted part of the supply chain and is frequently outsourced to a tl,ird party to handle for the con1pany. ENABLE: An additional aspect of the n1odel is "Enable:' Enabling processes facilitate a compa-

ny's ability to manage tl1e supply chain. Enabling processes include elen,ents such as supply chain systerns and nenvork operations, systerns configuration control, interfaces, gate,vays, database administration, electronic data interchange (EDI), teleconununications services, perforn1ance measurement, contract n1anagement, business rules, standards, and training and education, to name just a fe,v. ll1e processes associated ,vith this cornponent of tl1e SCOR model are spread throughout every stage. In other ,vords, ,ve ,vant to enable our capabilities as v.•e plan, source, n1ake, and deliver (and return). This is not a stage that occurs sequentially after all of t!,e others.

WHAT IS SUPPLY CHAIN MANAGEMENT? .................................. . In order to define ,vhat supply chain 1nanage1nent is, ,ve should start by dispelling so1ne conunon misconceptions. Supply chain n1anage1nent is NOT just a chain of businesses, it is NOT just a new name for purchasing or operations managen,ent, and it is NOT just a synonym for logistics. People rnay think of supply chain 1nanage1nent as sirnply controlling the sequence of steps involved in tl1e production of a product, that you obtain son1e rnaterials and manufacture or assen1ble them step by step into a product tl,at you then sell to a customer, but supply chain management is really the coordination of a network of independent organizat ions (i.e., trading partners) involved in creating a desired product or service, ·where the partners function together as one seamless organization. APICS defines supply chain manageruent as "the design, planning, execution, control, and monitoring of supply chain activities, with the objective of creating net value, building a competitive 6

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

infrastructure, leveraging ,vorldwide logistics, synchronizing supply with den1and, and measuring perforrnance globally."' Supply chain n1anage1nent is not just the production of products; it's about ho,v people, process, ted1nology, equiprnent, infrastructure, n1oney, and inforn1ation all integrate efficiently and effectively to facilitate the flo,v of products and services from the ra,v n1aterial stage to finished product manufacturing, out into ,vholesale and distribution channels, and ultimately to retailers and consun1ers, to the benefit of everyone in the supply chain. The principle mission of supply chain management is to ensure t hat demand is met. Supply chain 1nanage1nent delivers value by rnanaging the processes of all of those othenvise independent trading partners so that they collaborate ,,,ith one another in an efficient, effective, and costconscious way. The goals are to inlprove custon1er service ,vhile simultaneously reducing both inventory investment and operating expenses. By reaching these goals, cornpanies ,viii rnake significant progress to,vard achieving ,vorld-dass supply chain n1anage1uent. In line ,vith these goals, the l\vo n1ain reasons that firn1s i1uplen1ent supply chain n1anage111ent are to achieve cost savings and to better coordinate their resources. Because these individual goals can be diametrically opposed to one another, they can be very hard to ad1ieve. Corupanies that ,,,ant to in1prove their custorner service have a tendency to do it by increasing their inventory in an effort to always have enough product available to supply any potential deruand and to offset any deficiencies in their ability to 1naintain a continuity of supply. This rnay be the easiest and fastest way to in1prove customer service in tern1s of availability; ho,vever, increasing inventory in tun1 increases operating expenses and ties up capital that could other,,•ise be used for activities such as research and development, n1arketing and sales, ne,v product launches, salary increases, shareholder dividends, and n1ore. We ,viii detail rnore on the trade-offs ben,,een custorner service, inventory investn1ent, and operating ex'])enses throughout this text.

SUPPLY CHAIN MANAGEMENT VERSUS LOGISTICS ..................... . There are those \\•ho confuse supply chain n1311age1nent ,vith logistics. The concept of logistics refers to "the 31·t and science of obtaining, producing, and distributing ruaterial and product in the proper place and in proper quantities'.'' On the surface this sounds very sinillar to supply chain management. vVhereas supply chain rnanagement refers to a net\\•ork of independent cornpanies that ,vork together 311d coordinate their actions to deliver a product(s) or service(s) to 1narket for the benefit of all con1panies in the supply chain, logistics is more in"•ardly focused on your o,vn organii,ation's operations, encompassing activities specific to inventory n1anage1nent, \\•arehousing (i.e., material handling and storage), distribution (i.e., order fulfilhnent, pick, pack aI1d ship), and transportation (i.e., the 1noven1ent of inventories into and out of an organization). These internal processes are often aligned functionally but operated independently, creating inefficiencies due to a lack of coor-

el~\J>kt 1: Introduction to Supply Chain Management

7

dinalion. This lack of cohesion is ,vhere supply chain management goes beyond logistics by recognizing the need for integration of these functions and by promoting collaboration between internal and external me1ubers of a supply chain. Supply chain 1nanage1nent extends beyond the four walls of your organization and incorporates your supply chain partners on both the supplier side and the customer side, bringing them into a collaborative process ,vith you to the benefit of all participants in the supply chain. Supply chain 1nanage1nent incorporates all of those traditional logistics activities as ,veil as aspects of activities such as forecasting and de1uand n1anagen1ent, procure1nent, supplier relationship management, planning and scheduling, new product development, finance, and customer relationship management-all of " 'hich ,viii be covered in this text

YOUR ROLE IN ASUPPLY CHAIN

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Any organization that offers a product or a service has a supply chain. Supply chains can be very simple or very complex. At first glance, the supply chain for bottled water looks very simple, but it is 1nore con1plex than you n1ay think. l11ere are suppliers of the bottles, caps, labels, corrugated boxes, dear shrink ,vrapping, energy/utilities, n1aintenance supplies, office supplies, ,varehousing, distribution, transportation services, insurance, etc., and of course, a source of supply for the ,vater itself. Ho,vever, this supply chain is certainly not as complex as the supply chains for producing automobiles or airplanes " 'hich n1ay involve hundreds if not tl1ousands of suppliers and trading partners.

Both large and sn1all organizations have supply chains, fro1n rnajor corporations that can have 1nultiple supply chains for their products located all over the ,vorld, do,vn to even tlie sn1all n1om and-pop operation on tlie local corner, ,vhich also has a supply chain for ,vhatever products or services that they are providing. Public or private organizations whether they are for-profit or nonprofit all have supply chains. Organizations such as Johnson & Johnson, Walmart, and General Motors are publicly traded 1najor for-profit corporations ,vitl1 ex-tensive and co1nplex supply chain operations. Nonprofit organizations such as American Red Cross, Doctors ,vithout Borders, and Habitat for Hun,anity also have supply chains for the products and services that each provides. You don't need to be a large co1npany or have significant revenue to realize the need to 111anage your supply chain. All businesses need resources, n1aterials, and services, ,vhether they are large or small, public or private, for-profit or nonprofit. They all have a supply chain. You are part of n1ultiple supply chains vt'hether you are a,vare of it or not. You are on tlie supply side if you work for a con1pany that provides a product or a service. You are most certainly on the demand side of many supply chains as a consumer of products and services. Vve all consume food, use fuel and utilities, and take advantage of nurnerous services such as banking, instuance, hotels, dry cleaning, and car repair. On the de1nand side, companies n1ake and ship products to customers, either directly or through intermediaries, based on custon1er demand. Custon1er den1and may be in 8

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

the form of actual orders, or part of a forecast model based on kno\vledge of ,vhat consun1ers ,vant. Companies use forecast infonnation to develop plans to produce the products and services they detennine their custon1ers ,,,ai1t, so alinost everyone is part of ,nultiple supply chains.

SUPPLY CHAIN FLOW ••••••••••••••••••••••••••••••••••••••••••••••••••••••••••• To fully understand your supply chain, you need to understand the flo,v. It n1ay help to see ,vhat your supply chain looks like, which ,neans that you may need to actually dra"' it, at least at a macroscopic level. To facilitate this task, it ,nay help to ask a11d ans,ver the follo,ving questions: \,Vho are my suppliers? Where do they get their materials? 'v\/ho is n1anufacturing the product or service that J'1n selling? Ho"' is it being distributed? \,Vho are 1ny custo,ners and \\•here are they? Do I sell direct to consu1ners or to \\•holesalers or distributors? Ho"' are the products actually transported: by truck, by ocean, by rail, etc.? Figure 1.2 is a generic supply chain sho\\•ing the linear flo,v of supply from left to right as indicated by the Product & Ser vice Flo,v arrow.

Cooo«t«I by Tronspo,totk>tt ond StoroOf' ActMdt-s

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el~\J>kt 1: Introduction to Supply Chain Management

9

For illustrative purposes, let's assume we are the manufacturer in the middle of the diagram producing a finished product. Beginning on the left side, " 'e see links or nodes (the circles) for our suppliers and intermediate suppliers, who are providers of n1aterials and services that ,ve as the n1anufacturer ,vill need in order to produce the product(s) that our custo1ners ,vant. S01ne suppliers provide products or services to us indirectly through intennediate suppliers while other suppliers provide products or services to us directly. Referring to figure 1.3, any con1pany that delivers to us directly is a Tier I supplier. A supplier that supplies products we need to our Tier 1 supplier is our Tier 2 supplier. The tiers continue to gro,v as " 'e 1nove through 1nore and n1ore entities (Tier 3, Tier 4, etc.). In otl1er \\•ords, Tier 1 is our direct supplier, and Tier 2, Tier 3, and so forth, are our indirect suppliers. It is also possible for a supplier to occupy 1nultiple tiers. v\7e n1ight buy a co1nponent fro1n one supplier directly but another product fron1 that same supplier through an intennediate supplier. In this case, this supplier is a Tier I supplier for the first con1ponent and Tier 2 supplier for the second co1nponent. Just as our suppliers occupy different tiers, our custon1ers occupy different tiers as \\•ell. To the right of the manufacturer are the custo1ners, including " 'holesalers and distributors, retailers, and consu1ners. Wholesalers, distributors, and retailers are generally intermediaries in the supply chain ,vho facilitate the transfer of products from n1anufacturers to the consumer (i.e., the entity who is actually going to use the finished product). Anyone ,ve ship directly to is our Tier 1 custon1er. As 111anufucturers " 'e nught provide our products to ,vholesalers and/or distributors, retailers, or consun1ers. Our Tier 2 customers are any customers ,vho receive oUI· product(s) or service(s) through a Tier l custo1ner. Custon1ers can occupy multiple tiers simultaneously just as suppliers can.

Customers

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The arro,vs connecting each of the links or nodes in the supply chain indicate transportation activities, both inbound to the n1ai1ufacturer ai1d outbound fro1n the n1ai1ufacturer. Transportation n1odes can vary \\•idely and include rail, " 'ater, truck, air, and pipeline. Using n1ore than one n1ode of transportation to make a single shipment is referred to as intermodal. Transportation ,viii be explored in more detail in Chapter 9. To facilitate the physical flo,v of products and materials along the supply chain, information such as forecasts, orders, confinnations, and invoices n1ust flo\\• in botl1 directions as sho,vn by the dou 10

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

ble-sided Information Flow arro,v al the top of figure 1.2. lnforn1alion is vital for planning all of the activities in the supply chain, and for allocating and managing all of the resources necessary to execute the plan once developed. The Payment Flo,v arro,v indicates the flo,v of funds or money paid to 1nen1bers in the supply chain for product and services rendered. While products generally flo\\' fron1 left to right, there n1ay be the need for so111e reverse logistics (i.e., right to left flow) to accon11nodate returns, recycling, rejected products, and so forth, as depicted by the Returns Flow arro,v. Co1npanies need to invest in n1anaging both their outbound flo,v of products to the n1arketplace and their reverse flo,v, handling custon1er issues and problems that n1ight occur in the field ,,,ith the products that have already been sold and distributed. The follo,ving are exa1nples of supply chains fro1n various industries.

Example #1: Fresh Produce The exan,ple depicted in figure 1.4 is for fresh produce such as stra,vberries or peaches, ,vhich may con1e fron1 South Atnerica to the United States. Fro111 the orchards in South Atnerica, the produce

EXAMPLE: Fresh Produce Supply Chain

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21

Push Model versus Pull Model lne vast n1ajority of businesses today follo\v the push business model (figure 1.7).

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In this n1odel, manufacturers create a sales forecast, create a supply plan based on that forecast, buy the materials necessary to satisfy the supply plan, n1anufacture the product(s) accordingly, and then store the product(s) in a \\•arehouse until they receive a custon1er order for the product(s). This production strategy is la.10\vn as plan-to-stock or 1nake-to-stock, ,vhere products are finished before receipt of a custon1er order, and then these orders are typically filled from the existing stock. Ne"' production orders are used to replenish the depleted ,varehouse stocks. ·n,e product is pushed through the supply chain to\\•ard the custo1ner based on anticipated need. •

The n1ajor advanta~ of this 1nodel are that if the manufacturer creates a good forecast and supply plan, the product is in11nediately available to ship to the custo1ner on de1nand fro1n the existing finished product inventory in the warehouse. Manufacturers also have the opportunity to plan resources belier or with n1ore flexibility, and can maximize the utilization of resources at the lo,vest cost.

•

The major disadvanta~ are high inventories (and capital tied up in inventory), long lead tin1es, dependency on forecasting, and forecasting errors that create nonvalue by adding ti1ne, inefficiencies, obsolescence, shortages, and additional cost.

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22

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Only a sn1all percentage of businesses today follo\v the pull business model (figure 1.8). In this model, 1nanufacturers sell the product(s) first, then they create the supply plan, buy the materials, n1anufacture the product(s), and deliver the finished product. This production strategy is kno\vn as 1nake-to-order, where the 1nanufacturer is actually " 'ailing for the custo1ner to pull production of the product through operations, triggered by the custon1er order. •

The tnajor advanta~ are high levels of custon1er service through responsiveness and flexibility to n1eet uncertain custon1er de1nand. Pull n1odels have short lead ti1ues, reduce dependency on forecasting, use short and flexible production runs, store very lo"' inventories, reduce " 'aste, provide opportunities for customization, and in1prove cash flo\v.

•

The major disadvantages are that every order is a rush order, and any problems ,vill lead to custo1ner dissatisfaction. Pull models are highly dependent on customer relationships. This rnodel inherently has a reduced ability to take advantage of econoruies of scale. Fast, responsive, flexible, robust, and integrated systems and processes are a n1ust for this n1odel to ,vork. Resource issues will have a significant and in1111ediate iJnpact on throughput and custon1er satisfaction.

MANAGING THE SUPPLY CHAIN THROUGH DEFINED TASKS ......... In order to 1nanage all these activities efficiently and effectively, you ,vill need to have a forn1al, stepwise, and robust process in place so that you are able to consistently deliver your products when and ,vhere your custo1ners \Vant then1. Figure 1.9 shows the 1najor processes that companies n1ust plan and execute on a regular schedule/ cycle to 1nanage tl1eir supply chain. We " 'ill introduce each of tl1ese processes in 1nore detail later iJ1 the text: ho,vever, it is iJnportant to note that to be efficient and effective, all of these activities should be fully integrated and as seamless as possible, not only in your internal operation, but also ,vith your suppliers and your custon1ers. In order to be successful, companies must bring key suppliers and key custon1ers into their processes and ,vork witl1 then1 to identify ,vhat prirnary processes tl1ey have and ,vho their suppliers and custo1ners are. Co1upanies n1ust detenuine ho\,, they can work with their suppliers and custon1ers to 1nake the collective operations more efficient. Co1npanies must establish a collaborative relationship with their key supply chain partners and share critical supply planning inforrnation sud1 as forecasts, production plans, and inventory levels ,vith then1. If they can look beyond the four \valls of their con1pany and include trading partners on either end of the supply chain iJ1 plannmg activities, these con1panies " 'ill be collectively much n1ore efficient as a supply chain.

el~\J>kt 1: Introduction to Supply Chain Management

23

-

,'Strategic Plans

,...-Financial Plans

Business Planning

Sales & Oper--atlons Planning (S&OP> Demand Management Resource Requirements Planning (RRP)

• . Supply Management

Rough.Cut Capacity Planning (RCCP)

•

Capacity Requirements • • Planning (CRP)

Master Production Scheduling (MPS)

Material Requirements Planning (MRP)

Suppliers

.,..11anufacturtng r-orEJkt 1: Introduction to Supply Chain Management

27

the custon1er? The company can 1neasure each major process, identify variances, determine the root cause of the variance, and develop and i1nple1nent an irnprovernent plan. If a con1pany can do this as part of the regular planning cycle, it can identify whether its perfon11ance is getting better, \,rorse, or staying the san1e. It can identify focus areas and continuously improve its supply chain perforn1ance.

Flow ofInformation, Orders, Products, and Funds along the Supply Chain Figure 1.12 depicts the flo,v of all the various types of infonnation and 1naterials along the supply chain in both directions. Inforn1ation n1oves benveen trading partners in both directions-fron1 custon1ers to 1nanufactures to suppliers and from suppliers to manufacturers to customers. This infonnation includes forecast requirements, supply plans, order confirn1ation, shipping notifications, and invoices. Purchase orders flo,,, fr-0111 the custorners to the n1anufacturers and fro111 the 1nru1ufacturers to the suppliers. The physical 1naterial flo,vs in the opposite direction of the purchase order flo,v, going from the suppliers to the manufacturers who convert it into finished products and then deliver the products to the custorner. Last there is a funds flo,v. Based on the invoices, the custorners pay the mrun1facturers for the products, ru1d 1nanufacturers pay the suppliers for the 1uaterials.

Fo,ecas;ts I Reqw-ements

Forecasts I Requirements

PurchueClkt i:

Forecasting and Demand Planning

37

•

MEDIUM-TERM forecasts cover a period fro111 six 111onths to l\,ro years and are generally re-

vie,ved on a monthly basis

•

LONG-TERM forecasts cover a period of two years or n1ore and are generally revie"red on an annual or quarterly basis.

Forecasting is necessary, because it takes time to convert ra"' n1aterials to a finished product delivered to the custo1ner. Most custo1ners do not ,vant to ,vait for the ti111e necessary to produce a product fron1 start to finish. Most con1panies, therefore, cannot ,vait for de1nand to develop and then react to it. Co111panies 1nust anticipate and plan for future den1and so that they can react inunediately to customer orders as they occur, ,vhich is " 'hy 1nost 1nanufacturers use a "n1ake-to-stock" rather than "n1aketo-order" strategy. "Make-to-stock" 1nanufacturers plan ahead and then deploy inventories of finished goods into distribution channels in anticipation of de111and (i.e., use the push 1nodel). TI1ere are t,vo important considerations about a forecast that n1ust be stated: •

The 1ml is that statistically speaking, the forecast will be inaccurate. Although it n1ay be inaccurate, it is still useful. Forecasting is an in1precise science at best, but in the absence of any better inforn1ation, the forecast is not so111ething that con1panies can operate ,vithout. Because a forecast is an estimate of future den1and, which may be inaccurate, the goal of the forecasting and de1nand planning process is to n1inimiz.e forecast error in order to be as dose to accurate as possible.

•

The second in1portant consideration is that the forecast is the basis for most "do" rnstrean-i' supply chain planning decisions. Good forecasting can benefit a co1npany by facilitating more effective planning, ,vhich can lead to reduced inventories, reduced costs, reduced stockouts, and in1proved custo1ner service. Bad forecasting can be the root cause for creating just the opposite. There is a familiar adage that applies to forecasting: "garbage in = garbage out:· If a forecast is bad, everything else (i.e., the supply plan) based on that forecast ,viii also be bad. As a result, so1ne co111panies spend a lot of titne and effort trying to figure out ho"' they can best forecast because that ,vill 111ake everything else d0\\'11Strea111 flo,v n1ore sn1oothly.

38

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Coinpanies n1ust consider all factors that influence den1and ,vhen forecasting, not only statistical data and information, but also kno"•ledge about the marketplace, trends, 1narketing and sa.les efforts, co1npetitor activity, and the like. Soine considerations follo\\•: •

Is the product seasonal?

•

ls there a price increase coming?

•

Is a new competitor entering the n1arketplace?

•

Is the coinpany's ne,v product going to cannibalize one or 1nore of its other products already on the 1narket?

FUNDAMENTALS OF FORECASTING .......................................... There are so1ne funda1nental truths about forecasting in business about ,vhich supply chain 1nanagers should all be a,vare. These fundan1entals can easily be forgotten at times, to the detrin1ent of the quality and accuracy of forecasts. Supply chain n1anagers should consider the follo,,,ing fundan1entals when forecasting for their con1pany:

Adaptedfront Jeff Robson, 8 Funda111entals of Forecasting in Business, Business Strategy Blog. June 26, 2012. 1. Your forecast is most Likely inaccurate.

•

The question you should be asking is "Ho,v inaccurate is the forecast?"

•

Forecasts should include an estimate of error.

•

Forecasting is difficult n1ainly because people lu10"' it is likely to be inaccurate and nobody likes to be publicly and visibly inaccurate.

•

Nevertheless, a good forecast is essential in positioning the resources necessary to satisfy custon1er de1nands.

•

Forecasts require regular revie,v as circun1stances can change. You must be open to the first signs of change and be prepared to react quickly and decisively.

•

You n1ust be ,villing to recognize and adapt to changing conditions. Don't fall in love ,vith your forecast and ignore evidence that it may be inaccurate. Pride of authorship in this case can be deadly to the business.

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Forecasting and Demand Planning

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2. Sin1ple forecast methodologies are better than complex methodologies. •

Sin1ple forecast n1ethods are easy to understand, analyze, and adjust as necessary.

•

Co111plicated forecast 111ethods often hide key assun1ptions built into the 1nodel.

•

Yl' hen key assu1nptions are obscured it can be hard to trace failures.

3. A correct forecast does not prove that the forecast method is correct. •

Accurate forecasts could have been chance.

•

If you only question your n1ethods ,,,hen there is a large variance in the data, you'll 1niss all those times your forecast was just lucky - potentially hiding a multitude of sins.

4. If you don't use the data regularly, trust it less ,vhen forecasting. •

The quality of yotu data is proportional to ho,v often you use it.

•

YlrJ1en inforn1ation is not regularly used, errors often ren1ain undetected. Regular use of data helps identify n1istakes and s1nooth out inconsistencies over tin1e.

5. All trends ,viii eventually end . •

Many factors ,viii affect the pattern you are trying to forecast.

•

It doesn't n1at1er bo,v accurately you predict the trend, in the future the variables ,viii change and the forecast ,viii be inaccurate.

•

Short-term forecasts are n1ore accurate than long-term forecasts. The further out into the future you forecast, the n1ore likely that changes over time ,,rill undennine your esti1nates.

6. Most forecasts are biased, and it is hard to eliminate bias.

40

•

When you have to 1nake assumptions (i.e., ,vhich factors to include, ho"' strongly to weight them, etc.), it is li kely that you " 'ill be introducing so1ne bias into the forecast.

•

A forecast process with bias ,viii eventually get off track unless steps are taken to correct the course periodically. 1l1e best course of action is to n1easure for bias and then correct the bias routinely.

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

7. Large numbers are easier to forecast than small nun1bers. •

Forecasts are n1ore accurate for groups than for single items. Assun1ing that forecasts for each ite1n in the group are as likely to be too high as too lo,v, the lo,v forecasts tend to balance out the high forecasts.

•

It's usually better to forecast the bigger number and work back the calculation to determine the associated nurnbers than to forecast the srn all, related products and then add thern up to detennine the bigger nu1nber.

8. Technology is not the solution to better forecasting. •

Tech nology is not the ans,ver; it is a tool to facilitate the process.

•

Robust forecasting comes fron1 sound logic and n1ethodology.

•

Create an appropriate strategy and then use technology to 1nake it more successful.

FORECASTING TECHNIQUES

••••••••••••••••••••••••••••••••••••••••••••••••••

There are n,10 rnain categories of forecasting techniques: qualitative and quantitative (figure 2.1). A forecast can be developed by using qualitative 111ethods, quantitative n1ethods, or a con1bination of methods, and it can be based on intrinsic (internal) or extrinsic (external) factors. Companies that forecast ¼•ell generally use a cornbination of quantitative and qualitative techniques.

QUALITATIVE FORECASTING .................................................... QUALITATIVE FORECASTING TECHNIQUES are based on opinion, intuition, and judgn1ent. This technique is generally used ,vhen data are not available, limited, or irrelevant for some reason. For exa1nple, ,vhen cornpanies launch ne,v products into the rnarketplace, they don't have any direct statistical or historical data they can rely on to create a forecast. Although they 1night be able to use a similar product launched in the past by themselves or even a competitor as a n1odel, they don't actually have hard data on which to base the forecast, so they "'ill need to incorporate sorne judgn1ents or opinions. This is qualitative forecasting, and its success depends significantly on the skill and e>-verience of the forecasters and ,vhat infonuation is available to then1. The more experiences that can be brought into the process, the better this type of forecast ,viii be.

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Forecasting and Demand Planning

41

Personal lnslaht uryof

Inion ------

Qualitative

-

--1

Delphi Method Sales Force

Estimation Customer Sun,e

Forecasting Techniques

( M clA11t)\ 2016)

Five major types of qualitative forecasting are outlined here: Personal Insight, Jury of Executive Opinion (or Managen1ent Estimate), Delphi Method, Sales Force Estirnates, and Customer Survey. l.

The forecast n1ay be based on the insight of the most experienced, most kno"•ledgeable, or n1ost senior person available. Son1etirnes, this approach is the only option, but 1nethods that irlclude 1nore people are generally 1nore reliable.

..................... _,, of becutlwe OplnlOft

PERSONAL INSIGHT:

Qualitative

Delphi Melha d

--- . c.-

(M..l)erts requesting that they modify their original response if they think ii is necessary. 'This is done in several rounds until a consensus forecast is achieved. The use of sununaries reduces the defensiveness group n1e1nbers experience ,vhen challenged in person. It also reduces the potential for "groupthink:' The Delphi n1ethod can be tune-consuming and is therefore best for long-tenn forecasts. Advantages:

•

Decisions are enriched by the experience of competent experts.

•

Decisions are not likely a product of groupthink.

•

It is very useful for new products.

Disadvantages:

•

Experts may introduce son1e bias.

•

If external experts are used there is a risk of loss of confidential inforrnation.

•

Conlpanies must spend lin1e and resources collecting data by survey.

eJ~\J>kt i:

Forecasting and Demand Planning

43

4.

S ALES FORCE ESTI MAT ES: This n1ethod is also basically the san1e as the Jury of Executive

Opinion except that it is perforn1ed specifically " 'ith a group of salespeople. individuals working in the sales function bring special expertise to forecasting because they 1naintain the closest contact ,vith custo,ners. The resulting forecast is a blend of the infonned opinions of the group. This n1ethod can be improved by providing salespeople ,vith incentives for accurate forecasts and by training the salespeople to interpret their interactions " 'ith customers better. Advan tages:

•

No additional cost to collect data because internal salespeople are used.

•

The forecast is 1nore reliable because it is based on the opinions of salespeople in direct contact with custon1ers.

Disadvan tages:

5.

•

Salespeople may introduce so1ne bias.

•

Salespeople may not be a"•are of the economic environment.

•

It is not ideal for long-tenn forecasting.

CUSTOMER SURVEY: This 1nethod is generally used for short-tenn forecasting ,vhere an or-

ganization conducts surveys ,vith customers to deterntine the demand for their products and services and to anticipate future den1and accordingly. Custon1ers are directly approached and asked to give theiI" opinions about the particular product. A custon1er questionnaire 1nay be prepared for such tin1es. Questionnaires should be sin1ple and interesting so as to induce customers' responses. Customer surveys can be done in person (e.g., one-on-one, focus group), over the phone, by 1nail, en1ail, or online. \l\1hen collecting information ,vith questionnaires or surveys, the number of responses compared

to the nu1nber of nonresponses or incon1plete ans,vers should be tracked to detennine if the data are statistically valid. Response rates for son1e types of survey n1ethods n1ay be as lo,v as 10%. Rather than distribute a digital or tangible survey, son1e forecasters prefer a focus group, \\•hich is a small group of custon1ers " 'ho are interviev,ed together to collect their input. An intervie,ver creates an environment that encourages different points of view without pressuring participants to vote or reach consensus. l11e co1npany conducts several focus group sessions ,vith different participants to identify trends and patterns. Careful analysis of the discussions provide clues and insights as to how a product or service is perceived by the group.

44

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Advantages:

•

It is a direct 1nethod of assessing infonnation fro1n the priinary sources.

•

It is sin1ple to ad1ninister and co1nprehend.

•

Consun1er intercepts are usually held to gain a fast and quick overvie,v.

•

It does not introduce any bias or value judgment particularly in the census method if the questions are constructed carefully.

Disadvantages:

•

Custon1ers do not ahvays answer the questionnaire.

•

Poorly fonned questions 1nay lead to unreliable infonnation.

•

It is tilne-conswning and costly to survey a large population.

QUANTITATIVE FORECASTING ••••••••••••••••••••••••••••••••••••••••••••••• use historical dernand data to project future de1nand. \,Vhereas qualitative ted1niques are 1nore of an art forn1, quantitative techniques are n1ore of a science. In quantitative forecasting, historical demand data are used in conjunction ,vith statistical rnodels to create the forecast. Ideally, the p , .. ,,. . . historical data used should be actual de1nand data if available, rather than actual sales history. Actual sales history n,ay reflect ,vhat the cusTimr Se-ries ton1er ,vas forced to accept at tl1e tin1e due to lin1itations iI1 available supply rather than ,vhat scuCtJt the actual customer demand ,vas at the time. QUANTITATIVE FORECASTI NG TECHNIQUES

-

...... ,

Quantitative

The hvo n1ain quantitative techniques are tin1e series n1odels and cause-and-effect models. S1mplf'

-----

TIME SERIES MODELS are tlie n1ost frequent-

ly used of any method and folio"' the pre1nise tliat tl1e future is an extension of the past. ll1ey

eJ~\J>kt i:

Forecasting and Demand Planning

~US('

Recreu,on

and Uftcl Mult,plt'

(Mctou,y, 1016}

Rrsrru,on

45

are intrinsic forecasting techniques that incorporate data collected during specific time intervals such as days, ,veeks, and rnonths. For example, if a company's actual demand was 1,000 units per month for the last 24 months, a very basic tirne series rnodel ,vould project that the con1pany is probably going to experience dernand of 1,000 tuiits per 111onth going foPNard, all other things being equal. This sirnplistic exan1ple den1on strates the use of historical demand data to predict future de,nand. Tin1e series 111odels tend to be best for short-tern1 forecasting and should also include an estirnate of the degree of potential error.

CAUSE-AND-EFFECT MODELS basically use the san1e historical demand data as tin1e series n1odels but n1ake son1e assun1ptions and incorporate some independent variables in the effort to predict future den1and rnore accurately. TI1ere is a "cause" (independent variable) and an "effect" (dependent variable). Cause-and-effect 111odels are used ,vhere sufficient historical data are available, and the correlation benveen the dependent variable to be forecasted and the related mdependent variable(s) is ,veil known. Cause-and-effect forecasting 1nodels are extrinsic forecasting techniques because they evaluate the data based on sorne circun1stance or event that will likely have an impact on the demand for a product or itern. TI1ese approaches try to find a correlation, or a cause-and -effect relationship, benveen the ir1dicator and overall rnarket de111and. Cause-and-effect rnodels are 111ore advantageous if they are based on recent independent variables (i.e., recent events). The n1ore distant the event, the less useful it " 'ill be in achieving an accurate forecast. TI1e key challenge is to choose an independent variable that has true correlation with the de,nand being forecasted. TI1e best practice for a company is to do sorne combination of intrinsic and extrinsic forecasting. Using internal infonnation is po,verful by itself, but external infonnation can lend an additional layer of reliability by connecting external events to mternal processes.

VARIATION IN QUANTITATIVE FORECASTING ............................ . Quantitative forecasting seeks to connect historical demand data " 'ith future dernand probability. These predictions are seldo111 sin1ple and 1nust allo,v for variation ill the den1and. Variation can be problen1atic for forecast 1nodels if the nature of the variation is not understood, but understanding fluctuations in den1and allo,vs for a more complete forecast n1odel.

46

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

TREND VARIATION: Trend variation

is move1nent of a variable over tune. Quantitative forecasts 1neasure the rise or fall of de1nand for a product. Is the actual de1nand for an item increasing or decreasing over time; and is that pattern projected to continue into the future, and for how long? A trend 1night be 1nore easily observed by plottu1g actual de111and on a graph over tin1e to see \vhether there is an increase or decrease. Trends particularly occur at the beginnmg or the end of a product's lifecycle. When an ite1n is ne,v, the den1and might be steadily increasing (trending up); ,vhen the product is 1nature, the de1nand 1night be steadily declinu1g (trending dovm). The trend variation should be taken u1to consideration ,vhen creating a forecast for an item. RANDOM VARIATION: Randon1 variation is an instability in the data caused by randon1 occur-

rences. These randon1 changes are generally very short term, and can be caused by unexpected or unpredictable events such as ,veather emergencies, natural disasters, and the like. A sudden de1nand for ,vood 1nay occur, for exainple, after a hurrica11e because n1a11y ho1nes are daiuaged. As these variations are unexpected and unpredictable, they are normally excluded fron1 the forecast data as abnormal demand. Manufacturers n1ay provide a contmgency for these potential variations through a 1nitigation strategy such as 1naintaining son1e additional stock (i.e., safety stock). Seasonal variation is a repeating pattern of demand from year to year, or over so1ne other ti1ne interval, \,rith son1e periods of considerably higher den1a11d tha11 others. De1uand 1nay fluctuate dependiJ1g on tin1e of the year (e.g., seasonal " 'eather, holidays). Seasonality is based on history repeating itself, and therefore can be predicted. Son1e industries and products have definitive seasons (e.g., sno"' shovels, S\vi1nsuits, Hallo"•een candy, Christmas " 'rapping paper). TI1ese products predictably have large de1na11d at certain tu11es of the year and Io," de1uand the rest of the tune. If seasonal variation is observed in the historical demand data, it is aln1ost ahvays built into the forecast unless there is some other overriding information to the contrary. SEASONAL VARIATION:

CYCLICAL VARIATION: Cyclical variation is a demand pattern that repeats like a seasonal vari-

ation but follo"'S a v,avelike pattern that can extend over rnultiple years and, therefore, cannot be easily predicted. TI1ese long-terrn cycles typically correlate '"ith the general business or econo1nic cycle. The stock rnarket is an exan1ple of a cyclical variation. A "bull n1arket" or a "bear n1arket" can last for a long time, potentially even n1ultiple years. Another example of a cyclical variation is a product going through its lifecycle, starting ,vith a launch and rapid grov.rth ,,,hen it is ne"'• leveling off ,vhen it reaches 1naturity, a11d then trailing off ,vhen it is u1 the decline stage. eJ~\J>kt i:

Forecasting and Demand Planning

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TIME SERIES MODELS

••••••••••••••••••••••••••••••••••••••••••••••••••••••••••

The main purpose of a tune series model is to collect and study the past data of a given tin1e series in order to generate probable future values for the series. In other \vords, forecasts for future den1and rely on understanding past den1and. Accordingly, ti1ne series forecasting can be characterized as the act of predictu1g the future by understandmg the past. The followu1g are a few basic forecastu1g techniques using time series data.

•

d.

NAIVE: Nai've forecastu1g sets the demand for the next tune period to be exactly the same as the demand in the last (or current) time period. For exarnple, if a company had an actual den1and for 100 bicycles in Jw1e, usu1g the naive forecastu1g 1uethod for July, the forecast ,vould be set at 100 bicycles and so on for subsequent n1onths. This forecastmg technique does not factor in any variations (i.e., trend, randon1, seasonal, or cyclical). It is 1nost useful for products or iten1s that have a very stable/flat trend such as n1ature products, or for use in cornparison to other, rnore sophisticated forecasting techniques. Advantages: This technique " 'orks for n1ature products and is very easy to deterrnine. Disadvantages: l11is technique " 'orks for mature products only. Any variations in demand ,viii create inventory issues. Sll\1 PLE MOVING AVERAGE: Instead of using the rnost recent time period dernand data to forecast de1uand for the next tune period like nai've forecasting, a n1ovu1g average uses a calculated average of de111and durmg a specified nun1ber of the most recent tin1e periods. A silnple movmg average is where all the data points are assigned equal ,veights. For exan1ple, a four-111onth silnple moving average takes the average n1onthly den1and for the preceding four months to create the forecast for the next month.

Fonnula; (Ml + M2 + M3 + M4) / 4

48

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Coinpute the simple n1oving average forecast for ~ using the following data:

M6 M5 M4 M3 M2 M1 M

Month January February March April May June July

Units Actu al Forecasted 90,000 110,000 80,000 90,000 100,000 120,000 ?

(120,000 + 100,000 + 90,000 + 80,000) / 4 = 390,000 / 4 = 97,500 units for the July forecast As the actual demand data for each ne\\• time period are added, the oldest one is dropped and the average is recalculated (i.e., a "1noving" average).

Advantages: 'TI1is forecasting technique provides a very consistent de1nand over long periods of ti1ne and s1nooths out randorn variations. Including 111ore tirne periods ,vill sn1ooth the arnount of variation in the n1odel. Disadvantages: This forecasting tedu1ique generally fails to identify trends or seasonal effects. It ,viii also create shortages ,vhen de111and is increasing, because it lags behind actual de111and. Adding more periods to the average actually increases the amount the forecast lags behind actual demand. WEIGHTED MOVING AVERAGE: A weighted moving average is very similar to a simple moving average except that not all historical time periods are valued equally. In the previous exarnple, all of the tune periods " 'ere ,veighted equally, totaled up, and then divided by the nwnber of periods to get the sunple 1noving average. ,.vith a ·weighted n1ovmg average, different "'eight is applied to each time period according to its importance. The weight given to each till1e period is flexible so long as the ,veight for each ti1ne period is a positive number and all of the \\•eights total 100%. Forn1u!a: (Wl x Ml) + (,.v2 x M2) + (W3 x M3) + (W4 x M4)

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Forecasting and Demand Planning

49

Perhaps the company feels that the most recent n1onth or fev, months are more representative or relevant to the product's de1nand today than the den1and data fron1 the more distant past. In this case, the 111ost recent past tilne period(s) ,vould be given a greater percentage of the total ,veight and the n1ore distant past tilne periods " 'ould be given a lesser percentage. Co1npute the ,veighted 1noving average forecast for July using the follo,vil1g data:

Month M6 MS M4 M3 M2 M1 M

January February March April May

June July

Units Actual Forecasted

Weight

NIA NIA 10% 20% 30%

90,000 110,000 80,000 90,000 100,000 120,000

40% ?•

100%

TOTAL

(40% X 120,000) + (30% X 100,000) + (20% X 90,000) + (JO% X 80,000) = 48,000 + 30,000 + 18,000 + 8,000 = 104,000 units for the July forecast

As the actual de1nand data for each ne,v tilne period are added, the oldest one is dropped, the ,veighted percentages are reapplied, and the average is recalculated (i.e., a "moving" average). Advantages: This forecasting technique is 1nore accurate than a sin1ple 111oving average if actual den1and is increasil1g or decreasing-that is, if there is any trend variation. Properly ,veighted tilne periods provide accurate information for forecasts. D isadvantages: Though better than a siinple 1noving average, this technique " 'ill still lag behmd actual de1nand to some degree. l11e challenging part of using a ,veighted moving average is deciding on the ,veight for each tin1e period. TI1ere is no guideline to help decide ,vhich ,veights to use. Appropriate " 'eighting relies on e.>rperience and knowledge about the product and the n1arket. EXP ONENTIAL S l\tO OTHING: Exponential s1noothing is a 1nore sophisticated version of the

,veighted n1ovil1g average. The equation requires three basic elements: last period's forecast, last

so

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

period's actual demand, and a smoothing factor, which is a nun1ber greater than O and less than 1 (used as a ,veighting percentage). The formula for calculating the forecast using exponential s1noothing is the most recent period's den1and multiplied by the s1noothing factor, PLUS the 1nost recent period's forecast 1nultiplied by (one n1il1us the sn1oothing factor). Forecast = (D x S) + (F x (I - S)) Where: D = last period's actual de,nand S = the smoothing factor represented in decin,al forn, F = last period's forecast Compute the exponential smoothing method forecast for July using the follo,ving data:

Month M6 M5 M4 M3 M2 M1 M

January February March April May

June

Units Actual Forecasted

90,000 110,000 80,000 90,000 100,000 120,000

July

90,000 92,500 97,500 90,000 92,500 95,000

I Smoothing Factor 0.5 0.5 0.5 0.5 0.5 0 .5

?

{120,000 X 0.5) + (95,000 X (1 - 0.5)) = 60,000 + (95,000 X 0.5) = 60,000 + 47,500 = 107,500 units for the July forecast The smoothing constant is not a given. It has to be determined based on the best judg1nent of a company's experts. TI1e sn1oothing constant can be selected by experilnenting ,vith various constants in the historical data to see ,vhich one works best. Using the best possible sn1oothing constant is crucial to the accuracy of the forecast. In general, companies use a sn,oothing constant between 0.05 and 0.5. TI1e higher the constant, the more ,veight that is given to the actual demand data from the preceding period. A constant of O,vould give no weight (0%) to the last period's de1nand, ,vhereas

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a constant of 1.0 would give all of the weight (100%) to the last period's den1and, which would then produce the sarne result as a nai·ve forecast. Advantages: Exponential smoothing will create a forecast more responsive to trends than previous rnethods. Disadvantages: Exponential srnoothing \viii still lag behind trends, especially upv.•ard trends, because the srnoothing factor ,vould need to be greater than 1.0 to approach an accurate forecast. Picking an appropriate sruoothing factor is essential for this n1ethod to " 'ork, but selection of a smoothing factor requires much experience and experin1entation in order to arrive at a reliable value for the smoothing factor. LINEAR TREND: Linear trend forecasting is used to in1pose a line best

fit across the demand data

of an entire tirne series. 2 A linear pattern is a steady increase or decrease in nurnbers over tirne. In other v,ords, linear regression ,vill ah,,ays create a straight line that can be defined by a sin1ple formula. There are no bends (i.e., variations) in a best fit line. If a best fit line is foun d, it can be used as the basis for forecasting future values by extending the line past the existing data and out into the future ,vhile rnaintaining the slope of the line. 2016 Sales Data 300

,so ,oo 1SO 100

so 0

- - 201 6

201 6 Sales Data w ith Trend line 300

lSO 200 1SO

100

so 0

52

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Advantages: When a best fit line is available, this method can provide an accurate forecast several tin1e periods into the future. l11e use of linear regression allo,vs these n1odels to ren1ain useful even runid rando1n variation.

Disadvantages: v\Thile the overall trend is identified " 'ith linear regression, seasonal and cyclical variations are softened as the historical data beco1nes n1ore e>-.1>ru1sive, n1aking forecasts n1ore useful for annual forecasts than monthly forecasts. ln other ,vords, linear regression " •ill sho,,• the overall gro,vth from year l to year 9 and be able to project year 12. It ,viii not, ho,vever, generally sho"' that de1na11d increases in the su1n1ner and decreases in the winter (or so111e other variation), because the sin1ple line is creating an average of sorts.

CAUSE-AND-EFFECT MODELS .................................................. . l11ere are t"•o basic cause-and-effect 111odels described here: sin1ple linear regression and n1ultiple linear regression. Regression uses the historical relationship bet,veen an independent and a dependent variable to predict the future values of the dependent variable (i.e., demand). SIMPLE

LINEAR

REGRESSION

atte1npts to 1nodel the relationship bel\\•een a single independent vru·iable and a dependent variable (the demand) by fitting a li near equation to the observed data. The equation describes the relationship benveen the independent variable and dependent variable as a straight line. For exan1ple, the de1nand 1night be dependent on ho,v much 1noney is spent on advertising and pro1notion: the more n1oney spent, the higher the demand. The line that represents this relationship can be used to forecast den1and ,vith consideration of future values of the independent variable. In other ,,,ords, if a co111pany plans on investing 1nore in advertising, it 111ight be necessary to increase the forecast, or vice versa. MULTI PLE L INEAR R EGRESSION atte1npts to n1odel the relationship benveen t"•o or n1ore inde-

pendent variables and a dependent variable (i.e., demand) by fitting a linear equation to observed data. For exan1ple, the forecasted demand n1ight be dependent on ho,v much money is spent on advertising and pron1otion and on the selling price charged for the product. As ,vith the previous

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example, forecasts can be adjusted with knov,Jedge of the independent variables. lf advertising is increased, and the price is lo,vered, it is likely appropriate to increase forecast demand. Depending on the data and the number of independent variables, the 1nathen1atics involved can be con1plex. For exarnple, if advertising is increased and the price is also increased, the impact on de1nand is not as obvious. TI1e 1nathe1natics of 1nultiple regression can help predict the itnpact on demand. Forecasting and statistical software packages can be useful to facilitate the computations required for this type of forecasting technique.

OTHER FORECASTING METHODS ............................................. TI1ere are nwnerous other forecastit1g 111odels available and in use beyond ,vhat is covered in this text. The following are a few that n1ay be " 'Orth further research. •

Drift Method

•

Holt's Lit1ear Trend Method

•

Holt-Winters Seasonal Method

•

Autoregressive Integrated Moving Average (ARIMA)

•

Box-Jenkins

•

X-11

•

Econon1etric Model

•

Input-Output Model

FORECAST ERROR .................................................................. Because forecasts are almost always inaccurate, con1panies need to track the forecast agait1st actual dernand and 111easure the size and type of the forecast error. The size of the forecast error can be 111easured in units or percentages. In addition, calculating a value for the error 111ay be useful to help justify the tit11e and resources necessary to improve the forecasting process.

54

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Forecast Error is the difference bet ween the actual demand and the forecast den1and.

The error can

be quantified as a unit value or as a percentage. Forecast error value =A - F Forecast error percentage = ((A - F) / A) x I 00

Where: A = actual den1and F = forecast demand Error n1easuren1ent plays a critical role in tracking forecast accuracy, n1onitoring for exceptions, and benchmarking the forecasting process. Interpretation of these statistics can be tricky, particularly \vhen \Vorking ,vith lo1''•Volwne data or ,vhen trying to assess accw·acy across n1ultiple ite1ns.

MEAN ABSOLUTE DEVIATION •••••••••••••••••••••••••••••••••••••••••••••••• MEAN ABSOLUTE DEVIATION (MAD) measures the size of the forecast error in units. It is cal-

culated as the average of the unsigned (i.e., absolute) errors over a specified period of ti1ne. Absolute errors for a series of tin1e periods are added and then divided by the nun1ber of tin1e periods. The resulting value is the MAD 1neasure of forecast inaccuracy. Whether the forecast is over or under the actual de1nand is irrelevant; only the n,agnitude of the deviation matters in the MAD calculation.

MAD= E(IA-FI) / n 1~' '1ere: A =actual de111and F = forecast de111and n =number of tin1e periods

MEAN ABSOLUTE PERCENT ERROR

••••••••••••••••••••••••••••••••••••••••

MEAN ABSOLUTE PERCENT ERROR (MAPE) n1easures the size of the error in percentage

terms. It is calculated as the average of the unsigned percentage error. Many companies use the MAPE as it is easier for n1ost people to understand forecast error and forecast accuracy in percentage tenns rather than in actual tu1its. MAPE is a useful vru·iant of the MAD calculation, because it shows the ratio, or percentage, of the absolute errors to the actual demand for a given nun1ber of periods.

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MAPE =I ((IA - Fl) / A) / n (expressed as a percentage) Where: A =actual de1nand F = forecast demand n =nun1ber of tune periods MAPE allO\VS the n1agnitude of the forecast error to be clearly understood \,rithout needing detailed kno,vledge of the product.

MEAN SQUARED ERROR

•••••••••••••••••••••••••••••••••••••••••••••••••••••••

MEAN S QUARED E RROR (MSE) magnifies the errors by squarillg each one before adding then1,

and then dividillg by the nu1nber of forecast periods. Squaring errors effectively makes then1 absolute, because 1nultiplying t,vo negative nu1nbers results in a positive nu1nber. MSE =I (A - F)2 / n Vl' here: A = actual de1nand F = forecast den1and n =nun1ber of ti1ne periods

FORECAST BIAS

•••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••

Forecast error can be the result of bias, ,vhich is a consistent deviation fron1 the mean ill one direction, either high or lo"'· In other " 'ords, bias exists "'hen the den1and is consistently over- or under-forecast. A good forecast is not biased.

I Forecast error =I Actual demand - I Forecast den1and In this formula, if the sun1 of the forecast error is not zero, there is bias ill the forecast . The size of the number reflects the relative amount of bias that is present. A negative result sho,vs that actual de1nand ,,,as consistently less than tl1e forecast, ,vhereas a positive result sho,vs tl1at actual de1nand ,vas greater than forecast de111and. Once bias has been identified, correcting the forecast error can be realized by adjusting the forecast by the appropriate amount in the appropriate direction (i.e., illcrease the forecast ill the case of under-forecast Ipositive bias], and decrease it in the case of over-forecast Inegative bias)). 56

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

A forecast process with bias will eventually create significant problen1s in the supply chain if left unchecked. Good supply chain planners are a,vare of these biases. A best practice is to measure for forecast bias routinely and then rnake corrections accordingly.

RUNNING SUM OF FORECAST ERRORS

•••••••••••••••••••••••••••••••••••

RUNN ING SuM OF FORECAST ERRORS (RSFE) provides a measure of forecast bias. RSFE indicates the tendency of a forecast to be consistently higher or lov.rer than actual dernand. A positive RSFE indicates that the forecasts " 'ere generally too lo,v, w1derestin1ating tl1e den1and. In this situation, stockouts are likely to occur as companies are unable to n1eet customers' actual den1and. A negative RSFE indicates that the forecasts v.•ere generally too high, overestimating den1and. In this situation, excess inventory and higher carrying costs are likely to occur. RSFE = I e, Where: e1 = forecast error for period t

TRACKING SIGNAL ................................................................. . The tracking signal is a sin1ple indicator tl1at forecast bias is present in the forecast rnodel. It detern1ines if the forecast is ,vithin acceptable control lirnits and provides a ,varning "'hen there are significant unexpected departures fro1n the forecast. If the tracking signal Calls outside the preset control lirnits, there is a bias problem with the forecasting n1etl1od; and an evaluation of the ,,,ay the forecast is generated is ,varranted. Tracking signals are n1ost often used ,vhen the validity of the forecasting model is in doubt. A sn1oke detector is a good analogy for a tracking signal. It is preset to allo,v for a certain range of smoke, but beyond that range the alarm (tracking signal) goes off and ,varns individuals that circumstances are outside the safe control lin1its. Individuals can tl1en take action to correct the problern (or contact tl1ose individuals ,,,ho can take tl1e appropriate action). TI1e tracking signal is tl1e ratio of the running sum of forecast errors to rnean absolute deviation. Tracking signal= RSFE / MAD The RSFE is a cun1ulative sum that does not use absolute value for the errors. Therefore, the tracking signal could be either positive or negative to sho,v the direction of the bias. Con1panies use a trackeJ~\J>kt i: Forecasting and Demand Planning

57

ing signal by selling a target value for each period. lf the tracking signal exceeds this target value, it would trigger a forecast revie\v. It is important to remernber that forecasts are seldorn perfect, and any error in the forecast sho,vs a bias. Tracking signals allo"' a systern to ackr10,vledge that the forecast will not be perfect but should be reasonably close.

BULLWHIP EFFECT

•••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••

TI1e bullwhip effect refers to the phenornenon that even rnini.rnal variability i.11 custo1ner de1nand can be distorted and an1plified ,vith i.ncreasi.r1g volatility upstream i.11 the supply cllain. That is, variability in customer demand is magnified as the supply chain participants becon1e more remote fro1n the end custorner. 'TI1is results in large variations on orders being placed upstrean1 and inefficiencies all throughout the supply chain as suppliers react to their custorners " 'ho are reacting to their custorners. The reason for the effect can be attributed to individual supply chain participants second-guessing what is happening " 'ith ordering patterns in the absence of any other information or visibility. TI1e serial nature of conununicating orders up the chain ,vith the inherent transportation delays of rnoving product do,vn the chain i.r1duces rnore and n1ore overcorrection ,,,ith each successive link in the supply chain. The bulhvhip effect results fi:0111 a host of issues: •

Custorner dernand is rarely perfectly stable, and businesses rnust forecast dernand to position inventory and other resources properly. Forecasts, ho,vever, are based on statistics, and statistics are rarely 100% accurate.

•

Co111panies often carry an i.r1ventory buffer called safety stock due to the kno\vledge that forecast errors are a given. Moving back across the supply chain from the end consun1er(s) to ra,v rnaterial supplier(s), each supply chain participant has a greater observed variation in dernand and thus greater need for safety stock.

•

In periods of rising dernand, do,vr1strea1n participants increase orders. In periods of falling dernand, orders decrease or stop, and inventory accu1nulates. Variations are an1plified as one n1oves upstrea111 in the supply chain (i.e., further back from the end customer/consumer).

When tl1e retailer feels a sn1all de1nand ripple in the 1narketplace at the end of the supply chain, the retailer \Vill then start adjustillg its orders to the wholesalers, and the wholesaler ill turn ,vill adjust its orders to the distributor, the distributor to the factory, and so on back up the supply chain. When the ne,v demand reaches tl1e rnaterial or cornponents supplier at tl1e other end of the supply chain, tl1e 111agnitude of fluctuation becomes unrecognizable. An overreaction due to uncertai.r1ty occlrrS throughout the entire supply chain. 58

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

H o,v CAN T H E BU LLW HIP EFFECT BE ALLEVIATED? There is no single remedy that "rill con1pletely mitigate the bullwhip effect, but there are some actions that supply chain participants can take collectively: •

Collaboration: The sharing of infonnation through the use of electronic data interchange (EDI), point of sale (POS) data, and \veb-based inforn1ation systerns can facilitate needed collaboration.

•

Synchronizing the supply chain: Supply chain participants can coordinate production planning and inventory n1anage1nent to 1ninin1ize the need for reactionary corrections.

•

Reducing inventory: Reducing overall supply chain inventory levels through the use of just in ti1ne (JIT), vendor n1anaged inventory (VMI), and quick response (QR), all of ,vhich ,vill be discussed later in this text, reduces overreactions to stockouts and decreases the chances of overages.

If the various participants work together to get closer to custorners through collaborative planning, forecasting, and replenishment (CPFR), then the bulhvhip effect can be greatly reduced and the accu1nulation of inventory and the inefficient use of resources throughout the supply chain can be 1nini1nized.

COLLABORATIVE PLANNING, FORECASTING,AND REPLENISHMENT Collaborative planning, forecasting, and replenisl11nent (CPFR) is "a process philosophy for facilitating collaborative con1n1w1ications"1 ,vhereby supply chain trading partners can jointly plan key supply chain activities from production and delivery of ra,v n1aterials to production and delivery of final products to end customers. Collaboration encompasses business planning, sales forecasting, and all operations required to replenish ra,v n1aterials and finished goods. CPFR co1nbines the intelligence of multiple trading partners ,vho share their plans, forecasts, and delivery schedules ,vith one anotl1er in an effort to ensure a s1nootl1 flo,v of goods and services across a supply chain. CPFR can significantly reduce the bull"rhip effect and provide a plethora of benefits: •

Better custon1er service

•

Lo,ver inventory costs

•

In1proved quality

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•

Reduced cycle time

•

Better production n1ethods

CPFR requires a fundan1ental change in the ,vay that buyers and sellers " rork together. The real value of CPFR comes from the sharing of forecasts a1nong firn1s rather than firms relying on sophisticated algorithn,s and forecasting 1nodels to estimate demand. Con1panies could forecast what they think their customers plan to buy from then1, or customers could share their purchase plans " 'ith co1npanies, so both sides could benefit.

SUMMARY

•••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••

•

Forecasting and demand planning are the key building blocks from ,vhich all do,vnstream supply chain planning activities are derived.

•

Den1and is the need for a particular product or con1ponent. Den1and planning is the process of con1bining statistical forecasting techniques and judg1nent to construct demand estimates for products or services across the supply chain fro111 the suppliers' ra\\r n1aterials to the consu1ners' needs.

•

A forecast is an estirnate of future den1and. Forecasting is the business function that atte1npts to estin1ate future de1nand for products so that they can be purchased or 1nanufactured in appropriate quantities in advance. Forecasts, by their nature, are likely to be inaccurate but can still be useful. Forecasting is necessary, because it takes time to convert ra"' n1aterials to a finished product that ,vill be delivered to the custo1ner.

•

Dependent detnand is detnand directly related to other ite111s or finished products (i.e., a con1ponent part or n1aterial used in 1naking a finished product). Independent den1and is de1nand for an iten1 that is unrelated to the de1nand for other items (i.e., a finished product or spare/ service parts).

•

There are two main categories of forecasting techniques: qualitative and quantitative. Qualitative forecasting techniques are based on opinion, intuition, and judgn,ent. These techniques are used ,vhen there is no/little historical data for tl1e product. Quantitative forecasting techniques use historical den1and data to project future de1nand. Quantitative forecasting is the more co111mon n1ethod and involves I wo main qualitative techniques: tin1e series models and cause-andeffect n1odels.

60

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

•

Time series models predict the future by understanding the past. Cause-and-effect n1odels use the historical relationship bel:\,reen an independent and a dependent variable to predict the fu. ture values of the dependent variable (den1and).

•

Because forecasts are ahnost ahvays inaccurate, co1npanies need to track the forecast against actual de1nand and 1neasure the size and type of the forecast error. Error 1neasuren1ent plays a critical role in tracking forecast accuracy.

•

Mean absolute deviation (MAD), 1nean absolute percent error (MAPE), and 1nean squared error (MSE) are n1ethods used to 111easure the size of the error.

•

Running sun1 of forecast errors (RSFE) and tracking signals provide a n1easure and a " 'arning of forecast bias.

•

The bullwhip effect refers to the pheno111enon that even minin1al variability in customer den1and can be distorted and amplified with increasing volatility as the participants becon1e more remote fro1n the end custo,ner.

•

Collaborative planning, forecasting, and replenishment (CPFR) is a collaboration process " 'hereby supply chain trading partners can jointly plan key supply chain activities: fro,n production and delivery of ra,v ,naterials to production and delivery of final products to end custon1ers. CPFR can significantly reduce the bull,,rhip effect.

REFERENCES ......................................................................... 1

APICS Dictionary (14th ed.). (2013). Chicago, IL: APlCS. W\V\\'.apics.org 2 Harvey, A. C. (1989). Forecasting, structural ti111e series ,nodels and the Kal,nan filt er. Can1bridge, UK: Cambridge University Press; McGuigan, J. R., el al. (201 I). 1"1anagerial eco110111ics ( 12th ed.). Mason, OH: South-\.Vestern Cengage Learning; Robson, J. (2012, June). 8 fundan1entals of forecasting in business. Business Strategy Blog, http:/ " ·'"""'·businessstrategyblog.com. au/2492/8-fundamentals-of-forecasling-in-business/

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Supply Chain Planning

CHAPTER OUTLINE Introduction Supply Chain Planning

Basic Production Strategies Bill of Materials

Planning Goalsand Objectives Planning Responsibilities and Tasks

Material Requirements Planning Capacity Planning

Supply Chain Planning Diagram

Distribution Requirements Planning

Business Planning Sales and Operations Planning

Enterprise Resource Planning Systems

Production Planning (Aggregate Production Planning) Master Production Scheduling Time Fencing

63

INTRODUCTION

••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••

Supply chain planning is the elen1ent of supply chain management responsible for determining ho,v best to satisfy the requirements created by the den,and plan. Its objective is to balance supply and dernand in a " 'ay that realizes the financial and service objectives of the cornpany. It is a cornbination of all the planning processes across the supply chain, including aggregate production planning, master production scheduling, n1aterials requirement planning, and distribution requiren1ents planning. (Refer to Figure 3.2 later in the chapter.)

SUPPLY CHAIN PLANNING

••••••••••••••••••••••••••••••••••••••••••••••••••••

Supply chain planning is hierarchical and can be divided into three broad categories: •

LONG RANGE (typically 1-3 years; can be as long as 10 years)

Involves planning for n1ajor actions such as capital expenditures including the construction of facilities and rnajor equipment purchase, and new product introduction plans (sales and operations planning and/or aggregate production plan11ing). Exarnple: Fictional Motor Cornpany needs to increase manufacturing capacity to respond to an annual 5% increase in the den,and for XL-150 pickup trucks over the next one to three years. •

INTERJ\t EDIATE RANGE (typically 3-181nonths)

Involves planning the quantity and liming of end items- that is, specific make and model (n1aster production scheduling). Includes sales planning; production planning; setting rnajor resource levels such as n1anpo,ver, inventory, contracting; and analyzing operating plans. Exan1ple: Fictional t.1otor Company plans to 1nake 1,000 XL-150 pickup trucks per month for the next 3 to 18 months. •

S HORT R ANG E

Involves the detailed planning process for con1ponents and parts to support the rnaster production schedule. Includes ordering and scheduling activities using inforn1ation fron1 the bill-of-materials, inventory systen,, purchasing systen,, and so forth (1naterials requiren1ent planning). Example: Plan and order the components and materials needed for production of the XL-150 pickup trucks for delivery each ,veek over the next 24 " 'eeks (250 engines, 250 trans1nissions, seats, ,_,indo,.,s, etc.).

64

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

PLANNING GOALS AND OBJECTIVES

••••••••••••••••••••••••••••••••••••••

The first step in supply chain planning is for the top n1anagen1ent at the con1pany to establish the desired high-level planning goals and objectives. Example: Meet demand \\lithin the lin1its of the available resources at the lowest overall cost, or obtain the resources necessary to n1eet den1and at the lo,"est overall cost. The next step is to detennine \\>hat is necessary to ad1ieve these goals and objectives. Identify the specific action steps. Examples: Build or acquire a ne," facility, hire 111ore workers, buy more equip1nent. This is follo\\•ed by setting start and co1npletion dates for each action ite111 identified. Exan1ple: Begin hiring n1ore workers in February and finish hiring by April. Responsibility for each action iten1 should be forn1ally assigned to the appropriate individual or departn1ent ,vithin the company to execute. Example: The action ite111 of hiring more \Yorkers would be assigned to the hurnan resource manager or department \Yithin the con1pany.

PLANNING RESPONSIBILITIES AND TASKS

••••••••••••••••••••••••••••••

Planning Tasks and Horizon ➔

Operations Mlddle-Man11ement

Operations Managers, Supervisor, foremen, etc.

Responsibility (/11cLaury\ 2016)

el~\J>kt 3: Supply Chain Planning

65

Responsibility for the various levels of supply chain planning is generally held by different groups within a company. Figure 3.1 shows ,.-.,hich group(s) are typically responsible for short-, intermediate-, and long-range planning. As long-range planning enco,npasses 1naking strategic decisions and controlling the level of 1najor resotrrces, it is usually the responsibility of top 1nanage1nent in an organization. This level of planning sets the direction the con1pany \Viii follow into the future Intennediate-range planning translates the long-range plan into an executable plan and schedule in the near time fran1e. It details the specific products to be produced against a specific time schedule, and allocates the resources needed to achieve the long-range plan. This level of planning is best 1nanaged by 1nidlevel operations 1nanage111ent people v.•ho have the kno,vledge and infonnation about the operations necessary to develop the plan. Short-range planning enco1npasses converting the intennediate level plan into a detailed sequence of steps and actions necessary to execute the plan in the inunediate ti111e fran1e. This is the planning level ,vhere the plan becomes a reality, materials are obtained, products are produced, and orders are filled. TI1is level of planning is best managed by the individuals v.•ithin an organization " 'ho are the 1nost directly involved ,vith these activities-the 1nanagers, supervisors, supply chain planners, and foreperson of the n1anufacturing operations.

SUPPLY CHAIN PLANNING DIAGRAM

•••••••••••••••••••••••••••••••••••••

Figtu·e 3.2 sho,vs the sequence of supply chain planning processes, fro111 top to botton1, and their relationship to each other. The hierarchy of processes in the figure goes fron1 the long-range aggregated Business Planning and Sales and Operations Planning (S&OP) processes do\vn through the intennediate range Master Production Scheduling (MPS) process to the detailed short-range Material Requiren1ents Planning (MRP) process. Supply chain planning also includes Distribution Requirements Pla1111ing (DRP), which allocates the available and planned finished product inventory out to the various \\•arehouses serving the distribution channels in the nel\-.,ork. Figure 3.2 also sho,vs which plaTUling steps are associated v.•ith each of the supply chain management concepts that have evolved fron1 the 1960s to the present; Closed Loop MRP, Manufacturing Resource Planning (MRP II), Enterprise Requiren1ents Planning, and Distribution Require1nents Planning (DRP). These are co,nputer-based "push" resource systen1s. •

CLOSED LOOP

MRP: Developed in the 1960s, closed loop MRP is "a systen1 used for produc-

tion planning and inventory control. with an information feedback feature that enables plans

66

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Sales & Operations Planning (S&OP> RHourit• Re(tU1rem4'11tJ

Plannina (RRPJ

• •

Supply

Manac,tmtnt

r

MlnufactllMI RPlannlnc CkMd (MRP II)

lnttrmedllte

loop MRP

Ranp

L Short Roop

Suppllen

(llfrlai,ry. 2016)

to be checked and adjusted. Closed Loop MRP synchronizes the purchasing or materials procure1nent plans \Vith the 1naster production schedule. TI1e systen1 feeds back inforn1ation about con1pleted 1nanufacture and 1naterials on hand into the l\1RP systen1, so that these plans can be adjusted according to capacity and other requiren1ents. The system is called a closed loop MRP because of its feedback feature:•2 It incorporates the aggregate production plan, the master production schedule, the 1naterial require1nents plan, and the associated capacity planning tools needed to check the feasibility of the plan.

•

MANUFACTURING RESOURCE PLANNING (MRP II): Evolving in the 1980s, 1uanufacttrring resource planning (MRP II) is "an integrated infonuation systen1 used by businesses. Manufacturing Resource Planning (MRP ll) evolved from early Materials Requiren1ent Planning (MRP) systen1s by including the integration of additional data, such as employee and financial needs. TI1e systen1 is designed to centralize, integrate and process inforn1ation for effective de-

el~\J>kt 3: Supply Chain Planning

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cision making in scheduling, design engineering, inventory managen1ent and cost control in 1nanufacturing. ~1RP II is a computer-based system that can create detail production schedules using realtin1e data to coordinate the arrival of con1ponent 1naterials ,vith 1nachine and labor availability. MRP II is used widely by itself, but also as a n1odule of more extensive enterprise resource planning (ERP) systems:•z 1t incorporates the closed loop MRP system and adds the strategic, business, and financial plans. •

Evolving in the 1990's, Enterprise Require1nents Planning (ERP) is a process that interfaces \\•ith 1nanufacturing to act as an extension of n1anufacturing resouTce planning (MRPII). ERP functionality includes all aspects of production planning and scheduling, material planning and inventory control, purchasing, 1nanufacturing, capacity planning, distribution and logistics, as ,veil as planning for the finance and hu1nan resource activities of the supply chain. ERP is typically i111ple1nented through a software platforn1 of integrated functional 111odules providing computerized n1anagen1ent of all aspects of the enterprise's supply chain. The ERP soft"•are application facilitates the sharing of inforn1ation and the real -tirne co1n1nunication and collaboration across 111ultiple business ftu1ctions necessary for the supply chain to operate efficiently and effectively.

•

The DRP is"!) the function of detern1ining the need to replenish inventory at branch ,varehouses. A ti111e-phased order point approach is used ,vhere the planned orders at the branch " 'arehouse level are 'exploded' via MRP logic to become gross require111ents on the supplying source. In the case of n1ultilevel distribution nel\vorks, this explosion process can continue do,vn tl1rough tl1e various levels of regional ,varehouses (111aster ,v,ll'ehouse, factory ,varehouse, etc.) and become input to the master production schedule. Demand on the supplying sources is recognized as dependent, and standard MRP logic applies. 2) More generally, replenislunent inventory calculations, ,,,hich 1nay be based on otl1er planning approaches sucll as period order quantities or 'replace exactly what ,vas used; rather than being lin1ited to the time-phased order point approach:''

ENTERPRISE REQUIREMENTS PLANNI NG (ERP):

D ISTRIBUTION REQU I REMENTS PLANNING (DRP):

BUSINESS PLANNING

••••••••••••••••••••••••••••••••••••••••••••••••••••••••••

The business plan, ,vith its long-tenn focus, provides the con1pany's direction and objectives for tl1e next 2 to 10 years. Management gathers input fro111 the various organizational functions such as finance, marketing, operations, and engineering, to develop the business plan. The plan states the con1pany's objectives for profitability, gro,vth rate, and return on invest1nent It is then typically updated and reevaluated annually. It is also typically used as the starting point for developing the organization's production plan or aggregate production plan.

68

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

SALES AND OPERATIONS PLANNING ........................................ Sales and operations planning (S&OP) is an iterative business management process that determines the optimu1n level of manufacturing output. S&OP is a process that brings all the demand and supply plans for the business (sales, marketing, developrnent, production, sourcing, and finance) together to provide rnanagement \Vith the ability to strategically direct the business to achieve a cornpetitive advantage. •

"It is the definitive statement of the company's plans for the interrnediate to long terrn, covering a horizon sufficient to plan for resources, and to support the annual business planning process:••

•

It links the strategic plans for the business ·with its execution, and provides a ,vay for 1nanage1nent to detennine resource needs and to keep a handle on the business ,vithout having to review the plans at the detailed level.

•

It is perforn1ed at least once a n1onth and is reviewed by n1anage1nent at an aggregate (product fanilly) level.

•

Generally, issues are "bubbled-up" to senior manage1nent on an exception basis. Middle managen1ent and operational management are expected to try to resolve issues first whenever possible.

Monthly S&O P meetings are essential to decision malting. Senior management n1eets to discuss the various trade-offs bet\veen customer service, inventory investments, production capabilities, supply availability, and distribution concerns. The process strives to detern1ine ho\\• to best apply the con1pany's resources to strike an optin1un1 balance benveen 1naxin1izing profit and satisfying the conlpany's most iinportant operational goals. The S&O P process follo"•s sonic standard steps: •

Revie,v the current plan.

•

Revie,v current den1and and forecasts for changes and trends.

•

Identify capacity and material/product shortages and propose solutions.

•

Evaluate product portfolio changes for adding new products and phasing out older products.

•

Ensure that the plan 1neets financial targets.

el~\J>kt 3: Supply Chain Planning

69

•

Hold a formal S&OP meeting, typically monthly, to reviev,r the plan, n1ajor changes, and proposed scenarios, to detennine and decide on the resource adjustrnents necessary to 1neet the con1pany's objectives.

PRODUCTION PLANNING (Aggregate Production Planning)

•••

Production planning, or aggregate production planning (APP), is an integral part of the business planning process. It is "a process to develop tactical plans based on setting the overall level of 1nanufacturing output (production plan) and other activities to best satisfy the current planned levels of sales (sales plan or forecasts), while meeting general business objectives of profitability, productivity, competitive custon1er lead ti1nes, and so on, as expressed in the overall business plan. The sales and production capabilities are co1npared, and a business strategy that includes a sales plan, a production plan, budgets, pro forn1a financial staten1ents, and supporting plans for n1aterials and workforce requirements, and so on, is developed. One of its primary purposes is to establish production rates that v.>ill achieve 1nanage1nent's objective of satisfying customer demand by 1naintaining, raising, or lo,vering inventories or backlogs, v;hile usually atte1npting to keep the ,vorkforce relatively stable. Because this plan affects many con1pany functions, it is norn1ally prepared ,vith information from marketing and coordinated ,vitJ1 ilie functions of manufacturing, sales, engineering, finance, 1naterials, and so on." 1 Aggregate production planning is the hierarchical planning process that translates annual business and 111arketing plans, and de111and forecasts, into a production plan for a product fanilly (products that share sin1ilar characteristics) in a plant or facility. The aggregate plan identifies the resources needed by operations management to support the business plan over the next 6 to 18 n1onths. It details the aggregate production rate and size of the ,vorkforce, v,rhich enables planners to deterrnine the ainount of inventory to be held; tJ1e a1nount of overtitne autJ1orized; any subcontracting, hiring, or firing of en1ployees; and backordering of custo111er orders. 2 Developing the aggregate production plan includes: 1.

Deterrnining tJ1e de1nand for each period covered by the aggregate planning horizon

2.

Deterrnining the available capacity for each period covered by the aggregate planning horizon

3. Identifying any constraints ,vhicl1 may influence the plan 4.

70

Deterniining the direct labor and material costs and the indirect n1anufacturing costs for each product or product fa,nily covered by the aggregate production plan

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

5.

Identifying or developing strategies and contingency plans to n1anage the potential upside or do,vnside in the market

6.

Agreeing on a plan that best meets the planning goals and objectives

It is also advisable to test or challenge the plan, if possible, to detennine ho" ' robust the plan is, and ,vhether or not additional strategies or contingency plans need to be developed. Individual products are not represented in the plan as it would be cun1berson1e to include every product, so a company typically develops the APP by 1najor product fa1nily. Example: A cosmetic company may produce 1nany different products, such as mascara or lipstick, and each " 'ith different colors, different styles, and package sizes. Including all of these in a plan ,vould be cu1nberso1ne. TI1e aggregate plan considers a product grouping such as "tubes of lipstick" or "bottles of n1ascara" as a product n1easure for aggregate planning purposes. The ai.Jn is to develop tl1e aggregate production plan to cover all of tl1e operations resources (1nacllines, labor, and inventory), to produce the an1ount of product needed over a certain period of time. The aggregate plan wiJl then specify, for a particular period, ho,v many units of product are produced, ho"' 1nuch labor is needed, and ho" ' 1nuch inventory is on hand. Using product families reduces the level of detail but still provides tl1e i.J1fonnation needed for decision n1aki.J1g. S01ue conunon tenns of output used i.J1 the aggregate plans are units, gallons, pounds, standard hours, and dollars. Aggregate production planning is an iterative and ongoing process. The plan should be updated once every three months, rolling the plan out three more 1nonths into the future each tin1e, or ,vhenever there is a major change- whichever comes first. The APP is an intennediate plan and does not need to be updated continuously. Updating the APP too frequently ,viii add i.J1stability to the co1npany's operations.

Aggregate Production Planning Goals For the aggregate production planning process to be value added, it 1nust strive to acl1ieve son1e high-level goals, including: •

Meeting de1n and

•

Using capacity efficiently

•

Achieving the inventory targets

•

Mi.J1inlizing costs:

el~\J>kt 3: Supply Chain Planning

71

-

Labor Inventory Plant and equip1nent Subcontract

Available capacity versus de1nand: •

If capacity and demand are nearly equal en1phasis should be placed on 1neeting den1and as efficiently as possible.

•

If capacity is greater than demand the finn might choose promotion and advertising in order to increase de1nand.

•

If capacity is less than de1ua11d tl1e finn n1ight consider subcontracting a portion of the \\•orkload to an outside third party.

Aggregate Production Planning Strategies In order for the APP to achieve the desired goals, de1nand and supply n1ust be kept in balance. If tl1e APP projects a potential imbalance in de1nand and supply, there are some strategies typically en1ployed by companies to ren1edy the projected in1balance before it actually occurs. TI1e foUo,ving are so1ne strategic actions con1panies can take on both the de1nand and supply sides of the plan to avoid the unbalance. DEMAND STRATEGIES:

•

Influencing demand: Companies can try to influence projected de1nand so that it aligns better to available production capacity (e.g., airlli1es and hotels offeri11g ,veekend discounts, telecon1munication con1panies offering " 'eekend rates, off-season purchase discounts, early bird specials, happy hour). These can be facilitated through advertising, pro1notional plans, and price discount strategies.

•

Backordering: Accept that de1nand ,viii be greater than supply capabilities during high demand periods and allo"' some demand to go unfulfilled. Ho"rever, this action

72

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

n1ay create a negative customer experience and in1pact the company in both the short and long tenn. •

Counter-seasonal product mix: Develop a product mix v,ith opposing trends (e.g., opposite seasons) that level the cu,nulative required production capacity (e.g., 1nanufacture la1vn n101vers for the su,nmer and sno1v blo\vers for the \Vinter).

SU PPLY STRATEGIES:

•

Change inventory levels: Increase inventories: Build stock in advance of demand in order to use available capacity. Decrease inventories: Ten1porarily reduce inventory belo\v nonnal safety stock levels during peak den1and periods to n1eet custon1er requirements.

•

Change capacity: Vary production output through overti1ne or idle tin1e. Vary "'orkforce size by hiring or layoff. Use part-time "'orkers. Subcontract the work.

The output of the aggregate planning process is the aggregate production plan, "'hich guides developn1ent of the master production schedule (refer to figure 3.2).

MASTER PRODUCTION SCHEDULING ........................................ "The Master Production Schedule (MPS) represents what the company plans to produce expressed in specific configurations, quantities, and dates. It becomes a set of planning numbers that drives ,naterial require,nents planning. TI1e 1naster production schedule n1ust take into account the forecast, the production plan, and other ilnportant considerations such as backlog, availability of ,naterial, availability of capacity, and manage1nent policies and goals:• 1

el~\J>kt 3: Supply Chain Planning

73

NOTE: For the service industry, the n1aster production schedule 1nay be the appointment log or

book, where capacity (e.g., skilled labor or professional service) is balanced ,vith demand. Unlike the APP, which is expressed as product families, the MPS is expressed as specific finished goods. lt is a detailed disaggregation of the aggregate production plan, listing the exact end items to be produced by a specific period, and includes ho,v operations ,viii use available resources. TI1is allov.•s the company to 1nake infonned conunitn1ents to custo1ners. "MPS is the plan that drives the business and conunits resources and 1naterials (costs) to 111eet the plan. The plan is ,vhat the business can achieve not necessarily ,vhat the custo1uer ,vants:•• The MPS is a statement of production, not a statement of demand. As such, individual products can be finished ahead of ti1ne (i.e., before they are required to n1eet de1nand) and held in inventory rather than finished as needed. TI1e 1naster production scheduler is the person responsible for balancing custon1er service and capacity usage (see figure 3.3). •

The MPS is reviev.•ed and updated as necessary-v.•eekly or even daily.

•

The planning horizon is shorter than APP, but longer than the lead ti1ne to produce the ite1n. Exan1ple: If the lead tin1e to produce an iten1 is 2 n1onths, then the planning horizon of MPS 1nust be more than 2 months but generally not as far out into the future as the 18 n1onths covered by the APP. Typically the planning horizon of MPS is 3 to 12 n1011ths.

Forecast _ _ _._ Customer Orders- - - ~ Beginning Inventory

Master Production Scheduling

_ _..,...~Projected Inventory ---►Available-to-Promise

- - - I i i .Master Production Schedule (MclA11rJ1 2016)

74

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Example: Aggregate Production Plan -+ Master Production Schedule

Oct

I ½WI

3,cxxiJ

,cxxil

3,CIX)I 3,cxxiJ

2.cxxil

½WI

3,cxxiJ 3,cxxiJ

~

"" 3,aoJ

Die

~

2-l)oorC.B

-.ooo,cars {

Ccnvtn,bl•s

Mo,IH Produdion Schtdult (MPS) fartQSI ('-000,C.S}

USO

customer Otders ('-Door C.SJ

LCIX>

Mo,IH ProdUdioo Schtdulo (MPS}

Projtatd Available 8'11nce~

Planning Formula Beginning Inventory (projected available balance fro1n the end of tl1e previous period), plus production (i.e., the MPS) quantity for tlie current period, minus the demand (i.e., custon1er orders or forecast) for the current period, equals the projected ending inventory (i.e., projected available balance) for the current period (see figure 3.4). Available-to-promise (ATP) is a business function that provides a response to customer order enquiries, based on resource availability. It generates available quantities of the requested product, and delivery due dates.

It represents "the unconunitted portion of a con1pany's inventory and planned production n1aintained in tlie n1aster schedule to support custon1er order pro1nising:'1 In simple tenns, it is a calculation to detern1ine ho"" much inventory the company will have at the end of each period that has not already been pron1ised/planned/allocated to future custon1er orders. TI1is infonnation ,viii help the con1pany respond to ne,v custon1er orders or inquiries, detennining ,vhetlier the con1pany ,,rill have enough available inventory to deliver against these new custon1er orders or not.

el~\J>kt 3: Supply Chain Planning

75

lhree basic n1ethods of calculating the ATP quantities: 1.

Discrete Available-to-Promise [(on hand+ supply - ordered) per period]

2.

Cwuulative Available-to-Promise without look ahead

3. Cu111ulative Available-to-Pro111ise 1vith look ahead

Discrete Available-to-Promise 1. Add the beginning inventory to the MPS [planned production] for period 1, subtracting the com1nitted customer orders (CCOs) fro1n period I up to but not including the period of the next sd1eduled MPS. 2.

For all subsequent periods, there are t\vo possibilities:

If no MPS has been scheduled for the period, the ATP is zero. If an MPS has been scheduled for the period, the ATP is the MPS 111inus the sum of all the CCOs from that period up to the period of the nex t scheduled MPS. 3.

If an ATP for any period is negative, the deficit must be subtracted fron1 the most recent positive ATP, and the ATP quantities 1nust then be revised to reflect these changes.

TIME FENCi NG ...................................................................... Because MPS is the plan that drives the business, even sn1all changes in the MPS can cause n1ajor changes in the detailed production schedule and the material plan, creating nervousness and instability throughout the organization. To 111ini111ize the i111pact of the inevitable changes in MPS that ,viii occur, many con1panies have adopted a ti111e fencing policy separating the planning horizon into a firmed time period and a planned time period. This means that the business agrees that it ,viii not change the l\1PS ,vi thin a given ,vindo"' of tirne (e.g., the first six ,veeks of the plan). •

F IRMED TIME P ERIOD: From the current date out several ,veeks into the future

A firn1 tune fence is established at the outer limit of this period to signify ,vhen changes can no longer be n1ade auto1natically or ,vithout prior approval. The plannu1g system or 111aster production scheduler is not allo,ved to auton1atically make changes in the firn1ed time period, only recornn1end changes. 76

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Recomn1ended changes must be reviewed and approved by an authorized person(s) ,vho ,viii then initiate the appropriate action. •

PLANNED TIME P ERIOD: From the end of the firmed tin1e period to the end of the planning

horizon The planning systen1 or the 1naster production scheduler can create or n1ake changes to planned orders in this ti1ne period based on the data and planning logic detennined by the co1npany, ,vithout prior approval. Figure 3.5 illustrates an example.

••

••

~

r... ,-,,..•

II' ~ W

-

l-iitnii· ___ _ ,. _rtoc1 ....,._....._ _...._ _ _, 11ii&1kil@ - .....- ..........- .....- ..P1anntc1 i r Tr I I I I I I I I I I I I I T1mt .....

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7

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(A1clamJ\ 2016)

•• While this tiine fencing policy n1ay help to mmiinize the nervousness and instability in the MPS created by changes, it can be extremely difficult to stick to as there is a tradeoffbel\veen maintaining the stability and effectiveness of the plan, and supporting a custon1ers' urgent requiI'e1nents.

BASIC PRODUCTION STRATEGIES ............................................. . 'The three basic production strategies that companies use to complete the production plan are the level production strategy, the chase production strategy, and the 1nixed production strategy. I.

Relies on a constant output rate ,vhile varying inventory and backlog according to fluctuating den1and. This strategy 1nay be adopted in cases ,vhere the changeover is long, or it's inefficient to stop/start. The co1upany relics on variable finished goods inventory and backlogs to n1eet den1and. This strategy works ,veil for make-to-stock finns. Exarnples include pl)"vood, steel, light bulbs, razors. Example: The established stable ,~•orkforce has a capacity to produce 50 tu1its per de1uand tin1e period. If custon1er de1uand decreases, the ,vorkforce is kept stable and excess inventory is produced. lf the den1and increases, the workforce is kept stable and the incremental demand is satisfied through any available excess inventory or by accepting a backlog (i.e., unfulfilled custo1ner de1nand) until such tin1e as there is sufficient excess inventory to supply the shortfall (see figw·e 3.6). LEVEL PRODUCTI ON STRATEGY:

el~\J>kt 3: Supply Chain Planning

77

:

Customer Demand

Workforce

Finished Output of Goods or Services

Backlog or Inventory

10

Constant Number of Workers

so

40 Inventory

20

Constant Number of Workers

so

30 Inventory

80

Constant Number of Workers

so

30 Backlog get shortfall from

••

\:I

..

inventory (MCUIIIIJ\ 2016)

2.

CHASE PRODUCTION STRATEGY: Adjusts capacity to n1atch den1and. The company hires and lays off workers 10 n1a1ch the finished product output to fluctuating den1and. Finished goods inventory remains constant. This strategy ,vorks \,1ell for make-to-order firn1s. Examples include airplane con1panies, because of their lengthy training tin1e. Union en1ployees are sent back to the union hall, ,vaiting to be recalled and collect unemployment in the interin1. Another example is \\1orkers ,vho harvest crops. Example: The established stable ,,,orkforce has a capacity to produce 20 units per dernand tin1e period. If the dernand drops to IO units, the con1pany ,vould fire/lay off up to half the ,,,orkforce. If the dernand increases to 30 units, the company would hire up to an additional 50% to n1eet den1and (see figure 3.7).

Customer Demand

Workforce

Finished Output of Goods or Services

10

Fire

10

20

Stable Workforce

20

30

Hire

30

I (A1clA111J\ 2016)

78

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

MIXED OR H YBRID P RODUCTION STRATEGY: Maintains stable core " 'Orkforce while using

other short-tern, n,eans such as overtime, subcontracting, and part-time helpers, to n,anage shorttenn den,and. Exa1nples include construction con1panies and retail stores at holiday season (see figure 3.8).

cc -- Customer Demand •• .. CIC 10

Workforce

Finished Output of Goods or Services

Stable Workforce

10

20

Work Overtime

20

so

Work Overtime & Outsource some Output Overtime, Part Time Help and Outsource

so

~ ••

80

80 (McLaurJ, 2016)

BILL OF MATERIALS ................................................................ The bill of materials (BOM) is a docun1ent that sho\vs an inclusive listing of all con1ponent parts and assemblies, and the quantity of each, needed to produce or assen1ble a single unit of a parent iten,. "It is used in conjunction \,•ith the master production schedule to determine the items for ,vhich purd1ase requisitions and production orders n1ust be released. A variety of display forrnats exist for bills of n1aterial, including the single-level Bill of Materials, indented Bill of Materials, modular (planning) Bill of Materials, transient Bill of Materials, n1atrix Bill of Materials, and costed Bill of Materials. .. 1l1e Bill of l>1aterials may also be called the forn,ula, recipe, or ingredients list in certain process industries."' The follo,ving are different types of bills of rnaterial used in supply chain planning: •

SINGLE LEVEL BILL OF MATERIALS: Display of components that are directly used in a

parent itern, together \Vith the quantity required of eacl1 co1nponent (i.e., the planning factor). Shows only the relationships one level do,m. 1

el~\J>kt 3: Supply Chain Planning

79

•

MULTILEVEL BILL OF MATERIALS: Display of all the con1ponents directly or indirectly used in a parent, together with the quantity required of each con1ponent (i.e., the planning factor). If a co1nponent is a subasse1nbly, blend, intennediate, for exa1nple, all its co1nponents and all their con1ponents also \viii be exhibited, do\,1n to purchased parts and ra,v n1aterials.' This is often presented as an indented bill of materials.

•

PLANNING BILL OF MATERIALS: "An artificial grouping of iten1s or events in bill-of-ma-

terial fonnat used to facilitate n1aster scheduling and material planning. It may include the historical average of den1and expressed as a percentage of total demand for all options ,vithin a feature or for a specific end iten1 " 'itliin a product fan1ily and is used as the quantity per in tl1e planning Bill of Materials." '

EXAMPLE OF How THE BOM Is USED: The recipe for baking a cake includes a list of ingredients and the instructions on hO\Y to actually combine those ingredients to make a cake. The list of ingredients is the bill of 1naterials, ,vhich in this example 1night include 4 cups of flour, I cup of \Valer, 4 eggs, I cup of sugar, etc. The bill of 1naterials tells you ,vhich ingredients and ho"' 1nuch of each ingredient you need to produce eacl1 individual "cake:' In this ex.a1nple tl1e cake is an independent de1nand ite1n, and tl1e ingredients are dependent demand items, defined as follo,vs:

INDEPENDENT DEMAND: De1nand for an ite1n tl1at is unrelated to tile de1nand for oilier ite1ns (e.g., a finished product or spare/service parts). The demand for finished products generally con1es from the external custon1er, is independent from other items, and may therefore need to be forecast ed. It can be affected by trends, seasonal patterns, and general 1narket conditions. For example, if " 'e have been selling IO cakes per " 'eek for the past fe,.v months, ,ve can use this infonnation to create a forecast of how 1nany cakes \Ye expect to sell for the next fe"' ,veeks/inontl1s. This est:i.Jnate/ forecast for tl1e independent demand ite111 (i.e., cake) beco1nes the basis for detern1iI1ing how many cakes we will produce rn our production plan to satisfy the projected den1and.

DEPENDENT DEMAND: Den1and that is diI·ectly related to, or derived fron1, the bill of materials structure for other iten1s or finished products (a ra"' material, co1nponent part, packaging n1aterial, subassembly, etc.) used in 1naking a finished product or parent ite1n. Dependent de1nands are calculated and should not be forecasted. For ex.a1nple, if ,ve are going to bake a cake, and the BOM states that \\•e need 4 cups of flour for one cake, tl1e total an1ount of flouT tl1at \\•e need is entiI·ely dependent on ho,v 111any cakes \Ye are goillg to make. Flour is one of the dependent de111and items of the cake, ,vhich is the illdependent demand

80

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

iten1 in this exan1ple. If we plan to 1nake 10 cakes per week, and per the BOM "'e need 4 cups of flour for each cake, ,ve ,viii need 40 cups of flour in total each ,veek to make the planned IO cakes per ,veek. No forecast or esti1nation is needed for the flour because ,ve can calculate exactly ho"' 1nuch ,ve need based on the planned nun1ber of cakes.

Example: Single Level Bill ofMaterials Independent Demand • The external demand for an item that is unrelated t o the demand for ot her items (e.g., finished product). The demand for these items is forecast ed and can be affected by trends, seasonal patterns, and market condit ions.

Dependent Demand • the internal demand for items that are assembled or combined to make up the final product (e.g., component parts). Demand for t hese items is calculated based on the demand of the final product in which t he parts are used, by using t he planning factor.

Leg

4

End

2

Side

2

Top

1

Hardware Kit

1

• Planning Factor (Mc/,a11rJ1 2016)

Figure 3.9 is a single level BOM showing that for every table that is produced, 4 legs, 2 ends, 2 sides, I top, and I hard,~1are kit are required. The finished product (i.e., the table) is an independent de1nand ite111 forecasted based on anticipated external de111and. The co1nponent parts (leg, end, side, top, and hard,vare kit) are dependent de1nand ite1ns in ,vhich the den1and is calculated based on the nu1nber of tables that are planned for production.

el~\J>kt 3: Supply Chain Planning

81

Example: Multilevel Bill ofMaterials Finished Product

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Tire

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Level 3 ,_,_,

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(i\1cLa11ry, 2016)

Figure 3.10 is a n1ultilevel BOM sho"VIP, because all of the n1aterial, labor, and overhead costs are fully applied to finished goods. TI1e an1ount of finished goods inventory that a con1pany decides to 1naiI1tain is a strategic decision: •

Co1npanies can decide to operate a make-to-order supply chain ,vhere the finished goods are not produced until a custo1ner order is received, and the ra,v n1aterials 1nay not even be ordered from the supplier(s) ill advance. Once the custon1er order is received, the n1aterials are ordered/ delivered, the finished goods are produced, and the product shipped to the custon1er inm1ediately upon production. Little to no finished goods inventory is 1naintained by tl1e 1nanufacturer in a n1ake-to-order supply chain strategy.

98

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

•

Con1panies can alternatively decide to operate a make-to-stock supply chain where product is produced prior to receipt of a custo1ner order. A forecast and den1and plan are created for the finished goods based on anticipated de111and. The ra\v 1naterials are ordered in advance and the finished goods are produced against the production plan, \,,hich is based on the anticipated den1and, and then held in inventory until a custon1er order is received. Significant amounts of finished goods inventory can son1eti1nes be 1naintained by the n1anufacturer in a n1ake-to-stock supply chain strategy " 'hen large den1and is forecast.

Each of these strategies, and variations of these strategies, involves 1naking trade-offs an1ong inventory investn1ent, operating costs, and custo111er service. MA INTENANCE, REPAIR AND OPERATING (MRO) SUPPLIES are "iten1s used in support of

general operations and n1aintenance such as n1aintenance supplies, spare parts, and consun1ables used in the manufacturing process and supporting operations'.'' These are materials that you need to run the 1nanufacturing operation and the business but do not end up as part of the finished product. Son1e NIRO ite111s are consun1ed during the process of converting ra,v 1naterials into finished goods (e.g .. oil for the manufacturing equipn1ent). Other MRO items are used to facilitate the manufacturing operation (cleaning supplies, spare parts, etc.), and still other MRO items n1ay be used to facilitate the cornpany's ad111inistrative activities (office supplies, coffee for the break roon1, etc.). MRO inventory is separate fron1 production inventory, but it is just as important. It needs to be stored and accounted for sirnilarly to production ite1ns. As con1panies need MRO ite1ns to run their operations, a shortage of one or n1ore of these items rnay cause a supply disruption. Frequently these items are expensed at the time they are purchased, and there may be a separate function, group, or individual ,vho plans and orders these MRO items from tl1ose ,vho plan and order production ite111s.

INVENTORY IN THE SERVICE INDUSTRY

•••••••••••••••••••••••••••••••••••

Co111panies ir1 the service industry do not n1aintain inventory of services, because services are basically produced and consun1ed in11nediately upon de1nand. Companies in the service industry can, ho"'ever, 1naintain inventory of "facilitating products:• which are those ite111s tl1at are used to help facilitate the service beir1g provided. For exan1ple, a car rental service provides tile vehicles necessary to offer the rental service. The rental vehicles are facilitating products that can be inventoried in advance of providing the rental service. Restaurants offer dining services that involve preparing and servir1g the food, providing the seatir1g area, a1nbiance, cleanup, parking and valet, an1ong other amenities. Restaurants cannot inventory the actual dinir1g service; they can only begm tile service when the custo1ners arrive. Restaurants can, ho,vever, inventory the food, tableware, and other ele1nents of the dining operation as tl1ese are facilitating products necessary to provide tl1e dining ser-

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vice. Restaurants can even prepare some of their meal options in advance such as salads or deserts (i.e., inventory these facilitating products so they are ready to go \vhen the customers arrive for the dining service). Supply chains in the service industry "rill be covered in 1nore detail in Chapter 12.

FUNCTIONS OF INVENTORY .................................................... . There are four basic function of inventory, or reasons why con1panies hold inventory: I.

To n,eet customer den,and (cycle stock)

2. To buffer against uncertainty in den1and and/or supply (safety stock) 3. To decouple supply fron, den1and (strategic stock) 4. To decouple dependencies in the supply d1ain 1.

2.

To MEET CUSTOMER DEMAND: •

Meeting custo1ner de1nand is the purpose of"cycle stock."

•

Maintaining finished goods inventory allows a company to inm1ediately fill custon1er orders. A custon1er places an order \,,hich can then be shipped/delivered to hin, or her fron1 the available inventory.

•

Maintaining raw materials inventory helps a company ensure that the necessary materials will be available lo begin or continue the production plan/schedule uninterrupted.

•

To facilitate 1neeting custo1ner de1nand, co1npanies 1nay develop inventory deployn1ent strategies to ensure that the product is available ,vhen and \vhere the custo1ners \\•ant it Inventory deploy1nent strategies range from having all of the available inventory centrally located to having the inventory geographically dispersed to 1nultiple locations (e.g., distribution centers or retail outlets). 'TI1e n,ore dispersed the inventory is, tJ1e more likely it ,,,ill be that a higher level of inventory ,viii be needed to ensure adequate availability at all locations for all custo1ner den1and

To BUFFER AGAINST UNCERTAINTY IN DEMAND AND/ OR SU P PLY: •

100

A company 1nay decide to n1aintain son1e inventory of finished goods and/or ra"' materials due to uncertainty in demand. In the absence of actual custorner orders, the company n1ay FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

create a sales forecast (i.e., estimate den1and based on the information that it has about ,vhat custo1ners 1nay " 'ant). ll1e den1and plan is not likely to be I00% accurate. If the estimates are on the lo,v side (i.e., under-forecasted for any reason), and there is n1ore den1and than expected, the company will not be able to satisfy all of the de1nand unless it has proactively created a buffer or "safety stock'' of finished goods inventory fron1 ,vhich to satisfy this unanticipated den1and. Si1nilarly, the co1npany n1ay decide to create a safety stock of ra,v n1aterials in addition to, or in place of, finished goods safety stock to buffer for any unanticipated de1nand. •

A company 1nay also decide to rnaintain son1e inventory of finished goods and/or ra,,, n1aterials due to uncertainty in supply. Unexpected disruptions in supply can create a shortage, ,vhich leads to unfulfilled den1and and/or interrupted production plans and schedules. Suppliers, ,vhether internal or external, may be late ,vith delivery for any number of reasons or deliver a quantity less than ,vhat ,vas ordered, leading to a shortage. Even ra,,. 1uaterials or finished goods delivered on tune and i11 full n1ay be effected by quality problen1s and be unusable or unsalable. Because of the uncertainty of supply, some con1panies may proactively decide to create a buffer or safety stock of ra,v 1naterials and/or finished goods inventory frorn which to satisfy de1nand iii the event of a disruption and shortage.

•

ll1is is the purpose of"safety stock": an incren1ental quantity of stock kept in inventory to protect against fluctuations i11 either den1and or supply or a con1bination of both. Safety stock will be detailed later in this chapter.

3. To D ECOUP LE SUPPLY FROM D El\1AND:

•

TI1ere are a nun1ber of reasons ,vhy a company n1ay ,vant to buy an an1ount of ra,v n1aterials or produce an an1ount of finished goods that differs fron1 "'hat is specifically required by the dernand plan. This can result in inventory being held.

•

One reason to hold illventory n1ay be to achieve econon1ies of scale in ptu·cl1asing, n1antifacturil1g, and/or transportation. A con1pany 1nay receive a price break or discount from a supplier for buyillg a larger quantity than is specifically required, or receive a lo"•er per unit transportation cost for transporting a larger quantity in a truckload volume than in a less-than-truckload volume. If the price break, discount, or lo,ver per unit transportation cost is sufficient to offset the extra

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101

holding cost incurred as a result of the additional inventor)', then the decision lo bu)' the larger quantity is justified. Inventor)' can also be used as a hedge against price increases. •

Another reason lo hold inventor)' 1na)' be the decision to manufacture a finished product in full production lots rather than sn1aller quantities, because it 1nay be 1nore economical, n1ore efficient, offer n1ore consistent and better qualit)' control, or be n1ore appropriate for equip1nent operating require111ents.

•

ln each of these exan1ples the additional quantity purchased or 1nanufactured results in inventor)' that may be held for some period of time before it is used or sold.

4. To DECOUPLE DEPENDENCIES IN THE SUPPLY CHAIN: •

Inventory can be held bel\veen dependent operations in 1nanufacturing to decouple the dependenC)' of the operations. Sequential operations in n1anufacturing are dependent upon previous operations (i.e., production steps), to continue the manufacturing process. lfthere is a disruption of an upstrea1n (previous) operation due to a 1naterial shortage, labor issue, equip1nent proble1n, etc., then all do,vnstrea1n (subsequent) operations ,viii also be disrupted. lf son1e inventor)' of n1aterials or work in process is n1aintained bet,veen operations, then operations do,vnstream fro1n the disruption may be able to continue the manufacturing process for son1e period of tilne, perhaps even until the disruption is resolved. TI1is inventory helps to decouple son1e of the dependencies in the supply chain.

•

Inventory can also be used to sn1ooth or level den1and require1nents ,vhen den1and is irregular, seasonal, and so forth. For example, if a co1npany manufactures and sells seasonal products such as sno,v blo,vers or la,vn n1owers, the demand for those products is likel)' to peak during the season and fall off significantly in the off-season. It 1nay be very inefficient for tl1e con1pany to adjust 1nanufacturing capacity to 1natch the den1and in each season. TI1e con1pany 111a)' decide to adopt a level production strategy where the)' establish a steady manufacturing output rate based on the anticipated annual volume. The company can build up inventory ,vhen de1nand is lo,v, keeping ,vorkers busy during slack tilnes, so that v.•hen den1and picks up, the increased inventory can be slo,vly depleted ilirough nonnal in-season sales and the con1pany does not have to react by increasing production. The con1pany can avoid excessive overtime and the hiring, training, and other associated labor costs associated ,vith hiring n1ore v.•orkers to 1neet tl1e increased de1nand. It can also avoid layoff costs and the potential loss of skilled ,,,orkers in the off-season associated ",ith production cutbacks. Tius strategy might even prevent the idling or shutting do,vn of facilities. Tius type of level production strategy is designed to sn1ooth the peaks and valleys in demand, allo,ving the company to n1ai.ntai.o a constant level of output and a stable ,vorkforce.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

The steady n,anufacturing output rate means that the con,pany ,vill overproduce against detnand in the off-season in order to create inventory to meet the higher den,and in-season ,vhen it ,vill be underproducing against de1nancl By shifting den,and requirements to earlier tin1e periods and leveling the de1nand, inventory levels throughout the year vary significantly. lf inventory levels could not fluctuate in this ,vay, the manufacturing output- and associated labor, n1aterials, and costs- would need to fluctuate. 11,is tactic is co1nn1only used by retailers ,vho routinely build up inventory months before the den1and for their product peaks (e.g., at Hallo\\'een, at Christlnas, tl1e back-to-sd1ool season}.

INVENTORY MANAGEMENT .................................................... INVENTORY MANAGEMENT is defined as "the branch of business management concerned " 'ith planning and controlling inventories:•• Inventory n1anage1nent can help a con1pany be n1ore profitable by lo"•ering tl1e cost of goods sold and/or by increasing sales. Sn1all cost reductions fro1n tl1e application of sound inventory 1nanagen1ent principles can result in a significant increase in net inco1ne. Efficient inventory processes during the production phase of a product's life siinultaneously reduce costly ,vork stoppages and inventory storage costs. Reducing the amount of finished inventory that is held in stock reduces storage costs for the iten1. So long as tl1e production and distribution channels for a given product are efficient, tl1ese inventory savings translate into 1nore profit while selling the product for the san1e price. The stated advantages of maintaining sn1aller illventories are predicated on the notion of having sufficient supply as inventory management must balance t\vo competing considerations: ( I) reduce the amount of inventory held in stock, and (2) ensure there is enough inventory to satisfy custo1ner de1nand. Effective inventory 1nanagen1ent balances these t\vo considerations to achieve tl1e stated goals of lo·wering costs and increasing sales. Although sales are still tied to den1and, custo1ners cannot satisfy their de1nand if an ite1n is out of stock. Not haviI1g product available for custon1ers when they place orders is one of the self-defeating mistakes a con,pany can make. There are some products customers do not expect to receive inunediately, but any stockout adds delays in delivering a finished product to the cu stonier or adds cost to the n1anufacturer. lf 1nanufacturing supplies are out of stock, the conipany may have to expedite delivery of materials, expedite new production, spend extra n1oney ,vorking overtime, and use premiun, modes of transportation, to satisfy the custon,er demand. Any of tl1ese remedies effectively negate any cost savings generated fro1n 1naintaining lo,ver inventory levels, and not iI1vestiI1g in one of these costly solutions ,vill likely lead to upset customers, effectively decreasing future sales.

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Balance in inventory management is crucial. Effective inventory n1anagemen1 can yield decreased costs and/or increased sales, but sometimes co1npanies 1nay opt to concentrate on one end or the other and accept the potential trade-offs of their inventory decision: •

If a co1npany's supply chain strategy is to operate an efficient capabilities model, the company can choose to n1aintain a son1e\,1hat 1nore reduced level of inventory held at a centralized location, which 111ay potentially be n1ore ren1ote fro111 the customer(s). This strategy decreases the overall inventory costs, but increases the risk of a custon1er service issue.

•

If a company's supply chain strategy is to operate a responsive capabilities model, the company can choose to maintain a so1ne\',hat higher level of inventory held al multiple decentralized locations ,vhich 1nay potentially be closer to the custo1ner(s). This strategy increases the overall inventory costs, but reduces the risk of a custon1er service issue occurring.

So, ,vhat is the right ainount of inventory? The ans,ver to that question is, "It depends." TI1ere are many factors that go into detern1ining the right amount of inventory for a particular co1npany/ product. It depends on the supply chain strategy and setup, the type of product(s), custon1ers' expectations, custo1ner service objectives, product shelf life, a1nong other factors.

INVENTORY STOCKING LEVELS

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As introduced earlier in this chapter, there are various levels of stock held by con1panies to meet custorner demand, to buffer against uncertainty in den1ai1d and/or supply, to decouple supply fro1n de1nand, ai1d to decouple dependencies in the supply cl1ain (see figure 4.1 ). TI1e three n1ain inventory stocking levels are: •

Cycle stock

•

Safety stock

•

Strategic stock

In addition, pipeline inventory, \vhich is external to the con1pany, n1ay have an in1pact on decisions that co111panies n1ake about ho,v to 111anage and control their inventory resources.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

There are three levels of internal inventory which may be held by companies to: •

Meet customer demand

•

Buffer against uncertainty in demand and/or supply

•

Decouple supply from demand

•

Decouple dependencies in the supply chain

There may also be inventory which is held external to the company by downstream supply chain trading partners

Internal Inventory (,t,;c etc ~.c-:o· , •

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a temporary increase in inventory levels). This is also sometin1es called "build stock;' "seasonal inventory;· or "seasonal stock:'

Pipeline Inventory The first three types of stock in the upper half of figure 4.1 (cycle stock, safety stock, and strategic stock) are inventory, v,hich is internal to the company. ln the lower half of figure 4.1 you ,viii see pipeline inventory, ,vhich is external to the con1pany.

..-------------

~r:

PipeIi ne Inventory

Time

• ln-ttntorv ,n trJn"4t.

• lnvrntOol=lrrs. d,uributors. rtUtltrs. and customers.

ernal Inventory

Pipeline inventory is "inventory in the transportation net,vork and the distribution systern, including the flo,v through interrnediate stocking points."1 Pipeline inventory is in-transit, either out to the distribution channels or already out in the n1arket being held by ,vholesalers, distributors, retailers, and even consumers. The o,vnership of this inventory has been transferred to the con1pany's do,vnstrearn trading partners/custorners, but pipeline inventory rnay still influence decisions the con1pany 1nakes regarding how it rnanages and controls its internal inventory. Cornpanies n1ake inventory decisions regularly to rernain cornpetitive and to rnaintain their inventory strategy. In addition to factors such as the type of distribution nen,,ork and the type and nature of the finished products in the supply chain, a company should consider all of the inventory in the supply chain holisticaHy (i.e., internaHy and externally) "'hen detennining ho,v much safety stock and/or strategic stock to hold. •

If pipeline inventory is high, it rnight be less critical for the con1pany to maintain higher levels of safety and strategic stocks. A short-terrn supply disruption causing a ten1porary backorder (i.e., an unfilled custo111er order or co111mitn1ent) to intermediary custo111ers such as ,vholesalers and distributors might not necessarily turn into a rnajor market stockout, because there is a lot of inventory rnoving do\\1nstrean1.

•

Conversely, if pipeline inventory is lo,v, any issue that happens in the n1arketplace ,viii likely have a larger and rnore inunediate in1pact on the overall supply situation and, therefore, rnore safety and/or strategic stock n1ay be ,varranted.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Obsolete Inventory A company may also experience son1e level of obsolete inventory. These are "inventory items that have 1net the obsolescence criteria established by the organization. For exarnple, inventory that has been superseded by a ne,,• rnodel or othenvise rnade obsolescent. Obsolete inventory ,vill never be used or sold at full value. Disposing of the obsolete inventory n1ay reduce a company's profit:'' Simply put, obsolete inventory is stock that is expired, damaged, or no longer needed. Writing this obsolete inventory off of the books and disposing of it rnay be a difficult decision to n1ake as all or part of the obsolete product's value n1ay be lost. Unusable inventory does, ho\\•ever, take up space and cost ,noney to maintain, so it may be better to absorb the loss as soon as an ilen1 has n1et the obsolescence criteria than delay and continue to lose money on storage and related fees. Ho,,•ever, there rnay be a cost associated \\•ith the actual disposal of the obsolete inventory, depending on the type and method of disposal. Son1e con1panies ,nay find ,vays to donate this inventory to a nonprofit organization if it has any ren1aining value, ,vhich not only helps the nonprofit but also avoids disposal costs and 1nay result in a tax benefit for the con1pany.

INVENTORY COSTS

••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••

The categories of costs associated ,vith inventory are described as follows: DIRECT COSTS are expenditures that are directly traceable to the volun1e of units produced. Ex-

amples are labor, n1aterials, and expenses specifically related to the production of a product. INDIRECT COSTS are expenditures that cannot be traced directly to the volu111e of units produced.

Exan1ples are depreciation, administrative expenses, overhead, MRO iten1s, buildings, equipment, and utilities. Indirect costs n1ay be either fixed or variable and are typically allocated to a cost object as defined by individual con1pa11y policy. FIXED COSTS are expenditures that do not vary \\•ith the volwne of units produced. Exainples are

rent, property tax, and salaries of certain personnel, all of ,vhich are independent fro111 the output. Fixed costs are frequently time related (i.e., paid on a weekly, monthly, or annual basis). They are generally referred to as overhead costs. Fixed costs are, ho,vever, not permanently fixed; they are fixed only for the relevant period of tune. VVhether a cornpany manufactures I unit, 100 units, or 1,000 units, a manufacturing facility is needed. The cost is fixed in the inunediate tune period regardless of ho"' n1a11y units are produced. Even if no units are produced, there is still a cost for the building, depreciation, il1surance, security, maintenance, and so forth. 1l1e building represents a fixed cost no matter whether the building is owned

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or leased by the company. However, in the long run, the fixed cost may change as the building depreciates, the lease expires and is rene\\red, etc. At that point it " rill become a ne\v or revised fixed cost

VARIABLE COSTS are expenditures that vary directly \Vith a change of even one unit in the volume produced. Exainples are direct labor and n1aterials consu1ned, sales co1nmissions, and allocated overhead. Variable costs rise as production increases and fall as production decreases. Generally, the cost of goods sold (COGS) are variable costs. ORDER COSTS are the direct labor cost incu1-red ,vhen a purchaser places an order. Order costs are "used in calculating order quantities, [they are) the costs that increase as the number of orders placed increases. It includes costs related to the clerical ,vork of preparing, releasing, monitoring, and receiving orders, the physical handling of goods, inspections, ai1d setup costs, as applicable.''' Every titne an order is placed, regardless of the quaJ1tity of the order, there is a cost associated " rith processing the order. CARRYING COSTS are "the cost of holding inventory, usually defined as a percentage of the dollar value of inventory per unit of time (generally one year). Carrying cost depends mainly on the cost of capital invested as ,velJ as the costs of 1naintaining the inventory, taxes and insurance, obsolescence, spoilage, and space occupied. Such costs vary fron1 10 percent to 35 percent annually, depending on type of industry. Carrying cost is ultitnately a policy variable reflecting the opportunity cost of alternative uses for the funds that have been invested in inventory.'' Carrying costs are a.lso called "holding costs.''

Hidden Costs ofInventory Having too much or too little inventory on hand can create hidden costs that ,vill negatively in1pact a con1pany. Co1npanies need to be av.rare of these hidden costs. Financial resources tied up in too much inventory are not available for other purposes (e.g., research ai1d developn1ent, 1narketing and sales, shareholder dividends and salary increases). Excess inventory n1akes n1eeting custo1ner de1nand easier, but it n1ight also be 1nasking underlying problen1s ,vith the supply chain. Moreover, excess inventory sitting on shelves n1eans quality control issues may take longer to uncover, eventually leading to future inventory and n1aJ1ufacturing costs. Too little inventory, on the contrary, leads to production disruptions due to unavailability of materials, ,vhich can cause loss of sales and revenue from dissatisfied custo1ners, cancelation of orders, idle ,vorkers and equip1nent, extra 111achit1ery setups, loss of quantity discounts on purchases, ai1d more. Longer replenishn1ent lead ti111es and reduced responsiveness to customers ultin1ately yield lower sales.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

INVENTORY INVESTMENT

••••••••••••••••••••••••••••••••••••••••••••••••••••••

As discussed earlier in this chapter, inventory is typically a significant asset for a co1npany, but it can be a liability as ,veil. Co111panies should 111easu1·e inventory investn1ent routinely to ensure that their inventory practices do not adversely affect their co111petitiveness. Two co1nn1on 1neasures con1panies use are absolute inventory value and inventory turnover. ABSOLUTE INVENTORY VALUE is defined as

"the value of the inventory at either its cost or its market value. Because inventory value can change ,vith ti1ne, so111e recognition is taken of the age distribution of inventory. Therefore, the cost value of inventory is usually con1puted on (1) a FIFO, i.e., first in first out basis, n1eaning that the oldest inventory is used/sold first, (2) a LIFO, i.e., last in first out basis, meaning the ne\vest inventory is used/sold first, or (3) a standard cost basis, to establish the cost of goods sold:'1 Absolute inventory value is the cost of all finished goods and 111aterials a co111pany has on hand. This value 1nay be required for reporting on financial state1nents such as a co111pany's balance sheet. INVENTORY TuRNOVER is "the nw11ber oftin1es that an inventory cycles, or 'turns over: during

the year. A frequently used n1etl1od to co111pute inventory turnover is to divide the average inventory level into the annual cost of sales. For example, an average inventory of $3 million divided into an annual cost of sales of $21 million 111eans that inventory turned over seven times:•1 (See figure 4.2.) Generally, the 1nore turns, the better. TI1e 1nore tunes inventory is replenished, tl1e less opportwlity there is for it to expire, becon1e obsolete, spoil, or beco1ne da1naged. Inventory turnover n1easures the speed \vith which inventory passes through an organization or supply chain. It is a measure of 1nanagerial pro\\•ess. If a co1npany can turn inventory over very quickly, it likely n1eans that it is converting raw 1naterial expenditures into sales revenue very quickly, utilizing the inventory asset to generate income very efficiently.

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Cost of Goods Sold (COGS) Inventory Turnover Ratio

aka, Cost of Sales or Cost of Revenue

Average Inventory @ Cost

..

(A1cla1t1JI 20/ 6)

INDEPENDENT AND DEPENDENT DEMAND

•••••••••••••••••••••••••••••

INDEPENDENT D EMAND is "the demand for an item that is unrelated to the den1and for other items.

De1nand for finished goods, parts required for destructive testing, and service part~ requirement~ are exan1ples of independent den1and:' 1 Independent den1and is usually based on actual custon1er orders or son1e type of forecast, which by its nature creates son1e uncertainty and variability. The potential for variability is even greater when there is a lack of collaboration " 'ith customers. The uncertainty is a key driver in detern1ining " 'hat inventory n1anage1nent model to use. Independent den1and ite1ns are typically n1anaged using a "replenislunent philosophy" (i.e., reordered ,_,hen the currently inventory diminishes to a predefined level). These invent.Or}' ordering n1odels are stochastic or deterministic and include fixed-order quantity and fixed-tune period order quantity, " 'hich are discussed later in this chapter. DEPENDENT D El\i AND is "demand that is directly related to or derived from the bill of material

structure for other items or end products. Such de1nands are therefore calculated and need not and should not be forecast. A given inventory ite1n 1nay have both dependent and independent den1and at any given titne. For example, a part 1nay sin1ultaneously be the con1ponent of an asse111bly and sold as a service part:'• inventory n1anagement and determination for dependent den1and items is considerably different fro1n independent detnand iten1s, because there is significantly less uncertainty and variability. TI1e variability for a dependent den1and iten1 is directly related to ho,_, n1uch variability there is for the end iten1, from v,hich its demand is derived. Dependent demand iten1s are typically managed using a "requiren1ents philosophy" (i.e., only ordered as needed based on higher level co1nponents or products). TI1ese inventory ordering 1nodels include 1naterial require1nents pla1u1ing, kanban, and di-u1n-buffer-rope.

INVENTORV POLICY

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An inventory policy is "a state1nent of a company's goals and approach to tl1e manage1nent of inventories."' Inventory policies establish target inventory levels for all products and materials and the methods and systen1s used to achieve and 1nait1tain target goals. 112

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Inventory policies address the fundan1ental inventory concerns: l.

v\lhen to review inventory?

2.

When to order replenislunent inventory?

3.

Hov.r rnuch inventory to order?

WHEN T O R EVIEW INVENT ORY

There are l\vo basic approaches of inventory reviews that determine when replenishment orders must be placed. and each involves sorne trade-offs: •

In this method, inventory levels are continuously revie,ved. As soon as the inventory/stock falls below a predeterrnined level (i.e.. reorder point). a replenislunent order is triggered. A continuous revie,v syste1n is n1ore costly to conduct ilian a periodic revie,v systen1, but it potentially requires less safety stock because inventory is constantly n1onitored and replenishment actions are taken n1ore quickly. CONT INUOUS REVIE\V:

Advantages: Continuous inventory review systems allow for real-tin1e updates of inventory, ,\1hich can make it easier to kno,v ,vhen to replenish. "This n1ethod also facilitates accurate accounting. because the inventory systern can generate real-tirne costs of goods sold. Disadvantages: The continuous inventory revie"' systern is costly to implement. The hard,,1are and sofuvare necessary to run tl1e systern can be expensive to ptuchase, ir1stall, and rnaintain. •

In this n1etl1od. inventory levels are revie,ved at a set frequency (,veekly. n1onthly, etc.). At the tirne of revie,v, if ilie stock levels are belo,v the predetennined level (i.e.. reorder point), then an order for replenishn1ent is placed, othenvise no action is taken until the next cycle. This method segments the inventory iten1s into revie,v "buckets" (i.e., time periods), n1aking it easier to n1anage " 'hen using a rnanual process. when tl1e nurnber of iterns involved is extre1nely large. or ,vhen constraints exist. A periodic revie,v syste1n is less expensive to in1plement and operate than a continuous review syste1n. H0\\1ever, since inventory items are only revie\\1ed periodically. there is a greater risk of inventory dropping ,veil belo,v the reorder point trigger bet\veen revie,v points and there is a corresponding greater potential need for safety stock. P ERI ODI C R EVIE\V:

Advantages: Periodic ir1ventory revie,v systen1s reduce ilie tirne spent analyzir1g inventory, , \1hich allo,vs more tirue for other aspects of running the business. These systen1s are less expen sive than contil1uous counterparts.

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Disadvantages: It n1ay not provide accurate inventory counts for businesses ,vilh high sales volu1ne. You 1nust make assu1nptions benveen inventory revie\\• periods regarding inventory cow1ts, ,vhich can n1ake it difficult to detennine ,vhen reordering iten1s is necessary. It also can 1nake inventory accounting less accurate. W H EN TO ORDER REPLENISH MENT INVENTORY

Most, if not all, inventory replenish1nent systen1s use son1e type of predetennined reorder point to trigger a replenish order. A reorder point is "a set inventory level ,vhere, if the total stock on hand plus [ the stock] on order falls to or below that point, action is taken to replenish the stock. The order point is normaHy calculated as forecasted usage during the replenishment lead time plus safety stock:'• The reorder point is the lo·west inventory level at ,vhich a ne,v order n1ust be placed to avoid a stockout. This 1neans that the reorder point is set at the level of ren1aining inventory that is sufficient to cover all of the den1and that is projected to occur during the lead time necessary to receive the replenishment supply. If the replenishment lead time is JO days, and the projected de1nand is 5 units per day, the reorder point should be set at 50 units of re1naining inventory. When inventory drops down to 50 w1its, a replenishn1ent order is triggered for delivery in l 0 days: 5 units of de1nand per day x 10 days of lead time needed for replenishn1ent = reorder point of R EORD ER POIN T W ITHOUT SA FETY S T OCK:

Demand (0)

Inventory On Hand

=150 monlh I 30 days =S units/day

Lead Time (LT)= 10 days Safety Stock (SS) = 0 units Reorder Point (RO P )

----

150 Units

ROP • 50 Units

=D x LT+ ss =(S) x (10) + (0) =50 un,ts

-Tod•y

---

.- -

300oyo

.. -

60 O.yo

900ayo

-

-►

Time

(/11cl.Aury. 2016)

114

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

50 units of remaining inventory. (See figure 4.3.) ln this exan1ple the replenishment order will be delivered to the co1npa ny just as the inventory drops to zero but not after, avoiding a stockout. If the replenislunent order is placed after the re1naining inventory drops belo,v 50 w1its, then the co1npany ,viii likely run out of stock before the replenishn1ent order is received 10 days later. REORDER POINT ,v1TH SAFETY STOCK: If the replenishn1ent lead tin1e is 10 days, and the

projected demand is 5 units per day, and the company has a desired safety stock of 25 units, the reorder point should be set at 75 units of remaining inventory. When inventory drops do,vn 10 75 units, a replenislunent order is triggered for delivery in IO days: 5 units of den1and per day x I0 days of lead tin1e needed for replenishn1ent + safety stock of 25 tu1its = reorder point of 75 units of re1naining inventory. (See figure 4.4.) In this example the replenishn1ent order ,viii be delivered to the company 10 days after the order is placed ,vhen there are still 25 units remaining in inventory. This safety stock of25 units ,viii help to ensure that a stockout is avoided by protecting for an upside in de1nand (i.e., > 5 tu1its/day) duTing the ti.Jue it takes to replenish the mventory, a late delivery of the replenishinenl order from the supplier (i.e., > 10 days to deliver), or potentially both. If the replenish1uent order is placed after the re1naining inventory drops belo,v 75 units but before inventory drops belo,v 50 units, the safety stock ,vill help to 1nitigate the risk of a stockout before the replenish1uent order is received l O days later. If the inventory dTops belo,v 50 units before the replenishn1ent order is placed, the safety stock ,viii have been consun1ed and the company ,viii likely run out of stock before the replenish1nent order is received IO days later.

Inventory On Hand 17S Umts

---

150Umw

ROP • 75 Units I I

.

..

-.

--

---

-

-►

I I

LT•100ays ....,.

A,.,ple.nh.hmen1 I

r .......,. :

OUMs .__ _ _ _ _ _ _ _ _ _ Safety _ _Stock _ _• 25 _UnitS _ _ _ _ _ _ _ _ _ _... Today

eJ~\J>kt 4: Inventory Management

30 Days

60 Days

90 Days

Time

115

How MUCH INVENTORY TO ORDER The t,vo n1ost conunon inventory ordering systen1 categories are: •

Fixed-Order Quantity

•

Fixed-Time Period

FIXED-ORDER QUANTITY is "an inventory system, such as Economic Order Quantity, in which

the sa,ne order quantity is used from order to order. ·n1e time benveen orders (i.e., order period) then varies fron1 order to order." ' In this fixed-order quantity 1uodel, inventory is n1onitored on a continuous basis. \¥hen the inventory position drops to a predetermined reorder point, the san1e predetermined fixed-order quantity is placed. This approach would be silnilar to an individual drivil1g a car and paying attention to the fuel gauge. \¥hen the fuel gauge sho,vs that fuel is depleted do,vn to a predetern1ined level {e.g., ¼ of a tank retnaining), the person pulls into the nearest fuel station to refill the tank (i.e., replenish the fuel inventory) back to the full level again. The reorder point for fuel is ¼ of a tank and the fixed-order quantity is ¾ of a tank, the a1nounl needed to restore the fuel inventory to the full level. The time interval betv.reen refills may vary depending on ho,v n1uch driving is done and, therefore, ho,,r much fuel is burned. The reorder point and the order quantity are both fixed, ho,vever. F IXED-TIME P ERIOD QUANTITY is "a 1nethod of inventory planning that 1neasures actual in-

ventory levels at regular intervals of ti1ne; either an order is placed every tin1e, or a check of i11ventory levels is made and an order placed if needed. Often the quantity ordered varies from period to period as inventory is restored to a predetermined level:'' This model may also be referred to as the "n1in-1nax inventory 1nodel" (i.e., ,vhen inventory reaches the 1nini1nun1 aJlo,vable level, the iten1 is reordered to its n1axin1wu aJlo,vable level). In this 1nodel, inventory levels are checked in fixed-tin1e i11tervals rather than continuously like in the fixed-order quantity 1nodel, and the quantity ordered varies based upon the i11ventory position ,vhen checked versus a target level. The review interval and the target inventory level are set based on factors and criteria detern1ined by the con1pany. Inventory is then checked at the prescribed intervals (e.g., every ,veek), and the re1naining i11ventory at that point iii ti1ne is 1neasured against the target inventory level. If the actual inventory is belo,v the target inventory level, an order is placed with a quantity necessary to restore the inventory level back to the target level. The an1ount of inventory ordered v.rill potentially vary fro1n period to period based on the remaining inventory at each ti1ne interval checked.

116

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

The forn1ula for this model is:

Q =R- IP Where: Q = order quantity R = target inventory level IP = inventor)' position

This 1nethod v,ould be sunilar to a person v,ho drives a car and only checks the fuel gauge every fifth day. Uthe fuel gauge shows that fuel is an)',\1here below a full tank remaming, the person pulls into the nearest fuel station to refill the tank (i.e., replenish the fuel inventory to the full level again). The target fuel inventory level is a full tank, and the reorder quantity ,viii vary ,vith ead1 fifth-day check dependu1g on hov.• 1nuch drivu1g is done and, therefore, hov.1 n1udl fuel "'as burned betlveen the fixed-tune period intervals. This approach might be adopted when an individual knows that norn1al driving v.•ill never take his or her car to a dangerously lo,v fuel level in the given tin1e period. ·n1is person ,vould likely not pick a ti.Jne interval of IO days if that tune period n1ight lead to an en1pty tank (i.e., a stockout). The biggest difference betlveen the fixed-order quantity 1nethod and the fixed-ti.Jne period quantity method is in the tuning and quantities of the orders placed. vVith the fixed-order quantity n1ethod, inventory is d1ecked on a contu1ual basis and the systen1 is set up to place orders as needed, regardless of tune since last reorder. This S)'Stem has an advantage of providing greater system responsiveness, but it also requires ad1ninistrative processes to be in place to operate on a continual basis. vVith the fixed-time period order quanticy method, an unexpected surge in den,and could lead to a stockout, because the inventory level is not checked on a contu1uous basis. This systen1, therefore, potentially requires carrying n1ore safety stock inventor)' than the fixed-order quantity systen1.

ECONOMIC ORDER QUANTITY MODEL ...................................... E CONOM IC ORDER Q UA NTI TY (EOQ) is "a type of fixed order quantity n1odel that detennines

the amount of an iten1 to be purchased or 1nanufactured at one tin1e. The intent is to n1inunize the combined costs of acquirmg and carrying mventory:· 1 EOQ is a quantitative decision model based on the trade-off between the inventory carrying costs and the order costs. The objective of this model is to find the point of intersection of these two

eJ~\J>kt 4: Inventory Management

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costs in order to find the order quantity that bears the lo,vest total cost to meet projected demand. l11e opti1nal order quantity \\•ill become the quantity for every order placed until the next EOQ is calculated. It is ilnportant to note that the EOQ is a real calculation, but its \\•orth is lilnited because the variables do not hold true over ti111e. The calculation is still good as a baseline for ordering. but a supply chaill manager ,viii need to n1ake adjustments. The basic EOQ forn1ula is:

EOQ= ✓

2 x Order Cost x Annual Demand Volume Annual Carrying Cost % x Unit Cost

EOQ = The square root of2 tin1es the Order cost ti111es the Annual demand volun1e divided by the Annual carrying cost percentage ti,nes the Unit cost.

ORDER COSTS (v,hich \\•ere defined earlier in this chapter) are costs that are incurred each tin1e an order is placed. l11ese costs include order preparation costs, order transportation costs, and order receipt processing costs. Order costs are not in1pacted by the volun1e of inventory being ordered, only by the number of orders being placed per year. A NNUAL DEMAND VOLUME is the projected cumulative quantity of the item to be consumed/

sold over the course of a year.

CARRYING COSTS (which were defined earlier ill this chapter) are "the cost of boldillg inventory, usually defined as a percentage of the dollar value of inventory per unit of ti1ne (generally one year)." These costs include the cost of capital (i.e., the interest paid on borro,ved n1oney, or the lost opportunity cost of the n1oney used to buy the inventory), taxes on the inventory held ill storage, insurance, obsolescence, and physical storage. Carrying costs vary depending on ho,v much inventory is bought and held. l11e annual carrying cost percentage is the carrying cost co1nputed for a year and then expressed as a percentage of the cost of the inventory ite111. Co111panies typically adopt a standard such as 20% to use for this calculation. UNIT COST is the total expenditure il1curred by a con1pany to produce, store, and sell one unit of a particular product or service. Unit costs include all fixed costs, or overhead costs, and aU variable costs, or direct n1aterial costs and direct labor costs, involved in production. Demand volume and the carrying cost must both be expressed in annual quantity tern1s for the forn1ula to produce the desired results.

118

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

EOQ Example:

Order Cost

$25 per order

Annual Demand Volume

5,000 units

Annual Inventory Carrying Cost{%)

20% per year

Unit Value @ Cost

$5 per unit

EOQ =✓ 2

x 25 x 5,000

0.20

X

5.00

=✓ 250i000 =✓ 250,000 =500

Proof: Annual Order Cost is (5,000/500 x s25.00) = 10 x $25 = s250 Annual Carrying Cost is (500/2 x (5 x 0.20)) = 250 x 1 = 5250

Costs($)

Annual lotnl cost

I $500

•• ••

$250

•• ••

•• •• •

• EOQ = 500 units

I

Annuol ordering cost

Order Quantity (units) (McLat1T)\ 2016)

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119

EXP LAINING THE EOQ G RAPH

The EOQ graph (figure 4.5) displays the relationship benveen ordering cost and carrying cost. The Total Cost line is, in fact, the sun1 of these tv.•o costs (i.e., the sum of the other lines). The Carrying Cost line sho,vs the costs for holding inventory based on the number of items held. As more items are held (1noving right on the x-axis), the carrying costs also rise. TI1e Ordering Cost line sho,vs ho,v n1uch it costs per ite1n for orders of different quantities. As the size of each order increases (again, moving right on the x-axis), the cost per iten1 decreases. Unlike carrying costs, ordering costs cannot be represented ,vith a sin1ple straight line. The Order Cost line does not typically begin \vith a zero value (touching the y-axis) as there are no order costs until an order is placed. If the order is for a single unit, the line \\•ould begin at I on the x-axis. If there are 1ninin1wn order require1nents, the line 1vould start at this 1ninilnwu quantity. As this line 1noves toward the right, it will consistently get lo,ver as the ordering costs are shared by more and 1nore items in the order, but the line " 'ill never reach zero ($0). There is a point of di 1ninishing return, ho,,•ever, and this is ,vhy the Total Cost line eventually turns back up: The savings generated by placing a larger order no longer offset tl1e carrying costs of the additional ite1ns. TI1e EOQ is specifically targeted at finding the point of greatest return, ,vhere the savings generated by larger orders co1nbil1ed \vith the carrying costs for those iten1s is the lo,vest. As described earlier, this point is the intersection of the Carryil1g Cost and Order Cost lines. To the left of this point, carrying costs are lo,ver, but the price per item is significantly higher. To the right of this intersection, tl1e carrying costs for tl1e ite1ns are higher, but the order costs have decreased slightly, faili11g to offset the increased carrying costs. It is important to note that the EOQ generates an idealized value that n1ay not be possible in the real world (i.e., fractions of items or quantities not allo,ved by 1nanufacturers). Moving just a little to the left or right of the intersection \,•ill still allo"' a con1pany to realize 1nuch of the savings fro1n identifyil1g an EOQ. A SSUM PTIONS OF TH E EOQ M ODEL

TI1e EOQ rnodel involves some assun1ptions that must hold true for the n1odel to deliver the desired results: •

The 1nodel 1nust be calculated for one product at a time.

•

The demand must be kno,vn and constant throughout the year.

•

The delivery replenishment lead time is known and does not fluctuate.

120

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

•

Replenishment is instantaneous. There is no delay in the replenishn1ent of the stock, and the order is delivered in the quantity that ,vas demanded (i.e., in one v.•hole delivery).

•

The purchase price (i.e., unit cost) is constant and no discounts or price breaks are factored into the 1nodel.

•

Carrying cost is kno,\•n and constant.

•

Order cost is known and constant.

•

Stockouts are not allo"•ed

PRACTICAL CONSIDERATIONS OF

EOQ

As n1entioned earlier, the asswnptions outlined above rarely hold true over ti1ne in the real ,vorld. Supply chain 1nanagers typically need to consider aspects that 1night alter the ,vay they use the EOQ model. Some of the n1ore practical considerations v.•hich supply chain managers must consider include the follo,ving:

•

Volume Economies of Scale: Individual Iten1 Purchase Price Discounts. These discounts provide a lov.•er perunit cost ,vhen larger quantit'ies are ordered. If the volun1e discount is sufficient to offset the added cost from carrying additional inventory, then ordering a larger volume may be a desirable option, assu1ning obsolescence ,vi.11 not be an issue. To facilitate this decision, enterprise resource planning (ERP) syste,ns 1nust be progranuned v.•ith quantity discount logic to "'Ork with the EOQ formula to determine optimum order quantities. Multiple-lte111 Purchase Price Discounts. EOQ is calculated for one product at a time and does not consider any discounts for multiple item purchases, ,vhich v.•ould lower the unit cost of an iten1. If you purchase a co1nbination of ite1ns fron1 a supplier you 1nay be able to take advantage of a volwne discount based on the total volun1e across all the ite1ns purchased rather than just an individual item's volume. Transportation Freight-Rate Discounts. Carriers generally offer a rate discount for larger volume shipn1ents. A general rule of thumb for transportation is that the larger the shipment, the lo\\•er the cost per unit. Ordering a larger quantity may n1ean that you can take advantage of full truckload ship1nent rates, ,vhich ,vill lower the per w1it transportation costs. These adjustn1ents v.•ill vary the order cost at different order quantities, v.•hich is not accounted for in the standard EOQ n1odel.

eJ~\J>kt 4: Inventory Management

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•

Constraints: Lin1ited Capital. The EOQ 111odel n1ay generate an order quantity that the co111pany does not have sufficient available funds to purchase at one time. Capital limitations, ,vhich the n1odel does not consider, 1nay require that supply chain managers reduce the order quantity. -

Storage Capacity. Sin1ilar to limited capital, the EOQ model ,nay generate an order quantity that the con1pany does not have sufficient storage capacity to handle at one tin1e. Storage capacity lin1itations, ,,,hich the n1odel does not consider, 1nay also require that supply chain 111anagers reduce the order quantity.

-

Transportation. The nature of the ite111 being transported 1nay dictate the need for specialized or dedicated transportation, ,vhich may in turn impact the quantity per order. Certain con1111odities may be susceptible to time, tetnperature, contan1ination, or other types of issues necessitating the use of dedicated transport conveyances to prevent conuningling of products in a conveyance. Other products may be very high value and susceptible to theft requiring dedicated transport conveyances to ensure a direct (i.e., nonstop) secure delivery. In these cases, supply chain 1nanagers may want to increase order quantities to fill up the conveyance and to also 1nake fe,ver ship1nents per year. Obsolescence. l11e EOQ 111odel n1ay generate an order quantity that v.•ould create spoilage or obsolescence based on the iten1 nearing or reaching the end of its lifecycle before consu1nption, because too much was ordered at one tin1e. To resolve this issue, ERP systems may also include additional progra1nn1ing to detern1ine the maximum order quantity for an iten1 reacl1ing the end of the product lifecycle. Production Lot Size. The supplier n1ay require the company to order an itetn in full production lot sizes, particularly if the supplier does not have any other custo1ners for that iten1. Sin1ilarly, the company n1ay ,vant to order an ite111 in full production lot sizes, for various reasons (to ensure a consistent quality, due to the lot size of a key ra"' n1aterial, etc.). Unitizatjon (i.e., buying in full pack, case, pallet configurations). Similar to production lot size, the supplier n1ay require the company to order an item in full pack, case, or pallet configurations, particularly if the supplier does not have any other custon1ers for that iten1. Sin1ilarly, the co1npany n1ay ,vant to order an ite1n in full pack, case, or pallet configurations for various reasons of its o,vn.

As a result of these and other considerations, co1npanies 1nay calculate EOQ for use as a baseline and 1nake management decisions on how the output is used in practice. Managen1ent overrides may be necessary in response to so1ne of the considerations outlined above. 122

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

OTHER TYPES OF INVENTORY SYSTEMS

•••••••••••••••••••••••••••••••••••

The following are other types of inventory syste1ns that are essentially variations on the continuous and periodic reviev.• 1nethods:

•

ABC system is a type of inventory system that utilizes son1e measure of importance to classify inventory ite1ns and allocate control efforts accordingly. TI1is system takes advantage of " 'hat is co1nn1only called the 80/20 rule, 1vhicl1 holds that 20% of the items usually account for 80% of the value. The ABC classification is typically in decreasing order of annual dollar volun1e (price n1ultiplied by projected volume) or other sin1ilar criteria. "The ABC principle states that effort and cost can be saved by applying less stringent controls on lo,v volwne/value ite1ns than that v.•hich is applied to high volwne/value ite1ns. This principle is applicable to inventory, purchasing, sales, and the like. Not all ite1ns/products are equal, just like not all customers and not all suppliers are equal. Some are more in1portant than others. An ABC classification helps to identify ,vhich inventory ite1ns are 1nore i1nportant and ,vhich ones should receive the 1najority of efforts in optin1izing inventory. TI1e typical breakdo,.,n of an ABC classification is as follo,,•s (figure 4.6): Category A contains the 1nost in1portant ite1ns and typically represents 10% to 20% of the items and 50% to 70% of the value. Category B contains moderately i1nportant ite1ns, an d typically represents 20% of the iten1s and 20% of the value. Category C contains the least important items, and typically represents 60% to 70% of the items and l 0% to 30% of the value.

•

B C (Mcln11r, 2016)

Bin systems is a type of inventory syste1n that uses either one or tlvo bins to hold a quantity of the iten1 being inventoried (figure 4.7). It is n1ainly used for s1nall or lo,v value items. V.1hen the inventory in the first bin has been depleted, an order is placed to refill or replace the inventory.

eJ~\J>kt 4: Inventory Management

123

The second bin is set up to hold enough inventory to cover den1and during the replenishment lead time so as to last until the replacen1ent order arrives.

© Bin 112

Bin 111 Rtplcftts/1 lnwntorv

Bin 112

Bin 111

Demand

.

Rt ?lt nl>h Inventory

Bin 112

..,....,. . Demand

Bin 111 (Mcumry, 2016)

•

Tar get stock level (TSL) is a type of periodic inventory review system. TSL is the level of inventory that is needed to satisfy all demand for a product or ite1n over a specific time period. -

TSL = [Demand x (Lead time + Review time))+ Safety stock ln a n1in-1nax inventory syste1n, the TSL is the equivalent of the n1axin1U1u.

-

It is equal to the order point plus a variable order quantity. It is also kno,vn as an order-up-to -inventory level.

•

Base stock level systems are a type of inventory system that triggers a replenishment order ,vhenever a ,vithdra\val is 1nade fro1n inventory.

Replenishment order quantity is equal to the quantity ,vithdra\\•n fron1 inventory. -

This \Vill 1naintain the inventory at a base stock level. It is used prin1arily for very expensive ite1us (e.g., airplane engines).

•

"Single-period" inventory n1odel is a type of inventory syste1u in ,vhich inventory is only ordered for a one-tune stocking. The objective is to n1aximize profit.

124

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Often referred 10 as the newsboy or newsvendor problem, because nev.•spapers are usually printed only once per day in a certain quantity and imrnediately becon1e obsolete ,vhen the next issue is printed the follov;ing day. Magazines suffer similar short product lifespans. ll1is rnodel is used by vendors preparing for a very srnall sales ,vindo,v (e.g., fire\\•orks for the Fourth of July, Christ:111as trees, Hallo,veen costumes, Easter decorations}.

STOCK LEVELS AND REPLENISHMENT ...................................... Figu.re 4.8 looks rather con1plicated and can be intirnidating, but it illustrates ho"' the various types of stock relate 10 the process of supply and demand under a dynamically increasmg demand pattern. For illustrative purposes, figure 4.8 represents finished goods only.

Taritt

rnve,ntory Level

'

i

C:

oan.dlWW

o.--,,.,,_

Month '1

Month ,1

-""°" 1h13

==I

-MonthlS

Cycle

Stock

!:C

-

Safety

Stock

Pipeline

Inventory

The top half of the figure sho,vs the internal inventory, ,vhich consists of cycle stock and safety stock, ,vhile the bottorn half of the figw·e shows the external pipeline ir1ventory (or channel stock) divided eJ~\J>kt 4: Inventory Management

125

into Wholesale, Retail, and Consun1er inventories for illustrative purposes. These stock levels comprise the total inventory as indicated by the vertical axis. TI1e horizontal axis represents time moving for,vard fron1 left to right.

MONTH # t : Starting near the top left of the diagran1, the current inventory is exactly at the Target Inventory Level to begin tl1e De1nand Period for Month # 1. As ti1ne 1noves fonvard tllrough ?.1onth # 1, inventory is depleted at a constant rate (as indicated by the black diagonal line) exactly as anticipated by the demand plan, and Month # I ends by depleting the entire Cycle Stock as planned. Replenishn1ent lead ti1ne is one n1ontll, and an inventory replenislunent order ,vas placed earlier according to the de1nand plan. TI1e inventory replenislunent order quantity is equal to the projected demand for the following month and is the Target Inventory Level. This projected demand is represented by the peak at the beginning of Montl1 #2. ll1e replenishment order arrives on time and returns tl1e inventory back up to tile target inventory level to begin tile de1nand period for Month #2. MONTH #2: As tin1e n1oves for,vard through Month #2, inventory is depleted at a rate greater than anticipated by the de1nand plan and all of the Cycle Stock and s01ne of tl1e Safety Stock is used to meet customer demand. As this is tile very purpose of maintaining safety stock inventor y, th.is is perfectly acceptable. In fact, if safety stock is never used to adj ust for the uncertainty in demand, tlien safety stock is not needed and should be eliminated. An inventory replenish1nent quantity equal to the projected de1nand was placed at the beginning of tile n1onth. The replenislunent order arrives on time; however, since actual de1nand \\•as greater than projected den1and and necessitated use of some of the Safety Stock, the replenishment order quantity is not sufficient to return the inventory to the target inventory level to begin tl1e de1nand period for Montl1 #3. The de1nand 1night not be adjusted yet in order to see if the increase in den1and ,vas ten1porary or 1night be persistent, or the projections might be adjusted even without longitudinal data. MONTH #3: As time moves forward tllrough Month #3, inventory is again depleted at a rate greater than anticipated by the demand plan. All of the Cycle Stock and al.I of the Safety Stock is used to fill the unexpected volun1e of custo1ner de1nand. Again, as this is tl1e purpose of safety stock inventory, this is still acceptable. Month #3 ends at a critical point as all of the internal inventory (i.e., Cycle Stock and Safety Stock) has been depleted. Recognizing that the con1pany might be under-forecasting projected demand, in the absence of any additional or collaborative information about '"hY de1nand is increasing, an inventory replenislunent order is placed at tl1e beginning of Month #3 to arrive at 1nontll-end, but for a quantity significantly larger than previous orders. The replenislunent order arrives on lin1e; however, since a significantly larger quantity was ordered than in previous months, the replenishrnent order quantity returns the inventory to a level in excess of tl1e target to begin tl1e de1nand period for Month #4. The black line at tile end of Month #3 is above tl1e target inventory level indicating that inventory is above, or in excess of, target.

126

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

MONTH #4: As tune n1oves forward through Month #4, mventory is no,v being depleted at a rate even n,ore significant than the previous two months. The company is no,v forced to use ill of the Cycle Stock and all of the Safety Stock, and there are no,v \,Vholesaler/Distributor orders that cannot be filled as inventory is insufficient to satisfy the den1and. The black lli1e at the end of Month #4 is dippmg mto the Wholesale/Distributor mventory, mdicatiI1g unfulfilled demand. These unfulfilled custo1ner orders are kno,vn as "backorders:' Wholesalers/Distributors can/will contiI1ue to sell their pipelme inventory to their dov,nstream supply chain partners (i.e., Retailers and Consun,ers) until their stocks are depleted as ,veil. At this critical point, custo1ner service has been negatively ilnpacted as the co1npany's iln1nediate custo1ners (i.e., Wholesalers/Distributors) have unsatisfied den1and. Again, recognizing that they 1nay be under-forecasting de1nand, the con1pany placed an inventory replenish1nent order at the begiI1ning of Month 114 to arrive at month-end for a quantity similar to what was ordered at the begu,ning of Month #3. The replenislunent order arrives on tune; ho\\•ever, since actual de1nand ,vas once again significantly greater than projected de1nand and all Excess, Cycle, and Safety Stock \\•ere depleted, leaving the product on backorder ,vith the v\fholesalers/ Distributors, the replenishn1ent order quantity is not sufficient to return the inventory to the target inventory level to begin the den,and period for Month #5. The black line at the end of Month #4 stops belo,v the target inventory level.

MONTH #5: As ti1ne 1noves fonvard through Month #5, inventory is again being depleted at the accelerated rate experienced in Month #4 and all iI1ternal and external iI1ventory, including \,Vholesaler/Distributor and Retailer mventory, is fully depleted, creating a stockout in the n1arketplace. A stockout is the most serious inventory situation as it 1neans that there is no inventory available an)'\vhere internally or externally to support any further de1nand. At this point, custo1ner service is significantly and critically ilnpacted at all levels. Dan1age to the brand and the con1pany reputation 1nay occur, and business may be lost to con1petitors. Lost business may be temporary until replenish1nent inventory is available, or tl1is lost business might be permanently lost to competitors. COLLABORATIVE PLANNING, FORECASTING AND REPLENISHMENT (CPFR): Figure 4.8 illustrates the scenario for inventory chasing de1nand, reacting to an increasing de1nand pattern ,vithout any additional inforn1ation or collaboration ,vith your tradiI1g partners to ki10,v " 'hat is really happeniI1g. CPFR is "a collaboration process " 'hereby supply chain trading partners can jomtly plan key supply chain activities fron, production and delivery of ra"' materials to production and delivery of final products to end custon1ers. Collaboration enco1npasses business planning, sales forecasting, and all operations required to replenish ra,v 111aterials and finished goods. A process philosophy for facilitatmg collaborative conm1unications:'1 It is a process designed to avoid or mitigate the type of situation depicted in figure 4.8. CPFR helps an organization to be proactive and get out in front of tl1e situation before it spirals out of control. eJ~\J>kt 4: Inventory Management

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INVENTORY OPTIMIZATION

••••••••••••••••••••••••••••••••••••••••••••••••••

All of the ,nethods and approaches mentioned in this chapter look to optimize the inventory held by a company. 'TI1e optin1ization point is the intersection of inventory costs and customer service goals, and this point v.1ill be varied for different con1panies based on their capacities and philosophy. Identifying the appropriate inventory buffers is essential in realizing a company's 1nission. but these buffers can be set for individual sites or for an entire system. In single-echelon inventory optinlization, a distribution site is treated essentially as an island that holds needed inventory to meet the needs of its custo1ners, separate fro111 upstrea111 con1ponents. In 1nulti-echelon inventory optinlization (1'1EIO), inventory needs are established across various sites and levels of the supply chain, upstream and dov.1nstream, to meet the needs of the entire system's customers. MEIO initiatives typically reduce inventory by 10% to 30% v.1hile i1nproving service levels, resulting in dra1natically in1proved profitability and n1ore satisfied custo1ners. MEIO involves identifying n1ru1y vru·iables and constants, but the result is significant infonnation for in,proving inventory operations. INP UTS :

•

Desired Service Level is nonnally a user provided input. The desired service level depends on the ite,n in question: its sales attributes, de,nand, profitability, a11d associative relationship to the other ite1ns. Users norn1ally define groups of ite1ns that have similar at Iributes and desired service levels.

•

D em and is the historical and projected de,nand for the item.

•

Supply is the historical and projected supply of the ite111.

•

Supply Lead Time is the historical lead ti1ne of the supplies. The lead tilne 1nay vary for every order that is fulfilled even ·when using the srune iten1/vendor/distribution center con1binations. This tin1e-series data allov,s for the variability of such lead time and helps the inventory optinlization engine determine the probability that a specific projected supply \viii be realized on the needed date.

O UTPUTS:

•

Recom1nended safety stock levels

•

Recommended safety stock locations

•

Recon11nended reorder levels

•

Recon11nended order quantities

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

BENEFITS:

•

Inventory can typically be reduced by 10% to 30% by rightsizing inventory held at all stages (i.e., echelons) of the supply chain.

•

MEI O pro grains norn1ally reduce overall inventory v.rhile n1eeting or i.Jnproving service levels.

•

Decreasing the arnount of on-hand inventory frees up capital that ,vould othenvise be tied up in inventory.

•

The total logistics burden includes costs for ,varehousmg, i.J1surar1ce, labor, expedited shipping, and so forth. Eli.Jninati.J1g inventory ren1oves its associated logistics cost, ,,,hich can an1ount to 10% of mventory value.

•

Obsolete inventory is a ,vrite-off that represents lost revenue. Most con1panies can expect to save a portion of the COGS of optin1izable obsolete inventory. Savings can range from a fe"' percentage points to substantially higher for con1panies ,vith n1any ne,v product introductions or high rates of product chw·n.

•

Shortages and stockouts can be reduced. TI1ese inventory issues lead to both fulfilln1ent delays and pennanently lost revenue due to cancelled orders. Lo,vering the lost order rate results in higher revenue generation. MEIO can reduce the percentage of permanently lost orders ,vithin the optin1izable inventory by a significant atnount.

INVENTORY CONTROL TOOLS ................................................... Many inventory control tools exist in today's market. Those that incorporate barcode tracking or radio frequency identification (RFID) tagging generally offer the n1ost flexibility and ease of use.

Barcode Systems Barcode syste1ns help businesses and organizations track products, prices, and stock levels for centralized management in a computer soft,vare system allo,ving for mcredible mcreases m productivity and efficiency. TI1e lines ar1d patterns on a barcode are actually representations of nun1bers ar1d data, ar1d their use allov.rs basic infonnation about a product to be read by an optical scanning device, a barcode scanner, easily and auton1atically. The scanner is connected to a con1puter systen1 that supplies information to the scanner (e.g., the price of the item in a grocery store), and receives inforrnation frotn the scanner (i.e., the product sold) and, therefore, retnoves it frotn inventory. The

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computer control of the barcode system vastly reduces the tin1e ii takes to record necessary inforrnation and elirninates the potential for hu,nan data entry error. Barcodes started out \Vith siJnple one-din1ensional (linear) designs, consisting of basic black lines that could only be read by specially designed barcode scanners. Ho,vever, today barcodes corne in ,nany shapes and sizes and a ,vide range of designs; ,nany can even be read by 1nobile phones and other devices. The barcodes can be classified iJ1 one of l\vo categories: linear (1D) and t\vo dimensional (2D).

LINEAR (1D) BARCODES are "a series of alternating bars and spaces printed or starnped on parts, containers, labels, or other 1nedia, representiJ1g encoded iJ1forn1ation that can be read by electronic readers. A bar code is used to facilitate tirnely and accurate input of data to a con1puter systern:•1 Barcoding is "a rnethod of encoding data using bar code for fast and accurate readability:• 1 Barcoding iJ1ventory is a quick and efficient \vay of n1onitormg stock levels. Data error rates for barcoding are significantly less than those for 1nanual n1ethods, and efficiency rates are higher as less tin1e is required not only to set up initial data, but also to gather and generate reports. Linear barcodes do have so,ne limitations: they are one din1ensional, can only be read horizontally, and can only hold a n1ax:in1u1n of 85 characters. lbe 1D barcode is nearing the end of its lifespan. As 2D scanners beco1ne rnore affordable and ne"'er ted1nology beco,nes n1ore accessible, the linear barcode will becon1e obsolete.

2D BARCODES are graphical in1ages that store information both horizontally illli! 130

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

vertically. As a result of that construction, 2D barcodes can store over 7,000 characters, allo\ving transmission of ahnost t\vo paragraphs of infonnation. By moving to 2D barcodes, businesses are able to convey much more complex information, like expiration dates and serial nurnbers, ,vithout the need for any additional scanning. 2D barcodes allo"' users to custornize the data captured and the \vay it is stored. This flexibility increases the ability of organizations to achieve their specific goals and create a database catered to their needs. 2D barcode scanners are rnuch 1nore versatile than linear barcode scanners in that they can scan frorn any angle. TI1ey can also scan 1nultiple barcodes in one scan.

A barcode reader (or barcode scanner) is an electronic device that can read barcodes and transn1it the data to a cornputer. These might be handheld cordless devices, corded devices that attach directly to a PC's USB port, or cornputers \\•ith integrated laser scanners. A basic inventory tracking systern consists of soft,vare and a barcode scanner. Inventory iten1s (e.g., finished products or ra\v rnaterials) have barcode labels affixed so that when an itern is rernoved fro111 stock, the barcode can be scanned in order to reduce the available count in the inventory tracking sofuvare, instead of having to enter the information manually. Real-time access to location, quantity, destination, and so forth, allows inventory n1anagers the flexibility to n1ake the decisions outline earlier in tl1is chapter.

Radio Frequency Identification Radio frequency identification (RFID) is the successor to the barcode. RFID is "a systen1 using electronic tags to store data about items. Accessing tl1ese data is acco1nplished through a specific radio frequency and does not require close proxin1ity or line-of-sight access for data retrieval:'' The RFID tags can be either active or passive. An active RFlD tag broadcasts infonnation and contains its own po\\•er source. A passive RFID tag does not send out data and is not self-po,vered. Electron1agnetic energy is transrnitted fro111 the reader in order to obtain tl1e inforrnation fron1 passive tags. As the tags pass through/ near the reader, the reader pulls information from the tag (e.g., a security tag on a product that sends a signal when it passes through a reader at the front of a store). eJ~\J>kt 4: Inventory Management

131

lbe biggest advantages that RF! D has over barcodes is that RFID does not require direct line of sight to read a tag, it can provide n1uch rnore infonnation, and the infonnation on the tag is updatable.

1) Chip: holds information about the physical object to which the tag is attached

- 7 ~~~ 7

2) Antenna: transmits information to a reader (e.g., handheld, warehouse portal, store shelf) using radio waves - - - - - - - .

( RFD

3) Packaging: encases the chip and antenna so that tag can be attached to physical object

RFID ,vorks like a barcode, but unlike the barcodes you see in retail stores that have to pass in front of scanners to be identified, an RFID tag is triggered by a radio frequency frorn an an tenna and transnuts inforn1aiton back via radio frequency through the antenna to a reader that converts it into digitial informaton for use by a soft,vare package (see figure 4.9). Significantly n1ore information can be progranuned onto an RFI D tag than can be relayed with a linear barcode. A linear barcode usually provides a product code or serial nurnber, ,vhereas an RFID tag can include rnore and different kinds of inforn1ation such as lot nun1ber, ex-piration date, and even n1anufucturing instructions. RFID tags have excellent potential for " 'arehousing and asset tracking, because they can relay information over a longer di.stance (up to 100 meters in son1e cases), n1aking it possible to kno"' exactly how n,uch of sornething you have in real tirne, and reducing the risk of miscounted inventory. Some of the " 'ays RFID can be utilized in the supply chain include: •

MATERIALS MANAGEMENT : Goods can be counted and logged auton1atically as they enter

the supply "'arehouse. lten,s, cases, and/or pallets traditionally used barcodes, ,vhich " 'orkers

~

•smart· ubels are placed on pallets, urtons or Individual Items,

transfer data bttwten a reader and a moveable Item. An antenna captures

the item's ID number.

.,,.,..

~

A readtr converts the radio waves into digital lnformatlon. Ahost computer provides control ovtr and access to loglstlul data. (/.1kt 4: Inventory Management

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Hardware lne soft"•are requires input to manage the inventory. Servers, desktops, dumb terminals, RF devices, asset tags, RFID tags, scannable barcode label printers, and point of sale devices can all play a role as an inventory 111anage1nent tool. Selecting the right tools to balance labor versus infrastructure is part of the art of inventory n1anagement.

MEASURING INVENTORY PERFORMANCE ................................. . Co1npanies use several 1neasure1nents specifically for analyzing inventory: the nu1nber of units available

•

UNITS:

•

DOLLARS: the an1ount of dollars tied up in inventory

•

DAYS/WEEKS/MONTHS OF SUPPLY: (Avg. on-hand inventory)/ (Avg. usage)

•

INVENTORY TuRNS: (Cost of goods sold) I (Average inventory at cost)

Inventory turnover is a 1neasure of operational efficiency. Specifically, it tells you how 1nai1y ti1nes inventory is being sold ai1d purchased over a given tune period. A lo\\• turnover rate n1ay indicate overstocking, obsolescence, or deficiencies in the product line or marketing effort. It is ilnportant to note that every dollar saved in inventory drops right to the botton1 lme as pure savings. It's a dollar-for-dollar savings for the company. Any dollar not spent on iJlventory is a dollar that can be invested in research and develop1nent, 1narketing and sales, dividends for shareholders, to take as profit, ai1d so forth. TI1is i1111nediate effect on the botton1 liI1e is one reason \\•hy co111panies n1easure their mventory continuously and try to reduce their inventory investment as much as possible. Effective inventory management can potentially generate a significant an1ount of savings. Other related n1easures that can mdicate hO\Y well an mventory management system is ,vorking include the follo,ving:

•

SERVICE LEVEL is "a measure (usually expressed as a percentage) of satisfying demand through inventory or by the current production schedule in ti1ne to satisfy the custon1ers' requested delivery dates and quantities. In a 1nake-to-stock envil"ornnent, level of service is son1etin1es calculated as the percentage of orders picked co1nplete fro1n stock upon receipt of the customer order, the percentage of line iten1s picked complete, or the percentage of total dollar

134

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

den1and picked complete. ln make-to-order and design-to-order environments, level of service is the percentage of times the custorner requested or ackno,,•ledged date ,vas n1et by shipping cornplete product quantities."'

•

ORDER FILL RATE is "a n1easure of delivery perforn1ance of finished goods, usually expressed as a percentage. In a n1ake-to-stock con1pany, this percentage usually represents the nun1ber of items or dollars (on one or n1ore custo1ner orders) that ,vere shipped on schedule for a specific time period, compared with the total that ,vere supposed to be shipped in that tin1e period. In a n1ake-to-order cornpany, it is usually sorne cornparison of the nuinber ofjobs or dollars shipped in a given tin1e period (e.g., a " 'eek) co1npared ,vith the nu1nber of jobs or dollars that ,vere supposed to be shipped in that tin1e period'.''

•

LINE ITEM FILL RATE is the total nu111ber of line iten1s filled divided by the total nlunber of line items ordered. TI1is 1netric applies to products or orders that contain multiple products.

SUMMARY

•••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••

•

Inventory serves a useful purpose in the supply chain; ho,vever, co111panies can help nuniinize the need for inventory by carefully managing those factors that drive inventory levels up. Every dollar saved in inventory drops right to the botton1 line as pure savings.

•

There are four marn categories of inventory: ra,v materials; work in process (WIP); finished goods; and rnaintenance, repair, and operating (MRO) supplies.

•

'There are four basic function of inventory: to n1eet customer demand (cycle stock), to buffer against uncertainty in dernand and/or supply (safety stock), to decouple supply fro1n dernand (strategic stock), and to decouple dependencies in the supply chain.

•

There are three rnain inventory stocking levels: cycle stock, safety stock, and strategic stock.

•

Pipeline inventory 1nay have an impact on decisions that companies n1ake about ho,,• to manage and control their inventory resources

•

·n1ere are six categories of costs associated ,vith inventory: direct costs, indirect costs, fixed costs, variable costs, order costs, and carrying costs.

•

Inventory items can be divided into t\vo main types: independent den1and and dependent demand iten1s. TI1e systems for 1nanagiI1g these t\>\•O types of inventory differ significantly:

eJ~\J>kt 4: Inventory Management

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The t\vo classic systems for managing independent demand inventory are continuous revie,v and periodic revie,v systen1s. The systems for 1nanaging dependent de1nand inventory are 1uaterial require1nents planning, kanban, and drun1-buffer-rope. •

The reorder point is the lo•Nest inventory level at " 'hich a ne"' order n1ust be placed to avoid a stockout. The reorder point is set at a level of remaining inventory that is enough to cover all of the demand that is projected to occur during the lead tin1e necessary to receive the replenish 1nent supply.

•

The economic order quantity (EOQ) 1nini1nizes total annual order costs and carrying costs. Even if all the assu1nptions don't hold true in the long tern1, the EOQ gives a good indication of ,vhether or not current order quantities are reasonable.

•

Inventory optin1ization is finding opti1nal inventory strategies and policies related to custon1er service and return on investn1ent over several echelons of a supply chain.

•

Inventory control tools help to facilitate the 1nanage1nent of inventory, iluproving efficiency and reducing errors.

•

Measuring inventory perfonuance is essential as con1panies cannot ilnprove ,vhat they do not 111easure. Co1npanies n1easure their inventory in an effort to reduce their inventory investment and generate savings.

REFERENCE .......................................................................... . 'APICS Dictionary (14th ed.). (2013). Chicago, IL: APICS. ,vW\v.apics.org

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Purchasing Management

CHAPTER OUTLINE Introduction Defining Procurement and Purchasing The Basic Purchasing Process Financial Significance of Purchasing Make versus Buy Decision Supplier Selection Organization of Purchasing International Purchasing Government and Nonprofit Purchasing World-Class Procurement

139

INTRODUCTION

••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••

"Purchasing is a managerial activity that goes beyond the sitnple act of buying. It includes research and development for the proper selection of materials and sources, follov,r-up to ensure timely delivery; inspection to ensure both quantity and quality; to control traffic, receiving, storekeeping and accou11tit1g operations related to purchases:•• Purd1asing has beco1ne a critical function ,¥ithin 1nost organizations, responsible for spendit1g as much as half of the revenues that the co1npa11y receives from sales, in order to obtain the materials and services necessary for the company to succeed. More money is often spent on the purchase of 1naterials and services than for any other expense. In business today, the purchasing function has evolved into a core con1petency \\1ithin n1ost con1panies, perforn1ing the vital role of finding and developing suppliers, and bringing in external expertise that can be highly valued by the co1npany.

DEFINING PROCUREMENT AND PURCHASING

•••••••••••••••••••••••••

The process of selecting and vetting suppliers, negotiating contracts, establishing pay1nent tenns, and the actual purchasing of goods and services. PROCUREMENT:

•

Procure1nent is concerned ,vith acquiring all of the goods, services, and ,vork that is vital to an organization.

•

Procure,nent is the overarching or wnbrella tenn with.in whid1 the functions of purchasing n1an age1nent, strategic sourcit1g, and supplier relationship 1nanagement can be found (see figure 5.1).

TI1e objectives of a ,vorld-class procure1ueut organ ization are: I.

To support the organization's goals and objectives

2. To support operational requirements 3. To n1anage the procuren1ent process and the supply base efficiently and effectively 4. To develop strong relationships ,,,ith key suppliers 5. To develop strong relationships ,vith other fw1ctional groups v.•ithin the organization

140

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

PROCUREMENT

_________,A_________

r

~

SUPPLIER RELATIONSHIP MANAGEMENT Plan, Source, Make, Deliver/ Return, and Enable (/11cl,aury, 2016)

PURCHASING: The action of obtaining n1erchandise, capital equiprnent; rav,, rnaterials, services, or rnaintenance, repair, and operating (MRO) supplies in exchange for 111oney, or its equivalent. •

Purchasing is the process of ho,v goods and services are ordered.

•

Purchasing is typically described as the transactional function of procuren1ent for goods or . services.

PURCHASING is also a terrn co1nn1only used in industry to represent the function of, and the responsibility for, procuring rnaterials, supplies, and services for an organization. •

It can be a separate deparllnent or organization ,vi thin a con1pany, or it can be part of the supply chain 111anage1nent departn1ent or organization ,vithin a con1pany.

•

i\1any cornpanies have a Chief Procurernent Officer or Chief Purchasing Officer as part of their executive leadership tea111. See figure 5.2.

Purchasing Terms The follo,ving are son1e key purchasing terrns and definitions used in this text:

•

E-PROCUREJ\1 ENT: The business-to-business purchase and sale of supplies and services over the Internet.

•

MERCHANTS: Wholesalers and retailers ,vho purchase for resale.

eJ~\J>kt 5: Purchasing Management

141

Purchasing Manager

Category Manager

(McLa11ry. 2016) Administrator

•

Administrator

INDUSTRIAL BUYERS: Individuals v.•ithin an organizalion who purchase ra,v malerials for

conversion into products, and/or purchase services, capital equip111ent, and MRO supplies. A term often used for the acquisition of services

•

CONTRACTING:

•

SUPPLY MANAGEMENT: A ne"•er term lhat encon1passes all acquisition activities beyond the

simple purchase transaction. -

•

The "Identification, acquisition, access, positioning, and management of resources an organization needs or potentially needs in the attainn1ent of its strategic objectives:• Institute of Supply Ma11age111ent (ISM)

REQUEST FOR INFORMATION {RFI): "An inquiry to a potential supplier about that suppli-

er's product or service for potential use in the business. The inquiry can provide certain business requirements or be of a n1ore general exploratory nalure:•• •

REQUEST FOR PROPOSAL (RFP): A detailed lo,,1-level capabilities evaluation docun1ent

that is used to precisely determine a supplier's capability and interest in the production of a custo111ized product or service.

142

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

•

REQUEST FOR QUOTE (RFQ): A document generally used to solicit bids from interested and qualified suppliers for goods or services lhal the organization needs lo obtain.

•

BID: A tender, proposal, or quotation subnlitted in response to a solicitation from a contracting authority.

•

COMPETITIVE BIDDING: Offers submitted by multiple individuals or firms competing for a contract, privilege, or right to supply specified services or n1erchandise.

•

PURCHASE REQUISITION: Document that defines the need for goods and/or services. An internal docun1ent. Does not constitute a contractual relationship ,vith any external party.

•

PURCHASE ORDER (PO): The buyer's offer to the supplier to acquire goods or services. Becornes a legally binding contract only ,vhen accepted by the supplier.

The Role ofPurchasing in an Organization The prin1ary goals of purchasing are to: l.

Ensure an uninterrupted flo"' of n1aterials and services for the con1pany.

2.

Obtain 111aterials and services at the best value, rneaning the best quality at the best prices, ,,,ith the best service, in the n1ost econo111ic order quantities.

3.

Secw·e reliable alternative sources of supply as necessary to 111anage risk.

4.

Optin1ize custon1er satisfaction by using the kno\\•ledge and expertise of the supply base to provide high quality at the lo,vest total cost. Actively seek better rnaterials and reliable suppliers Work ,vith the expertise of strategic suppliers to improve quality and materia.ls and finished goods Involve suppliers and purchasing personnel in ne\\•product design and developrnent efforts

5.

Maintain good relationships \\•ith suppliers.

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143

THE BASIC PURCHASING PROCESS

•••••••••••••••••••••••••••••••••••••••••

TI1e industrial purchasing process can vary fro111 one organization to another, but there are so1ne key conunon ele1uents, and a nun1ber of inputs, interfaces, co1nn1unications, and outputs involved in the process. TI1e process usually starts \,rith a den1and for a 1naterial, co1nponent, or a service and progresses through the following steps: 1. A need is identified, and a purchase requisition is created/ issued. Request for goods or services subn1itted to the procuren1ent/purchasing organization for action. -

Typically initiated by a user within an organization.

2. Obtain authorization as necessary. -

A purchase requisition may be routed to an authorized approver(s) depending on the type of material or service being requested and/or the dollar value of the request.

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Multiple authorizations, in a prescribed sequence, to various managen1ent levels of the organization, 1nay be necessary if the value exceeds a specific predetennined threshold.

3. Identify and evaluate potential suppliers. May be detennined fro111 a list of con1pany-approved suppliers. -

4.

Alternatively, 1nay use a request for inforn1ation (RF!) to collect infonuation fro111 potential suppliers on their capabilities and interest in supplying the n1aterial or service.

Make supplier selection. If the buyers already ki10,vs ,vhich supplier they ,viii buy the ite1n fro111, 1nove to the next step. If not, a co mpetitive bidding process 1nay be initiated A request for proposal (RFP) or a request for quotation (RFQ) 1nay be issued to qualified suppliers, to identify proposed alternatives for supplying the desired material or service, and to obtain price and availability infom1ation. a.

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Buyer issues a RFP for ite1ns that have not been previously pw·chased, or not purchased from a specific supplier being evaluated. Supplier(s) provides the proposal to supply the ite1n(s) including price and delivery. FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

b. Buyer issues a RFQ for routine or repeat purchased iten1s. Supplier(s) provides a price and delivery quote on the specific iten1(s) requested. A supplier is selected fro1n the RFP or RFQ bids received based on criteria determined by the buyer, including price, availability, quality, delivery costs. 5.

A purchase order (PO) is created and delivered to the supplier.

A PO is generated and forwarded to the supplier to inform the supplier of the intent to purchase. TI1e purchase order \vill identify the ite1n(s) to be procured, the quantity required, the requested delivery date(s), and the price to be paid. It " 'ill also identify the delivery location and any tern1s and conditions that relate to the order. TI1e PO is the buyer's fonnal offer to the supplier to obtain the ite1n(s). The PO becomes a binding contract only \vhen accepted by supplier. 6.

Supplier confinnation of the PO ·n1e supplier fonnally agrees to supply the item(s) per the specifications, tern1s, and conditions described on the PO. The PO then becomes a legally binding contract between the buyer and the supplier for the ite1n(s) specified.

7.

Fulfilln1ent TI1e supplier ships/delivers the item(s) to the buying organization as per the PO.

8.

Receipt of goods Once the ite1n(s) arrives at the designated location, the buyer \Vill typically conduct son1e forn1 of receipt process \vhere the ite1n(s) are checked to ensure that they confonn to the details of the PO, including quality and quantity. A confirmation of receipt may also be sent to the supplier.

9.

Invoice Supplier prepares an invoice for the ite1n(s) ordered and transnlits to the buyer. The invoice either accon1panies the ite1n(s) or is sent separately.

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10. Reconciliation -

The invoice 1nay need to be reconciled to the purchase order and goods receipt before pay1nent is made. This step is so1netimes referred to as a "three-,vay match:'

I I. Payment -

Invoice pay1nent processed using an appropriate payment method assuming the item(s) is received and n1eets all of the criteria established on the PO.

12. Reclan1ation of taxes In so1ne situations, the supplier ,viii be obligated to charge a tax, but the buyer may be eligible to retain son1e or all of the tax based on corporate status. 13. Close out the PO

If the PO has been received co1nplete, and all tenns and conditions have been 1net, then it should be closed out in the pw·chasing syste1n ("'hether 111anual or auton1ated). I4. Analysis Measure1nents of the efficiency and accuracy of the procure1nent process. -

Specific PO data and infonnation captured and used during periodic supplier perfonnance 1neetings.

e-Procurement The "electronic" requisitioning, receiving, and reconciliation of the received goods, e-procw·e1nent involves the auto1nation of the nonstrategic and transactional activities that would otherwise consume the majority of a buyer's tilne. It provides increased enterprise level visibility of all purchases.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

The tern1 describes the auto1nation through ,veb-enabled tools of n1an)' elen1ents of the purchasing process including: •

The issue, collection, and analysis of bids

•

Execution and analysis

•

Av.•ard of business via reverse auction

e-Procure1nent tools typically auto1nate all or part of the follo,ving processes: •

Solicitation develop1nent tools (i.e., RF!, RFP, RFQ)

•

Reverse auctions

e-Procuren1ent 1nay not ,vork well for every type of purchase. Exa1nples include the procuren1ent of critical items that are only available through a fe,v suppliers; ,vhere procuring an item involves co1nplex negotiations; or ,vhere the potential to lo,ver costs through an e-procure1nent process is 1ninilnal.

Advantages ofan e-Procurement System •

TIME SAVINGS: A reduction in the ti1ne bet,veen recognizing the need for an item and the release and receipt of an order for that ite1n

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COST SAVINGS: Lo,ver overhead costs in the purchasing area

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ACCURACY: A reduction in errors; a virtual elimination of n1anual paperwork and paperwork handling

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REAL TIME: linproved con1munication both ,vithin the company and v,rith suppliers

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MOBILITY: Access to purchase requisition and purchase order information through the use of mobile devices and the internet, allo,ving actions to be taken regardless of v.•here a person is located at any given ti1ne

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TRACKABILITY: TI1e ability to track the status of purchase requisitions, orders, and inforn1ation

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MANAGEMENT: Allo"'S purchasing personnel to spend less time on processing of purchase orders and invoices, and n1ore ti1ne on strategic value-added purchasing activities

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•

BENEFITS TO THE SUPPLIERS: Custo1ner orders can be received and confirn1ed faster by the

supplier, and receipts and invoices can be processed faster by the buyer, facilitating the supplier's receipt of revenue.

Small Value Purchases Purchases of small value, noncritical items n1ay take as much time to process as purchases of higher value, critical ite1ns. In an effort to n1inin1ize the a1nount of valuable purchasing resource time spent on s1nall value purchases, there are so1ne tools and techniques that co1npanies can use to reduce this processing tilne and cost. These tools and techniques " 'ill allo,v the purchasillg group to transfer son1e of the routine transactional purchasing activities for sn1all value purchase to users or others within the company, thereby freeing up ti1ne for these valuable purchasing resources to ,vork on 1nore critical or strategic purchasil1g activities. •

CREDIT CARD/CORPORATE PURCHASING CARD (P-CARD): A fonn of co1npany charge

card that allo,vs goods and services to be procured "rithout usil1g a traditional purchasing process •

BLANKET OR OPEN-END PURCHASE ORDERS: A purchase order that the buyer negotiates

,vith its supplier, ,vhich can illCOrporate multiple delivery dates over a period of tin1e (often a year). It is typically used for frequently needed expendable goods. Once negotiated, authorized users " 'ithin the buyer's co1npany can arrange for the necessary ite1ns, quantities, and delivery dates directly witl1 the supplier. •

BLANK CHECK POs: A tenn used to describe a situation in ,vhich an usually high level of

trust is afforded to tl1e supplier by the buyer. The supplier can supply ite1ns to the buyer as need ed without confinning pricing ill advance. This may be used ,vhen the buyer is not exactly sure ,vhat iten1(s) ,viii be needed and cannot, therefore, create a blanket PO. •

PETTY CASH: An accessible an1ount of money kept by an organization for expenditure on

srnall items. A typical exan1ple of ,vhen this might be used is a company sending someone out ,vith petty cash to buy coffee and donuts for a business 1neeting. •

STOCKLESS BUYING OR SYSTEM CONTRACTING: An arrangement in " 'hich a supplier

holds the ite1us ordered by the buyer il1 its o,vn " 'arehouse, and releases then1 ,vhen required by the buyer. •

STANDARDIZATION AND SIMPLIFICATION OF MATERIALS AND COJ\1PONENTS: The

concept of !uniting the alternatives or options of so111e small value purchases ill order to maximize the volume and potentially obtain better pricing. Example: creating a catalog or listing of a set nu1nber and type of office supplies to be order fron1 a supplier.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

•

ACCUl\1ULATING SMALL ORDERS TO CREATE A LARGE ORDER: The concept of volume

consolidation for s1nall value purchases. Example: having an administrator collect all of the individual departments' office supply needs throughout the n1onth and placing one rnonthly order for delivery rather than allo,ving rnultiple deliveries. •

USING A FIXED ORDER INTERVAL: Establishing a set schedule ,vith a supplier to deliver a

predetennined an1ount of inventory of an iten1. Exainple: ,vater supplier delivers a fixed nun1ber of water bottles for the \vater cooler in a departn1en1 on a fixed time schedule (e.g., delivers t,vo 10-gallon water bottles to the XYZ Departrnent every Monday morning).

FINANCIAL SIGNIFICANCE OF PURCHASING .............................. Purchasing activities can have a significant and profound impact on the financials of an organization. The follo,ving are a fe"' examples of the financial significance of purchasing.

Profit-Leverage Effect The profit-leverage effect states that a decrease in purchasing CAlJCnditures directly increases profits before taxes (assuming no decrease in quality or purchasing total cost). The bottom line impact is a dollar saved is a dollar of profit to be used for such tl1ings as shareholder dividends, en1ployee pay increases, investrnents, con1pany reinvestrnents in R&D, or rnarketing and sales, arnong others. •

As sho"•n in figure 5.3, a I0% cost reduction generates significantly more profit before taxes than does a I 0% sales increase.

PROFIT LEVERAGE EFFECT

Baseline Simplified P&L

Increase Sales

Decrease COGS

10% 10% Sales $1,000,000 $1,100,000 $1,000,000 Cost of Goods Sold COGS SO% $500,000 $550,000 $450,000 Administrative Costs 45" ($450,000) ($495,000) ($450,000) Profit Before Tax $50,000 $55,000 $100,000

I

10%j

100%1

• A 1°" cost Reduction generates s.ignificanttymore Profit tsforsltl than does a 1°" Sales lncreue. • This is one of the main reasons that Procurement Ma~gers are under sign.ifk:ant pressure from senior management to reduce purt:hase costs.

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•

This is one of the main reasons that procurement managers are under significant pressure fron1 senior manage1nent to reduce purchase costs.

Return on Assets Effect RETURN ON ASSETS (ROA) EFFECT states that with the exact san1e number/value of assets, a decrease in purchasi11g expenditures significantly increases the return on those assets con1pared to a co1nparable increase in sales. A high ROA indicates n1a11agerial pro,vess in generating profits ,vith lov,er spending.

RETURN ON ASSETS EFFECT

Baseline Simplified P&l

Sales $1,000,000 Cost of Goods Sold (COGS) 50% ($500,000) Administrative Costs 45% ($450,000) Profit Before Tax $50,000 Assets Return on Assets

Increase Decrease Sales COGS 10% 10% $1,100,000 $1,000,000 ($550,000) ($450,000) ($495,000) ($450,000) $55,000 $100,000

$500,000 $500,000 10% 11% Profit Before Tax + Assets = ROA

$500,000 20%

• a 10% cost reduction generates a significantly higher Return on Assets (ROAi than does a 10% sales increase, given the same number/value of assets. ..._....

•

As sho,vn in figtu·e 5.4, a 10% cost reduction generates a significantly higher ROA thw does a l 0% sales increase, given the same nun1ber/value of assets.

Inventory Turnover Effect Inventory is an asset but it also represents financial capital tied up a11d not available for use in other pa1·ts of the business. The purchasing function in an organization is frequently responsible for supply management and therefore plays a large part in the amount of inventory the company holds. •

Inventory turnover represents the nun1ber of tin1es the con1pwy sold through inventory in a given t ilne period.

•

It is the costs of goods sold (COGS) divided by the average inventory.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

•

A high turnover ratio is beneficial because ii means the company is generating sales efficiently to sell inventory.

•

A lo"' turnover ratio is unfavorable as ii means the company is not selling through products efficiently. The co1npany is li kely ,naking/buying too n1uch inventory for den1and and/or the con1pany is thro,\kt 5: Purchasing Management

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•

CENTRALIZED P URCHASING: Larger con1panies often establish a centralized purchasing structure •Nith all of the purchasing staff reporting to a purchasing executive such as a chief purchasing officer or chief procurernent officer (CPO). The centra.lized purchasing organization ,vill typically be located at the con1pany's corporate office and n1ake all the purchasing decisions for the whole company including for any plants or satellite offices.

TI1ere are a nwnber of reasons ,vhy con1panies ,vould choose this type of purchasing structure. -

Leverage from concentrated volumes: By having a centralized purchasing organization, the company is able to leverage the total spend ,vhen negotiating ,vith suppliers. This should allow the purchasing organization to obtain the best price and terms from suppliers by offering thern a comn1itment to buy in larger quantities. Control: Centralized purchasing gives a co1npany a higher degree of control over the purchasing process. Decentralized purchasing disperses activities across the organization, involving a greater nun1ber of people and less control of the purchasing process.

•

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Avoiding duplication: Centralized purchasing avoids the possible duplication of roles and efforts across rnultiple locations. Decentralized puTchasing 1neans that purchasing personnel at 1nultiple locations ,vill essentially be performing the same role and potentially be purchasing the same items.

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Specialization: Centralized purchasing organizations allo,v purchasing professionals to specialize in one area. For exarnple, a purchasing clerk cou.ld ,vork ,vith vendors ,,,ho provide steel products, ,vhereas if they were in a s111aller ptuchasing depaTtrnent they ,vould have to v.•ork ,vith vendors fron1 1nany industries.

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No competition within units: Centralized purd1asing also avoids the potential for cornpetition betv.•een units or locations of the same con1pany, particularly for iten1s in short supply. A common supply base can be established and items in short supply can be allocated appropriately to benefit the organization as a ,vhole.

DECENTRALI ZED P URCHASING: Cornpanies ,vith n1ultiple locations n1ay choose to adopt a decentralized purchasing structure. In this n1odel, each w1it or location ,vill have their o,vn purchasing function, such as at the plant level, 1naking their o,vn purchasing decisions. Under decentralized purchasing, no individual purchasing manager or unit has the right to purchase rnaterials or services for all units and locations.

There are also reasons ,\•hy con1panies ,vould choose this type of purchasing structure as ,veil.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Diverse business needs: Decentralized purchasing n1ay be more appropriate for companies \Vith diverse business units having very different needs fro1n one another, or for co1npanies that have acquired another co1npany and not assin1ilated the111 into their core business n1odel. Local sourcing: Local purchasing functions ,vill likely have better kno,vledge of local requirements, will frequently have closer ties to local suppliers, and may be able to obtain better pricing, better quality, and lo,~rer transportation costs. Speed: Where locations require the delivery of items at a mon1ent's notice, the centralized purchasing model 1nay not be appropriate. If a stockout is imminent, and/or manufacturing \\till be stopped, a local supplier 1nay be able to deliver the saine day, ,vhereas centralized purchasing will likely deal ,vith a national supplier " 'ho 1night not be able to offer the saine response. Less bureaucracy: No heavy invesllnent is required initially. Purchase orders cai1 be placed quickly. The replace1nent of defective 1naterials takes less tin1e. •

H YB RI D P URCHASING ORGANIZATION: Mai1y con1panies have ti·ied to adopt a n1ix of

centralized and decentralized purchasing, where business units or locations have the purchasing responsibility for certain items, and the central purchasing organization has responsibility for other ite1ns. The l\vo n1ain types of hybrid purchasing orgai1ization are: Centralized - Decentral ized : Typically for a large organization ,vith centralized control. Large national contracts ,viii be centralized at the corporate level ai1d sn1aller specific ite1ns ¼•ill be decentralized at the business unit or location level. D ecentralized - Centralized Typical for a large 1nultiunit organization. There ,viii be decentralized purchasing at the corporate level and centralized purchasing at the business unit or location level. Business units ¼•ill buy aJI of their o,vn materials and services and the corporate level \Viii buy only those ite1ns needed for the corporate operations.

INTERNATIONAL PURCHASING ................................................ International purchasing involves the \VOrld,vide search for suppliers ,vho can meet the right quality at the right price, quantity, and delivery. It is identifying, developing, and accessing the opti1nal sources of supply for the business regardless of the location. Opening up the purchasing function to the global n1arket affords a company n1ore choices and n1ore access to innovation, information, and technology.

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lbere are many good reasons for a company to consider global sourcing, including: •

The opportunity to ilnprove quality, cost, and delivery perforn1ance

•

To exploit global efficiencies, such as access to lo"' cost labor and 111aterials; tax breaks and lo,v trade tariffs

•

To respond to insufficient do1nestic capacity

•

To achieve access to better process and product technology

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Due to a change in the don,estic business environment

•

To take advantage of reciprocal trade and countertrade arrangen,ents

Con1panies i11terested in pu1·suing international purchasing arrangen1ents n1ust develop or acquire specialized skills and kno,\•ledge to deal ,vith international suppliers, logistics, cominunication, political environment, and other issues. Son,e of these specialized aspects involve:

•

IMPORT BROKERS: Agents licensed by the governn1ental regulatory authority to conduct business on behalf of importers, for a service fee. 11,ey take the burden of filling out irnport papenvork, and clearing products through custo1ns barriers for ilnporters

•

ll\1PORT MERCHANTS: A person or co1npany engaged in the purchase and sale of in1ported con11nodities for profit. They buy and take title to tile goods beiI1g imported a11d then sell tile goods do1nestically.

•

TRADING COMPANIES: Buy products ii, one country and sell tllen1 in different countries where they have their own distribution net,vork. Trading conlpanies n1ostly ,vork with high production volume products such as ra,v n,aterials, chen,icals, generic pharmaceuticals, etc. They 1nay carry a wide variety of goods (sucl1 as front a catalog).

•

TARIFFS: Duties, taxes, or custorns in1posed by the host country for i1nported or exported goods.

•

NONTARIFF BARRIERS: Quotas, licensing agreen1ents, e1nbargoes, la,vs and regulations in1posed on ilnports and exports.

•

COUNTERTRADE: International trade by excha11ge of goods ratl1er tl1a11 by currency.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

There are some potential challenges to international purchasing that companies should consider and plan for prior to adopting this strategy, including: •

The potential lack ofknov;Jedge and skills concerning international trade policies and procedures

•

Av.•areness and cost of required tariffs and duties

•

·n,e difficulty in communicating v.rith suppliers due to language barriers, varying tirne zones, \\•orking v.•eeks, holidays

•

Locating, evaluating, sourcing, and expediting in global rnarkets

•

Payments and currency 1nanagen1ent

•

Longer time span for negotiations

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The potential for cultural, political, and labor proble111s

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Protection against product liability and quality 1nanagen1ent issues

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Potentially longer transportation lead tin1es necessitating additional inventory

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Specific and varying documentation requirements

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Handling legal matters and the process for settling disputes

GOVERNMENT AND NONPROFIT PURCHASING .......................... Govern111ent purchases are expenditures ruade in the private sector by all levels of governn1ent. Nonprofit purchases are expenditures n1ade in the private sector by all types of nonprofit organizations. Public purchasing for the government and the nonprofit sector is somev.•hat different from private industrial purchasing and is characterized by:

COMPETITIVE BIDDING: A transparent procurement method in whicli bids frorn competing suppliers are invited by openly advertising the scope, specifications, and tenns and conditions of the proposed contract as v.•ell as the criteria by v.•hicli the bids ,vill be evaluated. Con1petitive bidding airus at obtaining goods and services at the lowest prices by stin1ulating competition, and by preventing favoritism. A sealed bid is a docUJnent enclosed in a sealed envelope and is sub1nitted in response to invitation to bid.

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•

The sealed bids are opened in the presence of anyone "'ho 1nay wish to be present, and evaluated for a,vard of a contract.

•

CLOSED COMPETITIVE BIDDING:

OPEN COMPETITIVE BIDDING:

The sealed bids are opened in the presence of authorized

personnel only. •

The contract is usually a,varded to lowest priced responsive and responsible bidder.

Bidders are generally required to furnish bonds as incentive to ensure that the successful bidder " 'ill fulfill the contract awarded.

•

Bid bond is a debt secured by a bidder for the purpose of providing a guarantee that the successful bidder ,viii accept the contract once a,varded. If not, the bond ,vould be forfeited.

•

Performance bond is a debt secured by a bidder for the purpose of providing a guarantee that the ,vork ,viU be on tin1e and n1eet specifications.

•

Payn1ent bonds is a debt secured by a bidder for the purpose of providing protection against third-party liens not fulfilled by a bidder.

Some key regulations that rule governn1enl and nonprofit procurement include: •

Federal Acquisition Streamlining Act ( 1994), ,vhich ren1oved restrictions on bids less than $100,000. Purchases less than $2,500 can be made ,vithout bidding.

•

Buy American Act (1933) basically states that purchases (,vhether by the governn1ent or by third parties) using federal funds n1ust be bought from a U.S. source if the cost of the goods fro1n the U.S. source is not n1ore than a specific differential above the foreign source for the goods.

•

Green purchases involve a variety of federal, state, and local initiatives to include environ1nental and hun1ai1 health considerations ,vhen n1aking purchases.

WORLD-CLASS PROCUREMENT .............................................. . "\.Vorld-class procuren1ent organizations outperfonn their peers by striving to provide w1ique value beyond cost reduction, including beco1ning a trusted advisor to the business, driving supplier innovation, and focusing on risk management, according to new research fro1n The Hackett Group, lnc'.'2

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

The Hackett Group's research identified live key areas where world-class organizations are adopting procurement strategies to differentiate themselves: l.

BEING A TRUSTED ADV ISOR TO T HE BUSINESS: Having a high level of involvement in the

cornpany's budgeting and planning cycle. 1hey are considered valued business partners by the organization, not gatekeepers or adrninistrators. 2 2.

DRIVING SUPPLIERS TO INNOVATE: Effective at harnessing the inteUectual capital of their suppliers to bring nev; and i1u1ovative solutions to bear, helping to influence-not just support-the business strategy.2

3.

PROVIDING ANALYTICS-BACKED INSIGHTS: ,kt G: Strategic Sourcing

167

SOURCING STRATEGIES

•••••••••••••••••••••••••••••••••••••••••••••••••••••••

Strategic sourcing involves managing purchasing transactions in a strategic way providing the analysis and ability to make adjustments based on price, the evaluation of supplier performance, and the overall needs of the organization. A regular revie"' of an organization's sourcing strategy is a rnust in order to achieve significant agreed upon results. The high-level sourcing strategies utilized in today's business envirorunent include: Producing goods or services using a cornpany's O\Vn internal resources.

•

INSOURCI NG:

•

The traditional definition involves purchasing an itern or service externally, which had been produced using a cornpany's own internal resources previously. The term has 1nore recently beco1ne synonymous \Vith the concept of buying an item from an external source of supply regardless of whether the item had been produced using a company's O\Vll internal resources previously.

•

A sourcing strategy where there are n1ultiple potential suppliers available for a product or service; ho\vever, the cornpany decides to pw·chase fron1 only one supplier. This is in contrast to a situation \,,here there is only one supplier for an iten1 (i.e., sole sourced). Sole source is not truly a strategy as there really isn't a choice, and there is very little opportunity for a con1pany to negotiate price or service.

•

MULTI PLE SOURCI NG:

OUTSOURCING:

S INGLE SOURCI NG:

Purchasing a good or service front more than one supplier. Companies rnay use n1tiltiple sourcing to create con1petition bel\veen suppliers in order to achieve higher quality and lower price.

Strategies for Functional versus Innovative Products \,Vhen developing successful sourcing strategies co,npanies " 'ill likely adopt different strategies for functional products versus iru1ovative products, the differences being: •

MRO iten1s and other co1n1nonly lo\v profit rnargin iterns ,vith relatively stable den1ands and high levels of con1petition (office supplies, food staples, etc.)

FUNCTIONAL PRODUCT S:

Potential Strategy: Multiple sourcing ,vith several reliable, low cost suppliers •

168

lterns characterized by short product lifecycles, volatile dernand, high profit rnargins, and relatively less cornpetition (e.g., ted1nology products such as the iPhone)

INNOVATTVE PRODUCTS:

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Potential Strategy: Single sourcing wil'h an innovative, high-tech, cutting edge, market leading supplier; develop a long-term partnership A frame,vork for sourcing strategy development can utilize l'he follo,ving steps (additional and more in-depth steps will be discussed later in this chapter): l.

Classify the company's products and suppliers as belonging to either the functional or innovative category.

2.

Develop strategic sourcing goals and strategies for each category.

3.

Create the sourcing 1ea1n (typically a cross-functional 1ea1n led by procuren1ent team).

4.

Develop a tean1 strategy and con11nunication plan.

5.

Identify the targeted spend area(s) and conduct a spend analysis.

6. Gather inforn1ation on supplier capabilities; use RF!. 7.

Develop a supplier portfolio (i.e., a profile of each supplier in each category).

8.

Develop a future state (i.e., vision of what the conlpany v.•ants the future to look like).

9.

Conduct supplier selection and negotiation.

10. In1ple1nent supplier relationship n1anage1nent (SRM; see Chapter 7).

Spend Analysis A spend analysis is the process of collecting, cleansing, classifying, and analyzing expenditure data v.•ith the purpose of decreasing procure1nent costs, in1proving efficiency, and n1onitoring con1pliance. The basic steps for conducting a spend analysis include: •

Defining the scope

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Identifying all data sources

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Gatl1ering and consolidating all data into one database

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Cleansing the data (finding and correcting errors) and standardizing it for easy review

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Categorizing the data A typical spend analysis consists of: - The total historic expenditure and volumes -

Expenditures categorized by co1n n1odity and subconunodity

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Expenditures categorized by divisio n, depart111ent, and/or user Expenditures categorized by supplier

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Future demand projections or budgets

Analyzing the data For the best deals per supplier

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To ensure that all purchases are fro111 preferred suppliers

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·ro reduce the number of suppliers per category

Repeating the process on a regular schedule

General Portfolio Spend Categories Co111panies can generally apportion their total spend into the follo"-ing four 111ain categories: I. NONCRITICAL: Ite1ns that involve a lo,v percentage of the co111pa.ny's total spend and involve very little supply risk 2.

BOTTLENECK: Ite111s that present unique procure1nent problen1s (,vhere supply risk is high, availability is lo,v, and there are only a s111all nun1ber of alternative suppliers)

3. LEVERAGE: Con1111odity iten1s ,vhere 111any alternatives of supply exist and supply risk is lo,v (Spend for these iten1s is generally high, and there are potential procuren1ent savings.)

4. STRATEGIC: Strategic iten1s and services that involve a high level of expenditw·e and are vital to the conlpany's success

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

,... '

\C •• High Level

\:

Bottleneck Items

Strategic Items 1. Ensure availability of supply 1. Maint ain safety/strategic stock 2. Focus on relationship building 2. Develop contingency plans

3. Encourage process integration

3. Strengthen relationships

Supply Risk

••

and innovation

4. Search for alternatives

4. Frequent communications

s.

:.::

V,

0::

Low Level Supply Risk

Non-Critical Items 1. Simplify and streamline the

Leverage Items 1. Consolidate volume as a

purchasing process

negotiation tool

2. Reduce number of suppliers

2. Use competit ive marketplace

and simplify ordering

to reduce costs

3. Transfer buying responsibility

3. Automate supplier interfaces to

to "users' wit hin the company

Low Value to the Com pany

Establish mutually agreeable supplier performance criteria

VALUE

minimize process related costs

High Value to t h e Company -20111

Sourcing Strategies by Category Figure 6.2 is an exan1ple of a Kraljic matrix, which sho,vs the plotting of each of the sourcing strategies, ,vhere the vertical axis is Risk, and the horizontal axis is Value, Bottleneck items and Strategic iterns are high risk, and Strategic iten1s and Leverage iten1s are high value. TI1ere are different sourcing strategies that can and should be used for each category.

•

BOTTLENECK ITEl\1S: T\\10 1najor strategies are searching for alternative sources of supply that might be able to alleviate the unique sourcing problen1s, and strengthening the relationship with each supplier to maximize the opportunity for success. Efforts to integrate the supplier ,vith the company's operations 1nay also help to resolve the supply problen1s. Iten1s in this category are candidates for 1naintaining safety or strategic stock and also for the developn1ent of contingency plans in the event of a supply disruption.

•

STRATEGIC ITEl\1S: Strategies to ensure the availability of supply, and encourage process integration and innovation, should help to reduce the risk of a supply disruption. Companies should develop a formal supplier relationship 1nanage1nent prograrn \vith these suppliers to build the relationship. Using value 111anage1nent ted1niques such as value engineering, reducing con1plex:ity,

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and early supplier involven1ent in product design are son1e of the ,vays that procurement can ,vork ,vith suppliers toward that goal. Frequent con1n1unications coupled " 'ith n1utually established and agreed upon supplier perforn1ance criteria and 1neasure1nent are critical. •

The 1nain strategy for ite1ns in this category is to consolidate all of the vol un1es and use the co1npetitive 1narketplace to generate the lo,vest total cost of O\\•nership. This is the category where procuren1ent professionals can really use their analytical and negotiation skills to generate savings. Another aspect of the strategy 1nay be to automate supplier interfaces to 1ninilnize process-related costs, and build longer tern1 agreernents utilizing autornated payruent rnethods to Sill1plify the buying activity.

•

NONCRITICAL ITEMS: Because ite1ns iii this category are both lo,v risk and lo,v value, the strategy here is for procuren1ent to reduce their level of effort and focus. The transactional costs associated ,vith buying these items may actually exceed the purchase price of these iten1s. These are n1ost likely routinely purchased iten1s ,vhich rnay be suitable candidates for delegating the transactional purchasing activities to users ,vithil1 the cornpany based on son1e predetennined guidelines, rather than to use valuable procurement personnel's tin1e to process. Sinlplifyillg, streamlining, standardizing, and reducing the number of suppliers ,viH facilitate this strategy.

LEVERAGE ITEMS:

Supplier Base A supply base is defined as "the group of suppliers fro1n ,vhich a firn1 acquires goods and services:•• Over tin1e as a company 1natures and gro\\•s, its supplier base tends to gro"' as ,vell. All too frequently, con1panies have rnore suppliers than they truly need or than they can manage effectively. Managing suppliers takes time and resources, and every supplier-related activity costs n1oney, ill· eluding 1nonitoring and reporting supplier perfonnance, conducting supplier audits, perfonning site visits, 1nail1taining up-to-date supplier infonnation ill the co1npany database, and of course all of the transactional aspects of RFPs, RFQs, POs, invoice pay1nents, and the like. This is one reason why a company 1night want to conduct a supply base rationalization program. Supply base rationalization, or supply base optilnizalion, illvolves selectively and systen1atically detern1ining the right number of suppliers, ,~rith the right capabilities, to achieve the company's overall business objectives. Rationalizing or optirnizil1g the supply base could n1ean either reducing or increasing the nwnber of suppliers a company ,vorks ,vith, as " 'ell as potentially illcreasing or enhancillg the opportunity presented to new or existing suppliers. The current trend is co1upanies emphasizil1g long-tenu strategic supplier alliances consolidatillg volume into one or fewer suppliers, resulting ill a smaller supply base. Buyer-supplier partnerships are easier to 1nanage ,vith a rationalized supply base and can result in: 172

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

•

Reduced purchase prices

•

Fev,er supplier management problen1s

•

Closer and more frequent interactions bet,veen buyer and supplier

•

Greater levels of quali ty and delivery reliability

SUPPLIER SELECTION

••••••••••••••••••••••••••••••••••••••••••••••••••••••••••

Supplier selection is the process a company uses to choose a supplier. The process involves selecting the best and/or the 1nost appropriate supplier based on an assessment of the supplier's capabilities. Selecting suppliers is a con1plex process and should be based on nntltiple criteria using fonual evaluation fonus or scorecards. Typical criteria used to assess suppliers includes: •

Manage111ent, organization, and strategic fit

•

Reputation and references

•

An1ount of past business

•

Reliability

•

Quality syste111s

•

Order syste111 and cycle ti1ne (i.e., lead tune)

•

Cost

•

Supplier's v,illingness to share il1forn1ation

•

Capacity

•

Service performance

•

Supplier's product and process technologies

•

Coilllnunication capability, both in terms of the method in ,vhich they con1municate and "'hether they are proactive in com1nunicating, particularly if there are issues

•

Location/proxi1nity to the cotnpany's operations

•

v\larranties and clailn policies

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lbe supplier selection process is usually conducted by a cross-functional tean1 led by the procurernent organization and typically includes representatives responsible for quality, finance, engineering, etc. The process can be ti1ne conswning and costly. It can involve travel to potential supplier sites, and interviews v.•iili suppliers and wiili the suppliers' other customers. Accordingly, evaluation and selection can take weeks or months.

How Many Suppliers Are Needed? Detennining the optunal nu1nber of suppliers to use for eacl1 good or service being purchased is not an easy task. There is no standard rule. Generally, companies should use the fev.•est number of suppliers that they can ,vithout increasing risk significantly. S INGLE-SOURCE SUPPLIER STRATEGY: The follov.•il1g are some reasons a company n1ay opt

for

a single-source supplier strategy: •

To establish a good relationship ,vith the supplier

•

To reduce quality variability

•

To achieve the lov.•est cost, as 100% of volume ,vill be with the single source

•

To achieve transportation econo,nies

•

If the su1gle-source supplier has a proprieta1·y product or process

•

If the volume is too sn,all to split between n1ultiple suppliers

With a single-sow·ce supplier strategy, a buyer is likely to ex-perience significant bargainil1g po,ver, better transparency, easier relationship management, and better supplier responsiveness. \>Vhile tl,ese are valid reasons and advantages to a single-source supplier strategy, there is potentially also aJ1 increased risk of supply problen1s or shortages. If the single-source supplier has a problen1, it could quickly result in a supply disruption for the con1pany. TI1erefore, it ,nay be preferable to keep the nun1ber of siJ1gle-sourced suppliers at a minin1um if possible. MULTIPLE SOURCING SUPPLIER STRATEGY:

The follo,villg are some reasons a company 111ay

opt for a multiple sourcil1g supplier strategy: •

If the con1pany needs n1ore capacity than can be accon1modated by a single source

•

To spread tlie risk of a supply disruption among multiple trading partners

•

To create co,npetition on price, delivery, a11d other services

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

•

To take advantage of n1ore sources of information

•

To meet a require1nent involving some special kinds of business

If a con1pany adopts a 1nultiple sourcing supplier strategy, the risk of a n1ajor supply disruption may be reduced. Most businesses depend on a continuity in the flo"' of products or services and should not underestin,ate the i1nportance of reduced dependency on a single source of supply. When a disruption occurs in the supply of products or services due to quality issues, production or processing problen1s, capacity constraints, financial difficulties, etc., the purchasing con1pany can be significantly impacted and potentially irreparably damaged. v\7hen choosing bet\veen a single and a 1nultiple souTcing supply strategy, it is not about one strategy being better than the other strategy. It is about what strategy better n1eets the needs of business.

Preferred Suppliers A preferred supplier is a supplier of choice; generally one that has achieved a specific and exceptional level of perfonnance over tin1e as n1easured by a set of criteria agreed upon by both buyer and supplier. Preferred suppliers are typically trusted partners " 'ho kno\v the buyers organi1.ation, processes, procedures, and requiren1ents. TI1ey usually provide a higher value than their co1npetitors and are characterized as reliable, responsive, flexible, and cost effective. Preferred suppliers are conunonly used to provide: •

Product and process technology, and expertise

•

Product development and value analysis

•

Information on latest trends in n1aterials, processes, or designs

•

Capacity for 111eeting unexpected den1and

•

Cost efficiency due to econo111ies of scale

STRATEGIC ALLIANCES

, ....................................................... .

In general terms, a strategic alliance, in the context of strategic sourcing, is an agreement between a buyer and a supplier to pursue a set of agreed upon objectives, ,vhile ren1aining independent organizations. These con1panies have decided to share inforn1ation and resources to achieve a 111utual benefit.

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Preferred suppliers are potentially ideal candidates for a strategic alliance. The benefits of these types of arrangernents can vary, but the rnost basic benefits are the potential to increase revenue and profits for both parties, the potential to create a competitive advantage or block a cornpetitor fron1 gaining rnarket share, to n1itigate risks and ensure a continuity of supply, and to position the partners for future strategic opportunities. A strategic alliance is a natural extension of a supplier development program in v,hich «technical and financial assistance is given to existing and potential suppliers to improve quality and/or due date/perfonnance:•1 Strategic alliances can be very advantageous for both the buyer and the supplier. They can result in better n1arket penetration, access to new technologies and kno,vledge, and a higher return on investment. Eventually the arrangement could extend to a con1pany's second-tier suppliers as key first-tier suppliers begin to forn1 their o,vn alliances.

Tapping into Strategic Supplier's Knowledge As noted, strategic alliances can create access to previously untapped kno,vledge. Strategic sourcing partners offer buyers the opportunity to extend their O\\'n intellectual capabilities by involving their external partner base in their product developrnent process. The t\vo rnost co1mnon \vays to accomplish this are through: •

EARLY SUPP LIER INVOLVEMENT (ES I}: "The process of involving suppliers early in the

product design activity and drawing on their expertise, insights, and kno\vledge to generate better designs in less time, and designs that are easier to manufacture ,vith high quality.'' "These strategic supply partners becorne n1ore involved in the internal operations of the buyer's con1pany, particularly ,vith respect to ne"' product and process design, ,vorking ,vith buyers to do concurrent engineering, and designing products specifically for n1anufacturability. •

VALUE ENGINEERING: Activities help the buyer's con1pany to reduce costs, i1nprove quality,

and reduce new product development tune. lne goal is to satisfy the product's performance requiren1ents at the lo\vest possible cost. ll1is typically involves considering the availability of rnaterials, production rnethods, transportation issues, liinitations or restrictions, plannil1g and organization. Benefits can include a reduction in lifecycle costs, in1provement in quality, and a reduction in environmenta.l impact, to nan1e just a fe,v. 176

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Value engineering involves buyers and suppliers working together: Identifying the 111aterials and other key aspects of a product Analyzing those 111aterials and key aspects Developing alternative solutions for delivering those functions ,vith the ai1n of achieving reduced costs, ilnproved quality, and reduced develop111ent tin1e Assessing the alternative solutions Determining the costs of the alternative solutions Selecting the alternatives with the highest likelihood of success for further development

Negotiating Win-Win Strategic Alliance Agreements vVhen negotiating an agreen1ent, there are t,,,o basic negotiating strategies fro111 ,vhich the parties can choose: l.

DISTRIBUTIVE NEGOTIATIONS: A

process that leads to a self-interested, one-sided outcome 2.

INTEGRATIVE OR COLLABORA· TIVE NEGOTIATIONS: A process

"'here both sides ,vork together to 1nax:ilnize the outcon1e or create value. A ,,,in-"•in result. This negotiating strategy requires open discussions and a free flow of infonnation ben1•een the parties. Successful integrative or collaborative negotiations start ,vith a clearly e>..-pressed understanding of ho,1• each company wants to benefit from the collaboration. Desired benefits n1ay or may not be readily apparent. Confirming the align1nent bet,veen both parties regarding 1notivation, contribution, financial benefit, and the 1nanagen1ent of the alliance are essential to a successful conclusion to the agree1nent and to continuil1g success into the future. Consequently, negotiations are not about each company obtaining the n1ost value, but n1ore about establishmg a relationship that ,vorks ,veil for both parties.

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Rewarding Supplier Performance Another important aspect of a strong supplier alliance is implementing a supplier re,vards and recognition progran1. Recognition of a supplier is the identification of exceptional performance, contributions, and/or capabilities. Re,varding suppliers for outstanding perfonnance 1notivates and encourages the1n to continue to strive for excellence in their products, services, and operations. Recognizing and re,varding suppliers strengthens and fosters strong and productive supplier relationships. Rev.•ard incentives can include the pro1nise of future business, sonic fonn of public recognition such as a plaque, an awards dinner, an honors ceremony, a press release, or forn1al cornn1unication 10 the supplier's senior leadership tea1n. Recognition programs encourage perfonnance improve1nents by re,varding suppliers ,vith additional benefits, cash back for acl1ieving perfonnance-based objectives, and strategic or preferred supplier status. Re,varding suppliers provides an incentive to surpass perfonnance goals.

Pain and Gain Share Provisions A supplier re,vards and recognition prograin could also be reflected as part of the formal supply agreement in the forn1 of pain and gain share provisions. Agreements could be constructed and negotiated to spell out in detail the gains (rev.•ards) and pains (penalty) that the supplier will realize for either exceptional or poor perforn1ance. l11is is so1n eti1nes referred to as a "Pain and Gain Share Agree1nent:' Both parties ,vould mutually agree on the provisions and the positive and negative outco1nes. Generally this ,viii only be acceptable to both parties if both pain and gain provisions are included. •

I

I

I

I

---- -I I

I

I

I \:; l_= ~ I

Using a penalty or punislunent is a negative outco1ne for poor perfonnance, cost overruns, quality problen1s:

PAIN:

Buyer could ilupose a financial penalty (i.e., fine) on the supplier for poor perfonuance. Buyer could reduce future business ,vith the supplier for poor perfonu ance. 178

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Buyer could in1plement a bill-back an1ount equal to, or a percent of, the incremental costs resulting fro1n poor perfonnance. •

GAI N:

Using a re\vard as a positive outcon1e fron1 exceptional performance:

Buyer could a,vard a financial bonus to the supplier for exceptional performance. Buyer could av,ard n1ore business and/or longer contracts to the supplier. Buyer could share a portion of any cost reductions developed by the supplier ,vhich benefit the buyer. Buyer could provide access to in-house training se1ninars, conferences, tools and infonnation, or other resources to the supplier. Buyer could publicly recognize the supplier and/or confer a special status on the supplier such as "Preferred Supplier;' "Partner:• or "Supplier of the Year:•

SUPPLIER CERTIFICATION PROGRAMS

•••••••••••••••••••••••••••••••••••

One of the ele1nents for building a strong strategic supplier pa1·tnership is having a well-defined and established supplier certification program. Supplier certification is defined as "certification procedures verifying that a supplier operates, maintains, improves, and docu1nents effective procedures that relate to the custon1er's require1nents. Such require1uents can include cost, quality, delivery, flexibility, n1aintenance, safety, and ISO quality and environmental standards:•• •

Supplier certification progran1s are used to differentiate strategic supplier alliance candidates from others.

•

Companies n1ay choose to develop internal certification programs, and may also require external certifications such as ISO 9000 / ISO 14000, as part of their overall certification process.

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lbe follo\ving is a list of certification conlponents that a company ntight consider ,vhen evaluating its suppliers for a certification program: •

"TI1e supplier 1neasures its quality performance

•

The supplier uses parts-per-million (ppn1) as its quality unit of 1neasure, not percent defective

•

The supplier has quality perfonnance goals

•

The supplier has a docuinented record of continuous quality i1nproven1ent over several years

•

lbe supplier's quality efforts are focused on preventing defective iten1s from being produced rather than detecting defective ite1ns that have already been produced

•

The supplier has formalized quality docu1nentation, training progran1s, and the like to ensure that quality is sustainable through personnel changes

•

The supplier kno\vs its standard deviation

•

The supplier can de1nonstrate ho"' it uses tools to detennine ""hether or not its processes are in control

•

The supplier has a quality-related certification like IS0900 I

•

The supplier has itnplen1ented a leading quality itnprovement progran1 like Lean, Six Sigma, or Lean Six Sigma

•

The supplier has itnplemented a quality inlprovement progran1 ,vith its o,vn suppliers

•

The supplier has won a prestigious quality a,vard such as the Malcoln1 Baldrige National Quality A,vard"'

One of the benefits of a supplier certification program is being able to reduce the amount of titne and resources necessary for the buyer to conduct incoming inspections of products and materials fro111 certified suppliers. TI1ese suppliers can be trained on the buyer's procedures and 111ethods for testing the products or 1naterials they supply to the buyer so that they can test these iten1s before they are transferred to the buyer, and provide the buyer ,vith a certificate of analysis ,vith each ship111ent or lot. Buyers may then opt to only test iterns periodically on incorning inspection rather than with each delivery or lot, providing that the periodic testit1g confinns the supplier's results.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

External Certincations External certification can be very beneficial for a company, because having an independent third party verify that the products or services supplied by the con1pany n1eet specific and internationally recognized require1nents ,viii add credibility. It is also ,vorth noting that certification is actually a legal or contractual requirement in so1ne industries. Suppliers that are externally certified, such as "ISO 9001 :2008 certified;' are preferred by procuren1ent departments because of the following: •

They have to conforn1 to an externally defined set of standards for quality, delivery of service, etc.

•

TI1ey are easier for procure1nent to initially qualify and periodically audit.

•

Certification is done by an external register agency alleviating some of the procuren1ent ,vorkload.

•

TI1ey are open to sharing supply chain infonnation.

•

They ,~1ant to build relationships \\1ith their custon1ers.

•

They have fonual processes in place for continuous improvement.

•

They have to be recertified every three years.

ADDITIONAL SOURCING CONCEPTS

••••••••••••••••••••••••••••••••••••••••

TI1e follo,ving are son1e additional sourcing concepts of note.

Reverse Auctions Reverse auctions are a sourcing technique ,vhere prequalified suppliers access a website at prearranged ti1ne and date, and try to underbid con1petitors to \\1in the buyer's business. TI1e buyer n1akes potential sellers a,vare of the intent to buy a specified good or service. During the course of the actual reverse auction event, the sellers bid against one another to secure the buyer's business, driving the price to be paid for the iten1 dov,n.

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Vendor Management Inventory Vendor n1anagement inventory (VMI) is an inventory replenishment arrangement where the supplier directly n1onitors the buyer's inventory and refills the stock autornatically ,vhen necessary, without the custo111er initiating a purchase order. VMI arrange1nents transfer the responsibility for managing the inventory located at a custo1ner's facility back to the vendor (i.e., supplier, manufacturer) of that inventory based on a predetermined set of parameters. This arrangement reduces the buyer's ,vorkload and benefits both buyer and supplier. •

Fron1 the buyer's perspective: -

The supplier tracks the inventories.

-

The supplier detennines the delivery schedule and order quantities.

-

The buyer can take o,vnership at the stocking location. The buyer may be able to avoid taking 01'•nership until the 1naterial is actually being used, thereby reducing inventory carrying costs and irnproving cash flow.

•

From the supplier's perspective: -

The supplier avoids ill-advised orders from the buyer.

-

The supplier decides inventory setup and shipments.

-

The supplier has access to n1ore inforn1ation fro1n the buy to aid in planning.

-

The supplier rnay have an opportunity to educate the buyer about other products or services offered by the supplier.

V11I arrangen1ents can help to stabilize the supply chain. It reduces the risk of n1ajor disruptions that can affect all the companies that are linked directly and irldirectly through the supply chain. It reduces the potential for the bulh~•hip effect.

Co-Managed Inventory Co-n1anaged inventory (CMI) is an arrange1nent ,vhere a specific quantity of an iten1 is stored at the buyer's location. Once it is used, the item is replaced by the supplier, with the kno,vledge and approval of the buyer. In CMI, tl1e buyer provides systerns access to tl1e supplier, and the supplier takes responsibility for 1nanaging the replenislunent process ir1 the buyer's systen1 accordir1gly. The

182

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

supplier revie\vS all of the available information and generates orders in the buyer's system. The prirnary difference between CMI and VMI is that in CM! the supplier is just recomn1ending an order, ,vhich is not continued w1til and w1less the buyer approves it. In VMI, the order created by the supplier is a confirmed order and the supplier is responsible to deliver the product and bill the buyer for the materials delivered.

JIT2 The concept of JIT 2 is very si1nilar to VMI and CMI, except that ,vith JIT 2 a representative of the supplier is actually e,nbedded in the buyer's organization. The employee is on the payroll of the supplier but ,vorks for the buyer and is en1po,vered to forecast den1and, monitor inventory, and place orders. TI1e arrangernent involves the buyer granting the supplier access to potentially proprietary or sensitive data. JIT 2 benefits both buyers and suppliers, from day-to-day operational improvement, to strategic advances in the structure of the supply chain organization.

ETHICS AND SUSTAINABILITY ................................................. . As the discipline of supply chain n1anage111ent has been increasingly recognized for the value that it brings to an organization, supply chain professionals have been tasked " 'ilh a larger role, and an evolving set of responsibilities over the years. That role has expanded to include responsibility for ensu1·ing that not only does the co111pany act in an ethical 111a11ner, but that it holds its supply partners to a high ethical standard as \,•ell. Companies should seek to replace suppliers " 'ho do not exhibit strong corporate morals and behave ethically. Supply partners are an extension of the cornpany and can have a significant negative impact on the con1pany and its reputation. There are several significant cases in the recent past \Yhere this has occurred.

Business Ethics and Ethical Sourcing Most companies today have sorne type of corporate social responsibility progran,. Frequently these progra111s also require suppliers to agree to abide by a supplier code of conduct in order to be considered an approved supplier. So,ne key terms and concepts related to ethics include: •

CORPORATE SOCIAL RESPONSIBILITY (CSR) is the practice of business ethics.

•

BUSINESS ETHI CS is the application of ethical principles to business. TI1e n,•o rnain ethical

approaches are: UTILITARIAN IS!\1: An ethical act that creates the greatest good for the greatest nu111ber of

people, and should be the guiding principle of conduct. eJ~\J>kt G: Strategic Sourcing

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RIGHTS AND D UTIES: So111e actions are just right in and of themselves, regardless of the

consequences. Think; Do the right thing! •

ETHICAL SOURCING is that '""hich attempts to take into account the public consequences of

organizational buying, or to bring about positive social change through organizational buying behavior. This involves tl1e procure1nent organizations ensuring that tl1e products being sourced are acquired in a responsible and sustainable ,vay. The people involved in producing these products should be treated fairly and work in a safe environment. The environmental and societal impacts 1nust also be considered as part of the sourcing process.

Ethical Policies Con1panies that seek to create ethical policies to ensure con1pliance in this areas should: •

Create a supplier code of conduct and require all suppliers to fonnally agree to abide by the code as a condition of being an approved supplier.

•

lnfonn suppliers of etl1ical souTcing expectations and create specific provisions ,vithin supplier agreements accordingly.

•

Detern1ine ,vhere all purchased goods originate and the n1anner in ,vhich they are n1ade.

•

Have kno,vledge of their suppliers' ·workplace principles.

•

Seek independent verification of supplier co,npliance ,vith etl1ical standards.

•

Include ethics as part of tl1eir supplier performance rating system.

•

Routinely report supplier con1pliance to key stakeholders.

Sustainable Sourcing Sustainability is an integral part of etl1ical business practices. Sustainability in tl1e supply chain is defined as the ability to n1eet the cu1·rent needs of the supply chain ,vi.thout hindering the ability to meet future needs in tern1s of economic, environmental, and social challenges. In sin1ple terms, do not 1nortgage the future for tl1e present. For organizations to establish and achi eve a sustainable sourcing strategy they \.,•ill have to set and 1neet strong, realistic, 1neasurable, and achievable targets. Co1npanies 1nust understand their supplier's sustainability i.n1pact and initiatives, considering things like ,vorker safety, ,vages, ,vorking conditions, hwnan rights, and so forth. 184

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Establishing a sustainable procurement process takes work and the company involved must understand the value of incorporating sustainable standards into its sourcing goals.

Sustainable Sourcing Strategies Sustainable sourcing strategies should include ele1nents such as: •

Grov,ing the con1pany through the launch of new sustainable products

•

Increasing resource efficiencies \\•hich ,vill also help to reduce costs

•

Ensuring that the products or n1aterials used meet environ1nental objectives for things like v;aste reduction, reuse, and recycling

•

Linking co1npany brands to the social consciousness of consu,ners

•

Building intangible assets such as social and environmental responsibility; increasing consumer a,vareness of sustainable sourcing and sustainability (e.g., go green).

REFERENCES ......................................................................... 'APICS Dictionary (14th ed.). (2013). Chicago, IL: APICS. \\1W\\•.apics.org; Rouse, M. (2016). Strategic sourcing. Whatsit.co1n. Retrieved fron1 http://searchfinancialapplications.techtarget.com/ definition/strategic-sourcing; D01ninick, C. (2016). A 12-point supplier quality checklist; and Do you practice supplier quality 1nanagen1ent? Next Level Purchasing, Inc. Retrieved from http:/ ' ""vw. nextlevelpurchasing.conl/art iciestsu pplier-qual ity •1nanagen1en I. php

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Supplier Relationship Management CHAPTER OUTLINE Introduction Successful Partnerships Keys to Successful Partnerships Supplier Performance Evaluation Supplier Certification Supplier Development Supplier Recognition Supplier Relationship Management Systems Trends in Supplier Relationship Management Summary

187

INTRODUCTION

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Supplier relationship managen1ent (SRM) is the discipline of strategically planning for, and managing. all interactions v,ith the third-party organizations that supply goods and/ or services to an organization in order to 111axi1nize the value of those interactions. Most supply professionals vie,v SRM as an organized approach to defining ,vhat they need and ,vant from a supplier and establishing and managing the company-to-company link to obtain those needs. The focus of SRM is to develop tv,o -way, n1utually beneficial relationships ,vith strategic supply partners delivering greater levels of innovation and co111petitive advantage than ,votild be achieved by operating independently. In n1any ,vays. SRM is si1nilar to customer relationship 111anagen1ent. Just as con1panies interact witl1 custorners, so do they interact ,vith suppliers-negotiating contracts, purchasing, managing logistics and delivery, collaborating on product design, and n1ore. SRM is a recognition that various interactions ,vith suppliers are not unique and/ or insular; in reality they are comprising a relationship, one that can and should be n1anaged in a coordinated and systen1atic \\•ay across functional business w1its (tile entire organizations supply chain), and continue throughout tile SRM lifecycle. Supplier relationship 1nanage1nent starts v.•ith identification of suppliers and is follo,ved by 1neasuring their qualifications, w1derstanding their perfonnance ability, and deternlining their stability in the marketplace. Supplier relationship n1an agen1ent helps an organization ,vork with suppliers for better performance and returns on their invest1nent. It helps an organization to reduce their procurement expenses. It also coordinates benveen business processes and suppliers relationship, as seen in figure 7. l.

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E-Purchasing • E-Catalogue • E-lnvolce •E-Payment

• E•Tenclerlng • E•Auctlon/blclding • Procurement Cardss

Supplier Management

RM

• E-Reglstratlon • Supplier Self Service

Operational Procurement • Self Service Proc • Service Proc • Plan Driven Proc

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

SRM seeks to improve profits and to reduce costs using tools such as: •

SOURCING ANALYTICS: Drives deep category and supplier insights by using n1arket leading tools to process vast an1ounts of data

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SOURCING EXECUTION: The tactical operation of strategic sourcing performed by a procuren1ent organization

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PROCUREMENT EXECUTION: The tactical operation of purchasing/procurement performed by a procuren1ent organization

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PAYll1ENT AND SETTLEMENT

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SUPPLIER ScoRECARDING: A ,vay to track perforn1ance metrics; ccan be associated ,vith various categories, depending on the supplier's role ,vithin your enterprise

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PERFORMANCE MONITORING: Tool that enables end users, adn1inistrators, and organizations to gauge and evaluate the perfonnance of a given system

SRM is often a part of the roll out of strategic sourcing and is typically applied ,vith suppliers: •

Providing high volwnes of a product/service

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Providing lesser quantities of a crucial product/service

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Serving 1nany business units of a con1pany or organization

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Where intensive engineering, n1anufacturing, and/or logistics interaction is essential

SUCCESSFUL PARTNERSHIPS .................................................. . Strong and successful supplier partnerships involve a 111utual con1n1it111ent ben,,een the buyer and the supplier over an extended time, to work together to the mutual benefit of both parties, sharing relevant infonnation and the risks and rev.•ards of the relationship. Successful partnerships rely on achieving a ,vin-,vi11 for the buyer and supplier. This requires adopti11g a strategic perspective as opposed to a tactical position. A strategic perspective involves long-term thinking-that is, looking at relationships not for what's happening today, but for ,vhat you "'ant to get out of the relationship over the long run. That n1akes a big difference in the approach to creating a part11ership. One of the n1ost in1portant aspects is creatil1g a v.ri.n-v.1i11 situation. If you focus on the tactical or hold a very

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short-term view, you will look at what's best for you regardless of,vhether it is best for the supplier or not. If you think strategically, you ,viii look at not only "'hat you need to v.•in but also "'hat your supplier needs to ,¥in as ,vell. It does a con1pany no good in the long run to just beat up on their suppliers. The con1pany may feel that they have won in the short tern1, but in the long term they may lose their suppliers and do then1selves more harm than good. if you ,vant to be successful in the long run, you ,viii need your suppliers to be successful as v.•ell. l11ere has to be n1utual benefits; both sides have to feel that there's a benefit in the relationship. If you have different strategies, different perspectives, and different goals and objectives, it's not going to v.•ork. You have to share the risks and rewards.

KEYS TO SUCCESSFUL PARTNERSHIPS

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If you value your suppliers, developing partnerships ,vith son1e or most of those suppliers may be very important for the future of your business. There are son1e keys to developing successful partnerships ,vith your suppliers.

Building Trust

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\.Yith trust, partners are n1ore willing to ,vork together, find compron1ise solutions to problen1s, v.•ork to,vard achieving long-term benefits for both parties, and go the extra mile. SRM requires a consistent approach and defined set of behaviors to foster trust over time. It also requires nev.• ,vays of collaborating v.>ith key suppliers, and actively d1anging existing policies and practices that can hurt collaboration and lin1it the potential value to be derived fron1 supplier relationships.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

No partnership is going to work if you don't trust one another. Building trust can be as easy as just laying your cards out on the table: "Here's \\•hat I need to get out of this relationship; l'n1 neither trying to gan1e the syste1n nor deceive you in any ,vay, ,vhat I need is .. :• or "1'111 ,villing to pay you a fair amount of n1oney for your services, I value you as a partner, I "rill treat you as an extension of my organization:• If you can start 10 work together fron1 there, you ,viii start 10 build trust. The big proble1n ,vith trust is that it is lost a lot faster than it is built. You can 1nake one 1nisstep and then your partners V>'on't trust you and it is extre111ely difficult to regain trust once it is broken. You may kno,,, that fron1 personal experience. U you had a trusting relationship ,vith someone and they did something that caused you to feel like they are not on your side anymore, ii is very difficult to trust that person again. It is the saine ,vith organizations. Building trust 111ay mean that you have to make son1e con1pro111ises. Co111promising shO\\'S partners that you are \\•illing to ,vork \\•itl1 then1 ai1d that you recognize tl1at they have needs fro,n tl1e partnership as well. Usually, a good relationship involves con1pro111ise on both sides. Both parties give a little bit to gel a lot more out of the longer-term relationship.

Shared Vision and Shared Objectives Strong, successful partnerships involve all parties having a shai·ed vision and shared objectives. If a co1npany ,vants lo establish a strategic partnership with a supplier, then they both need 10 be on the sa1ne page. If the company, for exa1nple, ,,,ants to gro,,, and expand its business, but the supplier does not share that goal or objective because the supplier ,vai1ts to 1naintain its size and 1narket position, the partnership is not likely to succeed. Example: Co111pany N has a long-tenn relationship ,vith Trucking Company K, \\•hich handles all ofC01npany N's internal shipn1ents bel\veen its local n1ai1ufacturing facilities ai1d internal \\•arehouses. Trucking Co1npany K also handles ship111ents going to and fro111 the local airport and ocean port. Con,pany N approaches Compa11y K saying, "You are a great partner, and ,ve \\•ould like to have you start 10 do so,ne of our long-haul trucking, taking our product out to the ultin1ate custon1ers in addition to ha11dling our local short haul transportation. It is a very expensive product, but ,ve trust you:• Trucking Co1npany K responds, "\,Veil, thank you very n1uch for your confidence and trust in our con1pany, but ,ve don't have the capability to handle your long-haul trucking requirements, and that is not the business " 'e \\•ant to be in. Y,,le don't \\•a11t to develop into a long-haul trucker, ,ve ,vai1t to re1nain in the short-haul business:• Clearly, the l\vo con1pa11ies did not share the saine vision or the same objectives. Trucking Company K n1ay be a great partner, but didn't \\•ant to expand and evolve its business. If you don't have the same vision, and you don't have the same objectives, then you're not going to be able to build or expai1d on an existing partnership.

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Personal Relationships Most good long-tern1 business relationships start out \Vith personal relationships benveen individuals. Con1panies co111e together through people and it is these people that need to build the relationship ben,•een the companies. Developing a relationship on a personal level benveen con1pany counterparts \viii potentially facilitate the process of developing a long-term successful partnership ben,,een the con1panies. If you are going to share infonnation and negotiate, it helps if you get to know your counterpart and begin to build some trust with them. It is the people who con1municate and make things happen 1n any strategic partnership.

Mutual Benefits and Needs Clearly, if both parties in a potential relationship don't see a ,vay to have their needs n1et or if they don't both see the benefits of the relationship, one or botl1 ,viii not value tl1e relationship and it is not likely to succeed, or n1aybe even to begin. Partnership should result in a ,vin-v,in situation, \,•hich can only be achieved if both companies have compatible needs. An alliance is much like a marriage, and if only one party is happy. then the marriage (i.e., alliance) is not likely to last.

Commitment and Top Management Support Partnerships are n1ore likely to be successful when top management of both companies is actively supporting the partnership. That support 111ust flo,v do,vn tl1rough the ranks of 111anagers and staff to ensure everyone understands the potential benefits to be derived. Having the support of senior n1anagen1ent ,viii facilitate tl1e process of securing resources, funding, and decision n1aking related to the partnership, making it easier to operate and n1ove the partnership forward. In addition, as issues arise ,vhich need tl1e attention of senior management on either side of the partnership, having their buy-in and support 192

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

from the start will also help to facilitate and ease the process of obtaining their decisions or approval to resolve issues.

Change Management Organizations are facing faster, more con1plex, 1nore interdependent, and n1ore cross-functional change than ever before. Changes in business and business relationships occur frequently and so1netin1es in unanticipated \vays. Any relationship or partnership ,viii inevitably face the need to n1ake changes. If the change is not n1anaged \,,ell, it has the potential to derail the partnership. Therefore, having a formal and robust change n1anage1nent process, which both parties have agreed upon in advance, is critical to the long-term health of the relationship. Applying change managen1ent enables organizations in a partnership to deliver results on ead1 change rnore effectively and build co1npetencies that gro,v the partnership's capacity to handle 1nore changes.

Information Sharing and Lines ofCommunication Con11nunication is a big part of a supplier relationship-any relationship for that rnatter. A strong comn1u1lications plan that considers hO\V best to share and distribute information among, ,vithin, and behveen partners is a necessary part of good partnership n1anage1nent. The frequent sharing of information and having open lines of cornmunication fosters an ongoing dialogue, ,vhid1 is so i1nportant because it helps to reduce the risk of assumptions and encourages partners to stay focused on their shared vision. \IVithin a supplier partnership, hvo n1ain communications strategies should be considered. The first is a plan to share infonnation about the partnership internally, ,vithin your O\\'n organization and "'ith your supply partners. \,\Tith a good internal con11nunications strategy in place, you can then read1 out externally to begin to build and share your n1essage in hopes of successfully in1ple111enting yotu partnership's goals and objectives. Partners should collaborate in planning their con1munications strategies at the beginning of the partnership, considering each other's policies, procedures, needs, and objectives. Most companies ,vill set up both fonnal and infonnal conununication. Formal co111n1unication, for exa1nple, would be to have a regular interval revie,v 1neeting with the supplier. The partners meet and discuss iten1s on a set agenda, talking about \\•hat's happening in their businesses, ,vhat ne"' products are planned for launch, ne,,, services and ne,v markets, revie\vi.ng performance, and discussing issues and potential resolutions. Inforn,al communication, for exarnple, ,vould be if someeJ~\J>kt 7: Supplier Relationship Management

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thing happens in the day-to-day operation and son1eone at the organization v.•here the activity is happening needs to notify someone at the other organization quickly. What develops is an informal com1nunication chain primarily bet,veen individuals at the operations level of both organizations who then determine if so1nething needs to be 1nore formally comn1unicated. Informal comrnunications 1nay go a long ,vay to,vard building the relationship. If both parties knov.• that the other is going to notify thern pro1nptly and honestly if so1nething happens, then trust ,viii be rnaintained, and these types of ad hoc conununications generally take place inforrnally.

Capabilities For a supplier relationship to be effective and successful, suppliers must have the right technology and capabilities to meet the buyers cost, quality, and delivery requirements in a tin1ely manner. In tl1e exan1ple introduced earlier w1der "Shared Vision and Shared Objectives;' Trucking Corupany K, ,vho ,vas handling all the internal transportation for Con1pany N, didn't have the capability to beco1ne a long-haul trucker for Con1pany N, and didn't ,vant to develop that capability. \Alithout this capability, the relationship will not evolve beyond the present. Company N ,viii ,vant to develop a supplier relationship ,vith a supplier who has the desired capability and tlus n1ay even alter the current relationship with Con1pany K. If a co1npany chooses to partner ,vith a supplier based on its needs and the supplier's current capabilities, and does not consider ,,,hether the supplier's capabilities are in line ,vith the company's long-tern1 strategy, it 1nay find that the supplier is not capable of supporting its needs in the long term. U a con1pany, for exa1nple, is planning to expand its business into a nev.• market that is projected to increase volume requiren1ents from a supplier, and the supplier does not have the capability to meet the new volu1ne requirements, tl1e con1pany is not likely to achieve its expansion goal through this partnership. A supplier's capability is an essential aspect of the health and success of any buyer-supplier relationship.

Continuous Improvement "The act of making incren1ental, regular ilnprovements and upgrades to a process or product in the search for excellence:•1 Continuous ilnproven1ent is an ongoing effort to in,prove products, services, or processes. These efforts can seek incremental irnproven1ent over til11e or breakthrough improvement all at once. Making a series of small improvements over titne results in the eli1nination of "'aste in a system, 1naking the systen1 1nore efficient and cost effective. 194

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Continuous in1provement should be an integral part of the SR.111 process and evolution. Buyers and suppliers rnust be " rilling to continuously irnprove their processes and capabilities in rneeting custon1er requiren1ents. The process con11nonly utilized in continuous i1nproven1ent is: plan, do, check, act. •

P LAN:

Identify an opportunity and plan for

change.

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D o: ln1plen1ent the change on a sn1all scale.

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C H ECK : Use data to analyze the results of

the change and determine ,vhether it n1ade a difference. •

ACT: If the change ,vas successful, i1nple1nent

BUSINESS PROCESS

it on a "rider scale and continuously assess your results. If the change did not work, begin the cycle again. Other methods of continuous improven1ent often considered are Six Sigma, LEAN, and total quality 1nanagen1ent, "'hich emphasize employee involve1nent and teainwork, 111easuring and syste111atizing processes, ai1d reducing defects and cycle ti111es.

Performance Metrics Performance metrics are quantifiable indicators used to assess ho,v ,veU an organization or business is achieving its desired objectives. These rneasures are typically tied to an organization's strategy. Measures related to quality, cost, delivery, and flexibility are generally used to evaluate suppliers. Metrics should be (1) understandable, (2) easy to n1easure, and (3) focused on real value-added results. The best performance measures are S.M.A.R.T (specific, rneasurable, achievable, relevant, and tin1e oriented). When evaluating suppliers, a multicriteria approach is best, as it gives the company a better overall picture of the supplier's perforn1ance. For si1nplicity purposes, it is also preferable to build these measure111ent targets arotu1d the end goals that are being sought (price, cost, quality, specific logistics details, order cycle tunes, lead tinle, etc.) rather than on the 111eans or subcomponent activities that add up to accon1plishmg the end goal. For example, an order cycle linle target has " 'ithm it an order receipt time, ai1 order processing tin1e, and order filling tirne, and a trailsportation transit tirne, " 'hich are all 1neai1s or subco111ponent 111easures. Avoid over-requiring 111eans or subcornponent 111easurements of suppliers, and focus iJ1stead on n1easuring the supplier against the end goal, ,vhich is ,vhat's really inlportant.

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An ilnportant performance n1etric related to SRM is the total cost of o"•nership (TCO). 1n supply chain 1nanagernent, the total cost of o,vnership of the supply delivery system is the sutn of all the costs associated \vith every activity of the supply streain. TI1e 1nain il1sight that TCO offers to the supply chai11 1nanager is the understandmg that the acquisition cost is often a very small portion of the total cost of ownership. TCO is made up of Jill costs associated ,vith the acquisition, use, and 1naintenance of a good or service, ,vhich not only 1nust be considered today, but over the life of the product. For this reason, TCO is son1eti1nes called "lifecycle cost analysis:• It is i1nportai1t to actively n1onitor a supplier's perforn1ance and provide visibility and feedback on supplier perfonuance at each stage of the evaluation process. Relevai1t 1netrics include: •

Supplier price and cost performance

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Product receipt quality

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Delivery perforn1ance

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Contractual and standai·d con1pliance

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Financial stability

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Participation in product developn1ent

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Cooperativeness in third-party production n1anagement

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Support of both ethics and sustainable practices

SUPPLIER PERFORMANCE EVALUATION

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Successful con1pan.ies e1nbrace their suppliers, vie"o,n Akt 7: Supplier Relationship Management

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No incoming nonproduct rejections (e.g., late delivery) for a specified time period

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No significant supplier production-related negative incidents for a specified tin1e period

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ISO 9000 / Q 9000 certified or successfully passing a recent, onsite quality systen1 evaluation

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Mutually agreed-upon set of clearly specified quality perfonnance 1neasures

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Fully docu1nented process and quality systen1 " 'ith cost controls and continuous improvement capabilities

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Supplier's processes stable and in control

External Certincation: International Organization for Standards The International Organization for Standardization (ISO) is the world's largest developer of voluntary international standards. It " 'as founded in 1947, and has since then published more than 21,000 international standards covering aln1ost all aspects of technology and business. Today, the ISO has n1e1nbers fron1 163 countries and about 150 people " 'orking full tin1e for the Central Secretariat in Geneva, Switzerland. Organizations that becon1e ISO certified and request and receive \vritten pennission fro1n the ISO can display the ISO logo. ISO certification is highly sought after in the business world as it represents achieving and maintaining a stand of excellence verified by an independent third-party organization. l\\•O ISO

standards commonly used in supplier certification programs are:

ISO 9000 •

A series of 1nanagen1ent and quality standards in design, develop1nent, production, installation, and service.

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Co111panies ,vanting to sell in the global market ,viii \Vant to seek ISO 9000 certification.

The follo,ving are eight quality 111anagen1ent principles on ,vhicl1 the ISO 9000 series quality 1nanage1nent systen1 standards are based: l.

Custo111er focus-understand current and future customer needs

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Leadership- establish unity of purpose and direction of the organization

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Involvement of people-people are the essence of an organization

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Process approach-a desired result is achieved through a 111anaged process

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Syste111s approach to 1nanage1nent-111anagi.ng interrelated processes

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Continual improve1nent- perfor1nance i1nprove1nent is a pern1anent objective

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Factual approach to decision making- decisions are based on facts and data

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Mutually beneficial supplier relationship-interdependent benefits create value for both an organization and its suppliers.

ISO 14000 •

A family of standards for environ111ental 111anage111ent

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The benefits include reduced energy conswnption, environmental liability, \\•aste and pollution, and unproved conununity goodwill.

SUPPLIER DEVELOPMENT ....................................................... Supplier developn1ent is the technical and financial assistance given to existing and potential suppliers to in1prove quality and/or due date perfonnance. ln si111pler tern1s, it can be described as a buyer's activities to in1prove a suppHer's capabilities. A supplier's kno\\•ledge of, and technology used to produce, the conunodity they supply can be leveraged through supplier develop111ent initiated by the 111anufacturer to reduce costs and !o,ver project risks. Supplier develop1nent programs should be designed to achieve: •

Lo,ver supply chain total cost

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Increased profitability for all supply chain participants

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Increased product quality

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Near-perfect on-tin1e delivery at each point in the supply chai.J1

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A supplier developn1ent program must be aimed at in1proving suppliers performance, not bullying then1 into charging less or si1nply auditing and re,varding them. Supplier developrnent is all about providing suppliers \vith \vhat they need to be successful in the supply chain.

Tv.•o of the 1nost i1nportant functions of a supplier develop1nent progran1 are: •

Providing information about products, expected sales gro\vth, etc. Poor con1munication and a lack ofinforn1ation translates into additional costs (usually in the forn1 of just-in-case inventory). Suppliers need to beco1ne extensions of their custo1ners.

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Training suppliers in the application of LEAN and Six Sigrna / quality tools. Asking suppliers to lo\ver their price ,vithout giving the111 the kno,vledge on ho\v to lo\ver their costs (through LEAN implementation, for exan1ple) is not sustainable in the long tern1. This tactic \viii drive suppliers out of business, ,vhich goes against the purpose of supplier development.

The typical approach to supplier development is based on the follo\ving process steps: 1.

Identify critical products and services.

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Identify critical suppliers.

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Fonn a cross-functional tea111 internally to ,vork \,rith the supplier(s).

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Meet ,vith the top n1anagement at the supplier(s) to obtain their support and involvement.

5. Identify key developn1ent needs and projects. 6.

Define details of the agreement and the action plan.

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Monitor the status of the projects / action plan and n1odify strategies as necessary.

Vvith a robust supplier developn1ent progran1, co1npanies can establish trust through a heightened conunit1nent to their supply partners.

SUPPLIER RECOGNITION

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A supplier recognition progran1 is just \vhat it sounds like- a progra1n to recognize suppliers ,vho achieve the high perforn1ance standards necessary to 1neet custo1ner expectations.

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The success of the business can depend on the quality and perforn1ance of the con1pany's suppliers. TI1erefore, it is ahvays a good practice for a con1pany to have innovative supplier recognition prograins in order to recognize their achieve1nents and re,vard the1n for their exceptional perforn1ru1ce and services. There are several key benefits of such progran1s that 1nake them valuable for a business organization. •

MOTIVATE SUPPLIERS TO PERFORM BETTER: Elfe•Ctive progran1s that recognize and re·ward suppliers for their perforn1ance can 1notivate them to continue to excel in terms of their quality, pricing, ru1d delivery con11nit1nents. In a highly co1npetitive business environ1nent, strong and n1otivated suppliers can be a crucial co1upetitive advantage for a business. Therefore, the co1npany must take care to develop and nurture its supplier network ,vith innovative recognition and reward schemes.

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H ELP TO IMPROVE SUPPLIER LOYALTY AND COMMITl\1ENT: 1n today's competitive environ1nent, supplier loyalty cannot be taken for granted. Reputed suppliers are al\\•ays in den1and fro1u a nu1nber of con1petitors, and their supply capacity is !united. Therefore, the business organization needs to ensure that it continues to receive privileged support from its key suppliers. Supplier support is in1portant to ensure that customer delivery con1mitments are n1aintained. When there is a peak de1nand for the co1npany's product, it 111ay fail to exploit the n1arket opportunity fully if it does not have adequate supplier support to n1eet that de1uand i11 the peak season.

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ENCOURAGE SUPPLIERS TO ADAPT TO THE COl\1PANY's CULTURE: If the con1pany

treats its suppliers as a part of the fan1ily and engages m supplier recognition programs periodically, it can help to bring the suppliers closer to the corporate values, ethics, ru1d principles of the con1pru1y. They tend to identify then1selves ,vith the values ru1d policies of the organization, and adapt to its culture 1nore easily. This helps to consolidate the relationships ,vith suppliers for the long run. It also fosters a better understanding of each other's needs and creates a " rin-\\•in situation for both parties. •

HELPS TO C REATE ENTRY BARRIERS FOR COl\1PETITORS: Strong and mutually reward-

ing relationships \\•ith suppliers can lead to the creation of stiffer entry barriers for ne,v con1petitors. If the suppliers trust the con1pany, they may like to sign deals of exclusivity ,vith the company for certain crucial components. The company can give then1 a buyback assurance for their entire production capacity. In such a situation, it becon1es difficult for too many con1petitors to enter the busil1ess if tl1ey do not have access to critical supply sources. •

ENCOURAGES SU PPLIER PARTI CI PATION IN PRODUCT INNOVATION: Recognition to

suppliers also bri11gs about their enthusias1n to ,vork closely ,vith the co1npany on ne,v product

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development. A nu1nber of products require a close interaction and cooperation bet,veen the con1pany and the suppliers during the development stages. lnvolvernent of suppliers from an early stage helps to achieve the lowest costing and rninilnizes quality issues in the long run. Therefore, recognition of the value that a supplier can bril1g to an organiution is ilnportant to achieve the overall organizational objectives. Con1panies should recognize and celebrate the achieve1nents of their best suppliers. •

A sin1ple thank you goes a long ,vay to sho,v appreciation. Providing a recognition letter of appreciation (often supported by a wall plaque) is a good ,vay to start a recognition program.

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Co1npanies can establish supplier a,vards. A,vard ,vL11ners exe111plify true partnerships, contil1uous ilnprovement, organizational conmlillnent, and excellence.

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A,vard-v,i11ning suppliers serve as role 111odels for other suppliers and n1otive then1 to strive to achieve the award.

A properly developed and active supplier recognition progran1 can and ,viii n1ake n1ajor contributions to the organization, its suppliers, and its custon1ers and stakeholders. If a company is going to keep and utilize suppliers, there should be a rnotivation plan that reaches thern. Future success depends on the supply chain; therefore, the supplier recognition prograrn should support building a better and n1ore co1npetitive supply chaL11.

SUPPLIER RELATIONSHIP MANAGEMENT SYSTEMS .................. . When consideril1g developn1ent of a supplier relationship progran1 there are several technologies available to support developn1ent. The key is to ensure that the system(s) being considered can Lil fact gather and track a supplier's performance data across all business units and/or locations. The reason for, and a benefit of, a system is to provide a more comprehensive and objective vie"' of supplier performance, ,vhich in turn can be used when making sourcing decisions. Such a system ,vill also help iii identifying and addressing supplier perforn1ance issues. It is irnportant to recognize that an SRM system can only be iiuplen1ented in line ,vith other necessary business process changes. The SRM system is part of the process, not the whole process by itself. The follo,vL11g are five key points to consider in the develop1uent and iinplen1entation of an SRM system: 1.

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Auto111ation is 1neant to handle routine transactions.

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

2.

Integration spans 1nultiple departments, processes, and software applications.

3.

Visibility of infonnation and clear and concise process flov;s are vital.

4.

Collaboration occurs through infonuation sharing.

5.

Optin1ization of processes and decision 1naking are necessary.

Based on the technology and methods no,\' available to assist in the evaluation and certification process, an organization ,viii find it easier to 1nake better, faster, and 111ore inforrned decisions about potential suppliers. Systems can enhance the process; ho"rever, training and understanding of the system are critically ilnportant. ln1plementing simple systems is still a better value and provides a greater success rate than in1ple1nenting complicated (often expensive) syste1ns. 'TI1e key to any syste111 is to ensure that the staff has agreed to the syste111 and its abilities, and that the infonnation that it will yield "'ill i11 fact be useful to all parties involved both at the supplier and organizational levels.

TRENDS IN SUPPLIER RELATIONSHIP MANAGEMENT ................. l.

CLOSE ALIGNMENT OF SOURCING AND NEGOTIATION WITH SUPPLIER RELATIONSHIP MANAGEMENT

Many con1panies are detennining their supplier negotiation strategies by tying then1 to their category 1nanagen1ent strategy, and to what type of relationship and goals they have ,vith the supplier. 2.

Focus ON CROSS -FUNCTIONAL ENGAGEMENT SRM success depends on il1ternal relationship 111anagen1ent as n1ucl1 as external relationship manage1nent. Strategic SRM requires coordil1ation and alignment ,vith suppliers, and ,vith il1ternal functions. Mixed messages cause supplier confusion, con1pronlised trust, missed opportunities, inefficiencies, increased risk, and lost leverage. A best practice cross-functional governance structure for strategic supplier relationships involves SRM tean1s at both the co1npany and supplier levels, each led by a relationship n1anager, \\•ho along with executive sponsors fro1n both organizations, fonu a steering conuuittee to lead the process.

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3. Focus ON INNOVATION Custo1ners and suppliers work ,vith each other regularly or often on innovation projects. Companies that engage in more innovation ,vith suppliers report higher ROI fron1 their efforts. Companies esti1nating ROI fron1 innovation fromhvith their suppliers report much higher results than fro111 internal innovation efforts. 4.

INV ESTMENT IN PEOPLE AN D "SO FT S KI LLS"

Treat suppliers with the courtesy and respect due all people in all interactions. Be candid, and able to disagree (even forcefully), without being disagreeable. Hold both sides to the same standards. Actively search out opportunities for 1nutual benefit. Actively seek to cultivate n1utual trust. 5. MORE ROBUST MEASUREMENT Benefits of strategic partnerships ,vith suppliers are nwnerous. For customers: -

Preferred access to the supplier's best people Increased operating efficiencies Lo,ver costs Iinproved quality Enhanced service Influence over supplier investments and technology roadn1aps Preferred access to supplier ideas Increased innovation fro1u and ,vith suppliers, leading to lo""rer costs and incren1ental revenue Sustainable competitive advantage

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

For suppliers: Greater visibility into custo1ner purchasing plans Increased operating efficiencies Longer tenn custo1ner co1nmit1nents; greater predictability of future business Increased scope of busi ness and revenue Lower costs of sales; increased margins Opportw1ities to develop, pilot, and sho" •case innovative solutions Deeper insights into custo1ner strategy and plans Ability to align investrnents leading to increased ROI C Sustainable competitive advantage

SUMMARY............................................................................ . •

Supplier relationship n1anage1nent (SRM) is the discipline of strategically planning for, and n1anaging, all interactions \Vith the third-party organizations that supply goods and/or services to an organization in order to 1naximize the value of those interactions. Supplier relationship n1anage1nent helps an organization \vork with suppliers for better perforn1ance and returns on their investment.

•

Strong and successful supplier partnerships involve a 1nutual con1n1itn1ent bel\,•een the buyer and the supplier over an extended tune, to work together to the 1nutual benefit of both parties, sharing relevant inforn1ation and the risks and re\vards of the relationship. This requires adopting a strategic perspective as opposed to a tactical position.

•

·n1e keys to developing successful partnerships ,vith your suppliers are: Building trust Having a shared vision and shared objectives Buildi11g personal relationships

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Identifying n)utual benefits and needs Securing comn1it1nent and top manage,nent support Managing change

-

Sharing infonn ation and 1n aintaining open lines of conununication Understanding suppliers capabilities

-

l!nplemenling a continuous improvement program Establishing performance 1netrics

•

Successful con1panies e1nbrace their suppliers, vie,ving then1 as partners in helping to gro"' the business. Making sure that this is a n1utually beneficial partnership ",i,11 impact the price you are negotiating today and the quality of service you get in the future. Supplier performance evaluation against a set of 1nutually agreeable criteria can help to ensure that both parties in the relationship lu10\\• exactly ,vhat is expected, and if expectations are being met. One 1nethod of evaluating tl1e perfon nance of key suppliers is the ,veighted-criteria evaluation syste1n.

•

The 1nain reason for supplier certification is for tl1e con1pany to eli1ninate or n1inin1ize inco1ning inspections, saving the co1npany tin1e and n1oney. Co1npanies can i.Jnplen1ent internal or external certifications or a combination of both. One external certification partner conm1only used in industry is the lnternationa.l Organization for Standards (ISO). ISO 9000 is a series of management and quality standards in design, development, production, installation, and service. ISO 14000 is a family of standards for environn1ental management.

•

Supplier develop1nent is the technical and financial assistance given to existing and potential suppliers to i1nprove quality and/or due date perforn1ance. In simpler terms, it can be described as a buyer's activities to i1nprove a supplier's capabilities.

•

A supplier recognition progra1n is established to recognize suppliers ,vho achieve the high perfonnance standards necessary to 1neet custo1ner expectations. It is always a good practice for a con1pany to have innovative supplier recognition progra1ns in order to recognize their achievements and re"•ard them for their exceptional performance and services.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

•

The reason for, and a benefit of, an SRM system is to provide a more comprehensive and objective viev,r of supplier performance, which in turn can be used ,vhen n1aking a sourcing decisions. Sud1 a syste1n "rill also help in identifying and addressing supplier perforn1ance issues.

•

The current trends in supplier relationship n1anage1nent are: Close align rnent of sourcing and negotiation \\1ith supplier relationship managen1ent Focus on cross-functional engagement Focus on innovation lnvest1nent in people and "soft skills" ~1ore robust rn easurernent

REFERENCES

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l APJCS Dictionary (14th ed.). (2013). Chicago, IL: APICS. ,v,vw.apics.org; Influx Connect. (n.d.). A robust supplier incentive program. Retrieved frorn http://influxconnectcom/ ?q=node/ 1146

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Operations Management with LEAN and Six Sigma CHAPTER OUTLINE Introduction Manufacturing Strategies Total Cost of Manufacturing LEAN and Six Sigma Introduction to LEAN Key Elements of LEAN Manufacturing Introduction to Six Sigma Six Sigma Methodology Six Sigma Training and Certification Levels Total Quality Management Quality Gurus Voice of the Customer Cost of Quality Quality Tools Statistical Process Control Acceptance Sampling Implementing LEAN and Six Sigma 213

INTRODUCTION

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Operations Management Operations 1nanagen1ent refers to the design, execution, and control of the operations that convert resources into desired goods and services, aligned with the company's business strategy. In sin1ple tern1s, it is the business function responsible for managing the process to create goods and services. Major activities in operations 1nanage111ent beyond product creation often include, product devel opment, n1anaging purchases, inventory control, production operations, quality control, storage, and logistics. The focus is on the efficiency and effectiveness of processes including the measurernent and analysis of those processes. TI1e goal of operations managernent is not only to convert rnaterials and labor into goods and services as efficiently as possible, but also control costs to maximize the profit of the co1npany. The nature of how operations management is carried out varies by company and depends on the nature of the products or services in the portfolio. In this text we will specifically focus on the operations management areas of manufacturing strategies, LEAN manufacturing, and Six Sigma.

MANUFACTURING STRATEGIES

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Con1panies 1nust develop a manufactur ing strategy that suits the type(s) of products that they produce, their custon1ers' expectations, and their strengths. Manufacturing strategies can vary significantly depending on tl1e product and/or the custorner requirernents. Developing a rnanufacturing strategy that suits a cornpany's strengths is essential for establishing and 1naintaining an effective supply chain. In this section we ,vill revie\,, four key 1nanufacturing strategies; n1ake-to-stock (NITS), rnake-toorder (MTO), assemble-to-order (ATO), and engineer-to-order (ETO). \Ive will also review the irnplications to customer delivery lead tin1e " 'ith each of these n1anufacturing strategies. •

MAKE-TO-STOCK (MTS): "A production environrnent v,here products can be, and usually

are, finished before receipt of a custon1er order. Custorner orders are typically filled fron1 existing stocks, and production orders are used to replenish those stocks:•• Make-to-stock 1neans to n1anufacture products for stock based on den1and forecasts. The 1nore accurate the forecast is, tl1e less likely excess inventory \vill be created, and the less likely a stockout will occur. 1berefore, the critical issue is how to forecast demands accurately.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Most daily necessities such as foods, sundries, and textiles are MTS-type products. One issue of MTS is the potential to have excess inventory. Con1panies that operate a MTS n1odel struggle to make the correct product at the correct tune iJ1 the correct quantities. MTS features economies of scale, large volumes, long production runs, lo,v variety, and n,ultiple distribution channels. •

MAKE- TO-ORDER (MTO): "A production environn1ent where a good or service can be made

after receipt of a customer's order. The final product is usually a combination of standard items and iterns custorn-designed to rneet the special needs of the custorner." 1 ·n1e MTO strategy only rnanufactures the end product once the custon,er places the order, creating additional ,vait tirne for the conswuer to receive the product but allo,ving for rnore flexible customization. TI1e MTO strategy relieves the problerns of excessive inventory that is con1n1on "rith the traditional MTS strategy. MTO is not appropriate for all types of products. It is appropriate for highly configured products such as computer servers, aircraft, ocean vessels, bridges, automobiles, or products that are very expensive to keep in inventory. MTO relies on relatively s1nall quantities, but n1ore con1plexity. •

ASSEMBLE-TO-ORDER (ATO): ''A production envirorunent ,vhere a good or senrice can be as-

sembled after receipt of a customer's order. The key components (bulk, senu-finished, iJltermediate, subassembly, fabricated, purd1ased, packing, and so on) used in the assernbly or finishiJ1g process are planned and usually stocked in anticipation of a custon1er order. Receipt of an order iJutiates assembly of the customized product. TI1is strategy is useful where a large nun1ber of end products (based on the selection of options and accessories) can be assembled from con,mon components'.'' ATO is a hybrid strategy bet,veen a MTS strategy ,vhere products are fully produced in advance, and the MTO strategy " 'here products are manufactured once the order has been received. The ATO strategy atternpts to combil1e the benefits of both strategies-that is, getting products mto custo1ners' hands quickly while al10,vil1g for the product to be customiuible. TI1e ATO strategy requires that the basic parts for the product are already ruanufactured but not yet asse1nbled. Once an order is received, the parts are assen1bled quickly and sent to the customer.

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-

•

ATO is when base con1ponents are made, stocked to a forecast, but products are not assembled until the customer order is received

ENGINEER-TO- O RDER (ETO): "Products ,vhose custo1ner specifications require unique en-

gineering design, significant custornization, or ne\\• purchased n1aterials. Each custorner order results in a unique set of part nun1bers, bills of n1aterial, and routings:•• -

The essence of ETO is building a unique product every tin1e. TI1ere 1nay be cornponents that are co1nn1on fron1 one product to another, but not in the san1e quantity as in repetitive manufacturing. It is a 1nore dran1atic evolution of a MTO supply chain.

-

The cost of poor quality can be very high ,vith an ETO strategy. The v;arranty costs and the cost of rev.•ork to replace an item in a cornplex asse1nbly can have a serious negative effect on profit margins. Quality must be part of the entire process, and not just part of purchasing and rnanufacturing- the typical focus of a repetitive manufacturer. ETO is used ,vhen products are unique and extensively customized for the specific needs of individual custorners

The choice of strategy is the rnajor detern1ining factor in the total cycle time or lead time the custorner experiences. As sho\\•n in figure 8. 1, each rnanufacturing strategy involves completion of different aspects of the supply chain prior to receiving a custorner order, and accordingly, the custo1ner " 'ill experience different lead tirnes dependir1g on which manufact1uing strategy has been established.

•

MTS: The product is already produced and available ir1 the ,varehouse ,vhen the custon1er order is received, so the custon1er will only experience the customer delivery lead tin1e.

•

ATO: The product desig11 is co1nplete and the con1ponents/materials have already been procured when the customer order is received, so the customer ,vill experience the manufacturing (e.g .. assernbly) and customer delivery lead times.

•

MTO: The product design is the only elen1ent complete ,vhen the custon1er order is received, so the custorner v.•ill experience the procure,nent, n1anufacturing, and custorner delivery lead tirnes.

•

ETO: Since no supply chain elements have been cornpleted ,vhen the customer order is re-

ceived, the custorner ,viii experience the full curnulative supply chain lead tirne.

216

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

leadTimesExperiencedbyCustomers

•

cl ••

Product Design Lead Time

~ ..

Procurement Lead Time

Manufacturing Lead Time

Customer Delivery lead Time

MTS Strategy ATO Strategy MTO Strategy ETO Strategy (Mcu111ry, 2016)

Manufacturing Strategies for Manufacturing Processes There are four basic 1n anufacturing processes fro1n ,vhich con1panies can choose to produce their product(s) depending on various factors, including the level of custo1nization required by the custon1er, the type of product being produced, complex_ity, volume, and cost. Each of these n1anufacturing processes aligns 1nore closely ,vith one or nvo specific rnanufacturing strategies. Figure 8.2 stunrnarizes these four rnanufacturing processes. •

JOB SHOP: "A type of n1anufacturing process used to produce ite1ns to each custo1ner's spec-

ifications. Production operations are designed to handle a ,vide range of product designs and are performed at fixed plant locations using general-purpose equipment:'' Job shops produce s1nall lots of a variety of products, ,vhich require a unique setup and sequence of process steps to create a custo111 product for each custon1er. -

Characteristics: A job shop manufacturing process is characterized as being highly flexible, ,vith a large variety of products, very long lead ti111es, lo,v voltunes, lo,v labor require1nents, lo,v fixed costs, but high variable costs.

-

Exa1nples: ?11etal fabrication shops, print shops, custo1n cabinet 1uaking

-

Manufacturing Strategies: ETO or MTO are the 1nanufacturing strategies that are 1nost closely aligned ,vith the job shop process.

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~

--

Manufecturlnc

Volume

Costs

Costs

I.Hdnme

M1nufacturin1 Strateav

Very High

Very Low

Low

High

Very long

ETO/ MTO

Somewhat Flexible

High

low

Moderate

Moderate

Long

MTO/ATO

Somewhat Inflexible

Limited

High

Moderate

Moderate

Short

ATO/MTS

Highly Inflexible

Very Limited

Very High

High

Low

Very short

Highly Flexible

Batch

Une Flow

Job Shop

..

v.rlable

Flexibility

ProCiess

••

\:I

Fiald

Product variety

Continuous Flow

MTS

(AfrlallrJ1 2016)

•

"A type of rnanufacturing process used to produce ite1ns ,vith similar designs and that ,nay cover a v,,.ide range of order volwnes. Typically, ite1ns ordered are of a repeat nature, and production n1ay be for a specific custo111er order or for stock replenishment:'' BAT CH:

Characteristics: A batch 111anufactur ing process, in con1parison to a job shop process, is characterized as being less flexible, with a 111ore narro,\rvariety of products, long lead times. slightly higher volumes, n1oderate labor requiren1ents, and rnoderale fixed and variable costs. In batch processing. s01ne of the co1nponents for the final product rnay be produced in advance. Examples: Manufacturing con1ponent parts for a production line, 1nanufacturing clotl1ing, or furniture Manufacturing Strategies: MTO or ATO are tl1e 1nanufacturing strategies iliat are n1ost closely aligned with the batch process. •

LINE FLOW: "A fonn of rnanufacturing organization in ,,,hich n1achines and operators handle

a standard, usually uninterrupted, material flow. The operators generally perform the same operations for each production run. A flo,v shop is often referred to as a rnass production shop or is said to have a continuous rnanufacturing layout. The plant layout (arrange1nent of 111achines, benches, asse111bly lines, etc.) is designed to facilitate a product 'flo,v: Some process industries (chemicals. oil, paint, etc.) are extren1e examples of flo,v shops. Each product, though variable in rnaterial specifications, uses the same flow pattern through the shop. Production is set at a given rate, and tl1e products are generally 111anufactw·ed in bulk."'

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Characteristics:

A line flo,v n1anufacturing process is characterized as being son1e,vhat inflexible, " 'ith a li,nited variety of products, short lead times, and high volwnes. Products are standardized allo,ving a better organization of resources than ,vith job shop or batch processing. The sequence of operations in line flo"' is generally fixed, and production orders are not linked to customer orders as is typical in job shop and batch processing. Exa111ples: Auton1obiles, co111puters, appliances, household goods Manufacturing Strategies: ATO or MTO are the manufactw·ing strategies that are 111ost closely aligned with the line flow process.

•

CONTINUOUS FLO\V: "A production syste1n in "'hich the productive equip111ent is organized

and sequenced according to the steps involved to produce the product. This term denotes that material flo,v is continuous during the production process. l11e routing of the jobs is fixed and setups are seldo1n changed:'• Characteristics: A continuous flow 1nanufacturing process is characterized as being inflexible, ,_.ith a very !united variety of products, very short lead tunes, very high volu111es, high fixed costs, and low variable costs. This type of 111anufacturing process involves standardized production ,vith rigid line flows and tightly linked process segn1ents. The process is often operated 24/7 to n1ax:i1nize utilization and to avoid expensive stops and starts. Exa111ples: Gasoline, laundry detergent, che111icals Manufacturing Strategies: MTS is the manufacturing strategy that is n1ost closely aligned \\•ith the continuous flo"' process.

TOTAL COST OF MANUFACTURING

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Total cost of 111anufacturmg (TCM) consists of all the costs associated \vith production, procurement, inventory, " 'arehousing, and transportation. All of these costs are impacted by the n1anufactw·ing strategy. Since TCM results fro1n the ftu1ctional integration of 1nanufacturing, procuren1ent, and logistics, it is ilnportant for companies to design a supply chain strategy (and adopt a n1anufacturing strategy) that achieves the lowest TCM across the entire process. Key points: •

TCM is the con1plete cost of producing and delivering products to your custo1ners.

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•

TCM incorporates both fixed and variable costs.

•

TCM is generally expressed as a cost per unit for each product.

Relationship ofTCM Elements to Volume and Manufacturing Strategy •

Per unit procure1nent and production costs go do,vn as volu1ne goes up. Generally, a step function applies as 1nore capital (i.e., fixed cost) v.•ill be required to produce 111ore as volu111e grov,s beyond the existing output capabilities.

•

Per w1it inventory and \varehousing costs go !!J2 as volun1e goes up. The con1pany "'ill produce and manage 1nore inventory and therefore ,viii likely need more warehouse storage space, insurance, and potentially pay 1nore inventory taxes, a1nong other things.

•

Per unit transportation costs go do,vn as volun1e goes up, but level off at high volumes (econo1nies of scale in transportation until the container/conveyance is filled up).

LEAN AND SIX SIGMA

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LEAN: "A philosophy of production that en1phasizes the nlinimization of the an1ount of all the resources (including time) used in the various activities of the enterprise. It involves identifying and eli1ninating non-value-adding activities in design, production, supply chain 1nanage1nent, and deal ing ,vith custon1ers. Lean producers en1ploy tea1ns of n1ultisk.illed workers at all levels of the organization and use highly flexible, increasingly auton1ated machines to produce volumes of products in potentially enonnous variety. It contains a set of principles and practices to reduce cost through the relentless re111oval of ,vaste and through the si!nplification of all 111anufacturing and support processes:•• LEAN is an operating philosophy of ,vaste reduction and value enhancement. Elen1ents of \Yhat is today kno\vn as LEAN ,vere originally created as part of the Toyota Production System (TPS) by key Toyota executives. S i x S IGMA: "The six sigma approach is a set of concepts and practices that key on reducing vari -

ability in processes and reducing deficiencies in the product. linportant ele1nents are (l) Producing only 3.4 defects for every one 1nillion opportw1ities or operations; (2) Process improven1ent initiatives striving for six sig1na-level perforn1ance. Six sign1a is a business process that permits organizations to irnprove botto1n-line perfonnance, creating and 1nonitoring business activities to reduce \Vaste and resow·ce requirements ,vhile increasing custo111er satisfaction:•• It is an enterprise and supply chain-wide philosophy that en1phasizes a co1nmitment to\vard excellence, encon1passing suppliers, en1ployees, and customers.

220

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

LEAN and Six Sign1a complement one another: •

LEAN focuses on eliminating \Vastes and in1proving efficiency.

•

Six Sig1na focuses on reducing defects and variations.

The con1bination of LEAN and Six Sign1a creates a faster and better supply chain.

INTRODUCTION TO LEAN

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•

Starting in the 1910s, Henry Ford's mass production line created a first breakthrough by using continuous asse1nbly and line flo,v systen1s.

•

In the 1940s, Toyota executives, Taichii Ohno and Shigeo Shingo, created the Toyota Production Syste,n (TPS), \vhich incorporated Ford's production syste1n and other techniques to fonn the basis of ,vhat is no,v kno,vn as LEAN.

•

The term LEAN ,vas first coined by John Krafcik in 1988, and the definition was e>.i>anded in the book, The Machine that Changed the World (\.Yo1nack, Jones, & Roos, 1990).

•

In the 1990s, supply chain 1nanagen1ent co1nbined and incorporated the concepts of:

Quick Response, which is the rapid replenishment of a customer's stock by a supplier " 'ith direct access to data fron1 the custo1ner's point of sale; e1nphasizes speed and flexibility. Efficient Consun1er Response (ECR}, ,vhich is a strategy to increase the level of services to consu1ners through close cooperation an1ong retailers, " 'holesalers, and 1nanufacturers Just in Ti1ne (HT}. which is an inventory strategy to decrease \Yaste by receiving 1naterials only v.•hen and as needed in the production process, thereby reducing inventory costs; requires and accurate de111and forecast to be effective Keiretsu Relationships. v.•hich involve con1panies both upstreaiu and do,vnstreain of a 1nanufacturing process, remaining independent, but working closely together for n1utual benefit •

The co111bination of these approaches and concepts have e111erged as the philosophies and practices kno\vn as LEAN manufacturing.

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Lean is a culture, ii is llQl a toolbox of methods or ideas. LEAN provides value for customers through the most efficient use of resources possible. It has become standard in rnany industries. Implementing LEAN often resuhs in: •

Large cost reductions

•

ln1proved quality

•

Increased custorner service

To kno,v how LEAN provides value for custorners, we need to understand ,vhat is meant by the term "val ue... •

\ Talue is the inherent worth of a product as judged by the customer. and reflected in its selling price and 1narket dernand.

•

Value is further defined as anything for ,vhich the customer is ,,rilling to pay

Jn n1ost processes, there are value added process steps and nonvalue added process steps. •

Value Added process steps actually transform or shape a product or service that is eventually sold to a custon1er. Exa1nple: a process step that actually assembles component iten1s into a finished product, adds value to the product.

•

Nonvalue Added process steps take tin1e, resources, and/or space, but do not actually add value to the product or service. Exarnple: the process step of rnoving the con1ponent parts to the assen1bly equip1nent does not actually add value to the product. The overall process " 'ould be better and n1ore efficient if this step could be minimized or elin1inated.

LEAN is co111posed of three elen1ents working in unison: •

LEAN n1anufacturing

•

Total quality managernent

•

Respect for people

LEAN manufacturing is a natural fit within the discipline of supply chain management as all of the LEAN goals and objectives help to facilitate an efficient and effective supply chain. Supply chain 1nanage1nent strives to incorporate LEAN elernents by:

222

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

•

Satisfying internal as well as external customer demand

•

Con11nunicating den1and forecasts and production schedules up and do,vn the supply chain, to reduce/elinlinate the bull\vhip effect

•

Quickly 1noving products into and through the production process

•

Optin1izing inventory levels across the supply chain (internally and externally)

•

Increasing the value, capabilities, and flexibility of the ,vorkforce through cross-training

•

Extending collaboration and alliances beyond just first-tier suppliers and customers to include second- and third-tier suppliers and custo1ners as \veil

KEY ELEMENTS OF LEAN MANUFACTURING

••••••••••••••••••••••••••••

'There are n,any different aspects of LEAN n1anufacturing and each company 1nay value various aspects differently. The following are son,e of the more co1nn1on ele1nents of LEAN 1nanufacturing: I.

Waste reduction

2.

Lean layouts

3.

Inventory, setup tune, and changeover time reduction

4.

Small batch scheduling and uniforn1 plant loading

5.

Lean supply chain relationships

6.

Workforce e1npo,vennent and respect for people

7.

Continuous improven,ent

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223

Waste Reduction \lvaste reduction is the nun1ber one objective of LEAN. Waste in the context of LEAN and supply chain managernent is the expenditure of one or rnore resources for no purpose or value. Companies can reduce costs and add value by eli.rninating ,vaste fron1 the production systern. Waste can occur in 1nany fonns. Refer to figure 8.3 for the eight categories of " 'aste, and use the 111nen1onic "DO\kt 8: Operations Management with LEAN and Six Sigma

22S

•

Lean layouts can also incorporate a n1anufacturing cell model ,vhere sets of n1achines are grouped together or in close proxin1ity to one another based on the products or con1ponent parts they produce, saving duplication of equipn1ent and labor.

•

Lean layouts are often U shaped to facilitate easier operator and n1aterial moven1ents.

THE CONCEPT OF 5-S

A lean layout incorporates the concept of 5-S. ,vhich is a systematic process of ,vorkplace organization. It is a discipline designed to help build a quality \\rork environment, both physically and 1nentally. 5-S is also considered part of the broader idea lu10,,.n as visual control, visual ,,.orkplace, or visual factory. The 5-S process steps are: I.

SORT: Keep only necessary ite1ns in the ,,.orkplace, eli1ninate the rest.

2. S TRAIGHTEN: Organize and arrange items to pron1ote an efficient " 'orkflo,v. 3. S HINE: Clean the ,vork area so it is neat and tidy. 4.

STANDARDIZE: Schedule regular cleaning and n1aintenance.

5. SUSTA IN: Stick to the rules. Maintain and revie"' the standards. TI1ere is a place for everything, and everything should be in its place.

Inventory, Setup Time, and Changeover Time Reduction The third element of LEAN involves inventory, setup time, and changeover lin1e reduction. •

Excess inventory is a ,vaste. So1ne inventory 1nay be necessary, but excess inventory takes up space; costs 1noney to hold and 1naiI1tain; costs 1noney to protect, secure, and iI1suTe; and it ties up financial capital which could be used for other aspects of the busmess (e.g.. R&D, marketing and sales, improven1ents, dividends, pay increases). Reducmg inventory levels can free up capital and reduce holdmg costs. ln addi tion, there is less likelihood of " 'aste being created by obsolescence, expiry. spoilage. or dan1age \\•ith lo"'er inventory levels.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

What do you see? ... a river flowing smoothly

No,v that the water level is lo"•er '"hat do you see?

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-

-

Traditionally, supply chains ,vork as a push systen1, ,vhere inventory is carried to cover up problems. Reducing inventory levels can also uncover production proble,ns. Refer to the follo,ving analogy. •

The water represents inventory. When the water level is high, you don't see the rocks beneath the ,vater, and don't kno,v they are there.

•

The rocks represent hidden obstacles, problen1s, and issues. These dangers are hiding just beneath the surface.

•

Inventory can hide the underlying proble1ns, but they are still there and can potentially create 1najor issues in the supply chain.

Lo,vering inventory ,viii help to expose the hidden problems. Once the problems are detected, they can be solved. TI1e end result ,viii be a smoother rw1ning supply chain ,,,ith less inventory invesllnent.

• Setup Tinte and Changeover Time are both considered ,vaste as

they are intervals 1vhen the equipment is not perfonning its intended function- that is, producing product. Setup tune is the tin1e taken to prepare and fonnat the 1nanufacturing equip1nent and syste1ns for production. Changeover ti1ne is the tin1e taken to adapt and n1odify the 1nanufacturing equipment and systems to produce a different product or a ne,v batch of the sa1ne product.

-

While selling up the equipment is a necessary function, if the setup lin1e can be minimized, the difference "'ill be more tin1e available to produce. Both setup and changeover are non value added operations and should be 1nininuzed as 1nuch as possible.

Small Batch Scheduling and Uniform Plant Loading The fow·th elen1ent of LEAN is small batch scheduling and unifonn plant loading. In a LEAN n1anufactw·ing environ111ent, the ideal scl1edule is to produce every product as quickly as possible and at the sa1ne rate as custon1er demand. ln the real ,vorld, n1aterial availability, labor availability, and setup or changeover time influences the scheduling of large batches. SMALL B ATCH SCH EDULING

Large batches can exacerbate the bull"•hip effect as production in large batches creates an uneven ,vorkload as production is not synchronized with custon1er demand, and an uneven demand for 228

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

upstrean1 processes, n1aking a pull system impossible. 'TI1roughput tirnes in n1anufacturing go up and ,vork-in-process inventory goes up, creating more v.•aste in the systen1. Think of a snake trying to S\\•allov.• a large n1eal. LEAN n1anufacturing atternpts to reverse this though sn1all batch scheduling or sn1all lot production. If den1and can be leveled and setup/changeover tin1es can be reduced, sn1aller batches "'ill facilitate producing at the san1e rate as customer de1nand. Production in sn1all batches creates a smooth ,vorkJoad as production can be synchronized ,vith customer demand, and a smooth de111and for upstreain processes, facilitating a pull systern. It increases flexibility allo,ving the cornpany to respond to changes in custo111er de1nands n1ore quickly. Throughput tin1es in n1anufacturing go down, and work-in-process inventory goes do,vn, thus eliminating or minimizing waste in the syste1n. 'The company can also get the product to the customer more quickly. Srnall batch scheduling can reduce costs by reducing inventory, " 'hile also increasing flexibility to 111eet custon1er de111and. UNIFORM PLANT LOADING

In a n1anufacturing environ1nent, unless dernand is perfectly flat, or capacity is highly variable, it is likely tl1at de1nai1d ,vill exceed capacity, not reach capacity, or botl1, at various points in the plai1ning horizon. Matching the production plai1 to follo,v demand exactly can conn·ibute to inefficiency and ,vaste. The technique of unifonn plai1t loading involves shifting plai1ned production fonvard ai1d planning production \tp to the available capacity in earlier tiine periods, in order to 111eet den1and in later tin1e periods, where the production necessary to n1eet demand would have othenvise exceeded the available capacity. In figure 8.5, the Original Plan sho,vs that production ,vould be under capacity in the first seven 1nonths of the year and overcapacity in the final five months of the year. Both in-

More efficient use of resources

Very inefficient use of resoorces

:1111111.. ... .. - --

...

el~\J>kt 8: Operations Management with LEAN and Six Sigma

•

1111 .. - ....

.. - ---,,.

. ... ...

229

stances \vould result in an inefficient use of resources and a potential customer service failure in the second half of the year. TI1e Level Loaded Plan sho\vs the shifting of sorne of the production frorn the final five 1nonths of the year, fonvard into the first half of the year ,vhere capacity is available. And ,vhile this "front-loading" or "leveling" of the plan creates some te1nporary excess inventory, it is a better utilization of the con1pany's resources and avoids a customer service failure in the second half of the year. This rnore "uniforn1" plan helps suppliers better plan production as ,veil.

Lean Supply Chain Relationships The fifth ele1nent is lean supply chain relationships. LEAN represents a ne\v ,vay of thinking about supply chain partners; its principles require cooperative supplier and custon1er relationships that balance cooperation ,vith con1petition. Cooperation involves a variety of collaborative relationships including supplier and customer partnerships, and strategic alliances, ,vhich are a key feature of LEAN supply chain 1nanage1nent. Cornpanies develop lean supply chain relationships \Vith key supplier and " 'ith key custorners. Supply chain partners n1ust ,vork together to rernove ,vaste, reduce cost, and ilnprove quality and customer service. Mutual dependency and benefits occur ainong these partners. Lean supply chain relationship pril1ciples are: •

Focus on the value streain

•

Elirninate ,vaste

•

Synchronize the flo,v of products and information

•

Minilnize transactional costs and production costs

•

Balance cooperation and co1npetition

•

Ensure visibility and transparency

230

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

•

Develop quick response capabilities

•

Manage uncertainty and risk

•

Align core con1petencies and con1ple111entary capabilities

•

Foster innovation and kno\vledge-sharing

Workforce Commitment and Respect for People The sixth element is \vorkforce con11nitmen1 and respect for people. WORKFORCE COMMITMENT

For LEAN n1ai1ufucturing to \\•ork, n1ai1agers n1ust support its principles by providing subordinates \vi.th the skills, tools, tin1e, and other resources necessary to identify problen1s and in1plen1ent solutions. Manage111ent has the responsibility for motivating and engaging large nun1bers of people to work together toward a conunon goal such as LEAN 111anufacturing. Defining and explaining \,rhat that goal is, sharing a path to achieving it, 1notivating people to take the journey, ai1d assisting the111 by re111oving obstacles are 111anagen1ent's reason for being. One of the funda111ental elen1ents of LEAN manufacturing is that n1anagement n1ust be totally committed to the "custo111er-first'' philosophy. Typically, organizations think of the custon1er only in tenns of the person or organization that purchases the final product. LEAN 111anufacturing pro111otes the vie\\• that each succeeding process, workstation, or department is the customer. It is management's responsibility to ensure that all tea.1n me1nbers and all departments realize their dual role: they are both the custo111ers of the previous operation and the suppliers to the next operation do,vnstreain. R ESPECT FO R P EOPLE

People are the 1nost valuable resource in any company. Vl1ithout good people the business \Viii not succeed. vVhen people do not feel respected the1nselves, they tend to lose respect for the co111pany.

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lhis can becon1e a n1ajor problem at any lin1e but particularly " •hen you are trying to in1plement LEAN. Most people ,vant to perforn1 ,veil in their jobs. "They ,vant to feel like they have contributed to the con1pany goals. A co1npany that respects people "rill appreciate their ,vorkers' efforts and keep the111 in high regard. Son1e of the 1nore basic ,vays a company can ensure that their people kno,v they are respected include frequent communication, actively listening to their ideas, praising good perforn1ance, and providing help and support ,,,hen necessary. In a LEAN manufacturing environment: •

A flatter hierarchy than traditional organizations is e1nbraced.

•

Ordinary ,vorkers are given greater responsibility.

•

Supply chain 1ne1nbers ,vork together in cross-functional tean1s.

•

The goal regarding the workforce is NOT to reduce the nu1nber of people in an organi1..ation, but to use the people resources 1nore ,visely and n1ore efficiently.

l11e role of ,vorkers, n1anage1nent, and suppliers in a LEAN 1nanufacturing environment:

•

ROLE OF WORKERS: Workers are given greater responsibility and their expanded duties include i1nproving the production process, 1nonitoring quality, and correcting quality proble1ns. Workers often \\•Ork in tean1s and forn1 quality circles to facilitate these expanded responsibilities.

•

ROLE OF MANAGEMENT: Manage1nent 1nust create the cultw·al change needed for LEAN to succeed. They provide an atinosphere of cooperation, en1power ,vorkers to take action based on their ideas, and develop incentive systems to encourage and re,vard lean behaviors.

•

ROLE OF SUPPLIERS: A key elen1ent of LEAN is to build lean supply chain relationships \\•ith suppliers over the long tenn. Suppliers are expected to help improve process quality and share inforn1ation. l11e goal is to have fe\\•er but n1ore strategic supply partners.

232

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Continuous Improvement The seventh elen1ent is continuous in1proven1ent. In the context of LEAN n1anufacturing, continuous in1prove1nent is a 1nethod for identifying opportunities for streantlining work and reducing waste. Continuous in1provement can be viev,ed as a formal practice or an infonnal set of guidelines. Continuous in1proven1ent helps to strea1nline workflo,vs; and efficient workflows save time and money, allo,ving the co1npany to reduce ,vasted tin1e and effort. •

TI1e continuous i1nproven1ent approach helps to reduce process, delivery, and quality problen1s such as 1nachine breakdo,vn proble1ns, setup problen1s, and internal quality proble1ns

INTRODUCTION TO SIX SIGMA

•••••••••••••••••••••••••••••••••••••••••••••••

What Is Six Sigma? Six Sign1a is a quality managen1ent process that seeks to i1nprove the quality of process outputs by identifying and re1noving the causes of defects (errors) and minimizing the variability in n1anufacturing and business processes. TI1e goal of Six Sig111a is to attain less than 3.4 defects per million opportunities (DPMO). Six Sigma is a structured and data-driven approach to drive a near-perfect quality goal (i.e., "Zero Defects").

Six Sigma

Six Sigma History •

TI1e n1odern-day concept of Six Sig1na \Vas originated by Motorola in I 980. Bill Stnith, a Motorola engineer, is credited ,vith coining the tenn "Six Sign1a."

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233

•

In the early to mid-1980s, Motorola developed the new standard, created the n1ethodology, and copyrighted it as ,veil. Motorola has docun1ented n1ore than $16 billion in savings as a result of Six Sigma.

•

Thousands of co111panies around the ,vorld have adopted Six Sigma as a ,vay of doing business. This is a direct result of 1nany of An1erica's leaders openly praising the benefits of Six Sigma (e.g., Jack \,Velch of General Electric Co1npany). Six Sig111a becaine fa1nous ,vhen \,Velch 1nade it central to his successful business strategy at General Electric in 1995. GE reported $200 1nillion in savings in the first year of ituple1nentation (1996).

SIX SIGMA METHODOLOGY

••••••••••••••••••••••••••••••••••••••••••••••••••••

There are three 1nait1 foundational aspects of Six Sigma: l.

QUALITY IS DEFINED BY THE CUSTOl\1ER: Custon1ers expect performance, reliability, con1petitive prices, on-time delivery, good service, clear and correct transaction processing, ai1d 1nore. It is vital to provide ,,,hat the custo1ners need to achieve custo1ner satisfaction.

2.

USE OF T ECHNI CAL T O O LS: Six Sign1a provides a statistical approach for solving any prob-

le111 and thereby itnproves the quality level of the product as ,veil as the con1pany. All en1ployees should be trained to use technical tools (e.g., statistical quality control and the seven tools of quality). Six Sign1a is concerned ,vith the permanent fix to quality problems and seeks to identify and correct the root cause of the proble1n. 3.

PEOPLE INVOLVEMENT: Six Sigma follo,vs a structured 1nethodology, and has defined roles for the participants. A con1pany 1nust involve all its e1nployees in the Six Sigina progra111, and provide opportunities and incentives for the111 to focus their talents and ability to satisfy customers. All en1ployees are responsible to identify quality problen1s. lt is important that all Six Sigma tea.in members have a ,veil-defined role ,vith n1easurable objectives. Under Six Sigma, the 1ne1nbers of an organization are assigned specific "roles" as follo,vs: Senior Leader: Defines the goals and objectives in the Six Sign1a initiative.

Implementation Leader: Supervises the Six Sign1a initiative. Coach: Six Sigma expert or consultant who sets a schedule, defines result of a project, and ,vho mediates conflict, or deals ,vith resistance to the program. 234

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Sponsor: High-level individual within the company that acts as a problem solver for the Six Sigma initiative.

Team Leader: Oversees the ,vork of the Six Sign1a team and acts as a liaison bet\veen the sponsor and the tearn n1e1nbers.

Team Me1nber: Executes specific Six Sign1a assignrnents. Process O,vner: Takes responsibility for a process after the Six Sign1a team has completed its ,vork. Six Sigma has two key methodologies: •

DMADV ,nethodology:

.Qefine --> Measure --> Analyze --> Design -->Yerify: a data-driven quality strategy for designing products and processes. This n1ethodology is used ,,•hen the cornpany v.•ants to create a ne\\• product design or process that is n1ore predictable and defect free. •

DMAIC methodology:

Define --> Meastue --> Analyze --> l rnprove -->Control: a data-driven quality strategy for in1proving processes. This n1ethodology is used ,vhen the con1pany ,vants to in1prove an existing business process. DMAIC is the most ,videly adopted and recognized Six Sign1a methodology in use. It defines the steps a Six Sigma practitioner typically follo,vs during a project. This text will focus on the DMAIC 111ethodology. which consists of the follo,ving five steps. Define the proble,n: The focus should be on the custo,ners' expectation of the process. Measure the proble1n and process: Map out the current process. Detennine the frequency of defects.

SIX SIGMA

60

Anat,ze the data and the process: Identify the root cause(s) of the proble1ns and defects. Determine v.•hy, when, and v.•here defects occur.

el~\J>kt 8: Operations Management with LEAN and Six Sigma

23S

-

I1nprove the process: Find solutions to fix or reduce the root cause(s) of the problems, and prevent problerns frorn occurring. In1plement and verify the solution(s). Control and sustain the improven1ent solutions: TI1is ensures that the process stays fixed. "Bake" the solutions into the process perrnanently.

SIX SIGMA TRAINING AND CERTIFICATION LEVELS ..................... . TI1ere are rnultiple Six Sigrna certification levels based on training, lu1o"'ledge, and experience. 1l1ese people conduct Six Sign1a projects and implement improvements. •

YELLO\Y BELT: Has a basic understanding of Six Sigrna rnetllodology and tl1e tools in tl1e

DMAIC problem-solving process. A learn 1nember that revie\vs processes and process in1provements in support of a Six Sign1a process in1provement project. A person ,vho has passed the Green Belt certification exa111 but has not yet co111pleted a Six Sign1a project. •

GREEN BELT: A Six Sigina trained individual tl1at can ,vork as a tean1 n1en1ber on co111plex

project and lead srnall, carefully defined Six Sigrna projects. On con1plex Six Sig111a projects, Green Belts " 'Ork closely " 'ith the Black Belt tea.m leader to assist \vitll data collection and anal ysis, and to keep the teanl functioning through all phases of the project. •

BROWN BELT: A Six Sigma Green Belt who has passed the Black Belt certification examina-

tion but has not yet con1pleted a second Six Sign1a project. •

BLACK BELT: A full-tune quality professional ,vho has a thorough kno,vledge of Six Sigrna

philosophies and principles, and possesses technical and 1nanagerial process irnprovement/ innovation skills. Leads the Six Sign1a project team and problem-solving efforts. Identifies projects and selects project tea111 111en1bers. Trains and coaches project tean1s. A Black Belt is typically rnentored by a Master Black Belt. •

MASTER BLACK BELT: Is a career patl1. A Master Black Belt has successfully led IO or 111ore

learns through complex Six Sigrna projects. A proven change agent, leader, facilitator, and tech nical expert in Six Sigma. A seasoned individual with a proven mastery of process variability reduction, and \\•aste reduction. Acts as an advisor to executives, and a coach and n1entor on projects that are led by Black and Green belts. Functions as tl1e keeper of tl1e Six Sigrna process, and can effectively provide Six Sigrna training at all levels. In addition, every project needs organizational support. Six Sigma champions and executives set the direction, ensure that projects succeed and add value, and that selected projects fit ,vithin the organizational plan. 236

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

TOTAL QUALITY MANAGEMENT

•••••••••••••••••••••••••••••••••••••••••••••••

Total quality n1anagen1ent (TQM) is a management philosophy based on the principle that every employee 1nust be committed to main taining high standards of " 'Ork in every aspect of a co1npany's operations, focused on 1neeting custo1ner needs and organizational objectives. TQM is a con1bination of quality and 1nanage1nent tools designed to increase business and reduce losses resulting fro1n wasteful practices.

TOTAL

QUALITY

MANAGEMENT When i1nple1nented, Six Sigma is an integral part ofTQM. Its key principles are as follO\\fS:

•

Management Co1nmitment

•

E1nployee E1npO\\fennent

•

Fact-Based Decision Malcing

•

Continuous hnprove1nent

•

Custo1ner Focus

There is no single acaden1ic fonnalization of total quality, but noted quality gurus W. Ed,\fards Deming, Philip Crosby, Joseph Juran, and Kaoru lshika,va, among others, contributed to the basic frame\\1ork: •

This discipline and philosophy of n1anage1nent institutionalizes planned and continuous irnproven1ent.

•

Quality is the outco1ne of all activities that take place " 'ithin an organization.

•

All functions and all e1nployees 1nust participate in the itnproven1ent process.

•

Organizations need both quality systen1s and a quality cultuTe.

QUALITY GURUS .................................................................... Each of these quality gurus (i.e., experts) significantly contributed to OUT CUI'rent understanding and practice of quality n1anage1nent today. el~\J>kt 8: Operations Management with LEAN and Six Sigma

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•

W. Ekt 8: Operations Management with LEAN and Six Sigma

239

COST OF QUALITY

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Cost of quality is an approach that supports a company's efforts to determine lhe level of resources necessary to prevent poor quality, and to evaluate the quality of the con1pan)1s products and services. Any cost that " 'ould not have occurred if quality ,vas perfect, contributes to the cost of quality. This infonnation ,viii help a co1npany to detennine the benefits and savings generated by potential process improve1nents. Cost of q uality can be divided into "the cost of good quality" involving prevention and appraisal costs, and "the cost of poor quality" involving internal and external failure costs.

Cost ofGood Quality •

Prevention Costs are incurred to prevent or avoid q uality proble1ns. TI1ese costs are associated ,vith the design, in1ple1nentation, and 1naintenance of the quality n1anagement systen1. They are planned and experienced before actual products or materials are acquired or produced. They include: Establislunent of specifications for incon1ing m aterials, proce.sses, prod ucts, and services Creation of quality plans Quality training (developrn ent, preparation, and 111aintenance of progran1s) Creatio n and m aintenance of the quality system

•

Appraisal Costs are associated ,vith the measuring and n1onitoring of activities related to quality. These costs are associated with the evaluation of purchased materials, processes, products, and services to ensure that they conforrn to specifications. They include:

-

Testing, evaluating, and inspecting the quality of incon1ing materials, process setups, and products, against agreed upon specifications Quality assess,nent and approval of suppliers Perform ing audits to confirn1 th at the quality system is operating properly

Cost ofPoor Quality •

Internal Failure Costs are incurred to fix defects discovered before the product or service is delivered to the custon1er. TI1ese costs occur v, hen the product or service does not 111eet the designed quality standards, and are identified before the product or service is delivered to the customer. They include:

240

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Defective product or 1naterial that cannot be used, sold, or repaired Correction of defective 1naterial or errors (e.g., re\\•ork and repairs) Unnecessary v.•ork or inventory resulting fro1n errors, poor organization, or poor co1n1nunication Analysis activities required to establish the root causes of internal product or service failures •

External Failure Costs are incurred to fix defects discovered by custon1ers. These costs occur '"hen the product or service that does not 1neet the designed quality standards are not detected until after the product or service is delivered to the customer. They include: All \\1ork and costs associated ,.,,ith handling and responding to custo1ner complaints All work and costs associated with failed products that must be replaced or services that are repeated under a warranty All ,vork and costs associated v.,jth the repair and servicing of returned products and products still in the field All v.•ork and costs associated '"ith the handling and investigation of rejected or recalled products, including return transportation costs

QUALITY TOOLS

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Seven quality tools are comn1only used in making quality managen1ent decisions based on facts. Any one or any combination of the tools may be helpful depending on the circu1nstances, and none of the tools are n1andatory in Six Sig1na. There are a nun1ber of software prograins available to support these tools. The seven tools n1ost co1runonly used for quality control and in1prove1nent are: I.

CAUSE-AND-EFFECT DIAGRAJ\1 (Ishika,"a or fishbone diagrain): Tool used to aid in brainstonning md isolating the cause(s) of a proble1n. TI1e function is to identify the factor(s) that are causing a defect(s) so that improven1ent actions can be taken. Typically, the potential factors are identified by those fa1niliar with the process involved. Major factors could be grouped using the four Ms: materials, n1achinery, 1nethods, and n1ai1po,ver. It is conunonly used in con1bination ,vith the Five W11ys md Five Ho,vs teclinique to help identify the root cause. See figure 8.6 for m exm1ple.

el~\J>kt 8: Operations Management with LEAN and Six Sigma

241

Machinery

Materials Not enoush

tickt!l )la lion) Inadequa te

Internet connection los t

Shortage of cash forcihan

~

Credit card s

1~m breaks

Run out of ticket

Ticket )~tern

blank'i,

b~.1k,;

No queulna

system

Problem

Under-staffed

Undertr'9ined

Stoff CredlVDeblt not accepted

Turnover

No Supervision

No adv•nced ticket s:.les

Methods

Poor Hirina Pr-.:1 ct i Cf! s

Manpower

Used to aid in brainstorming and isolating the causes of a problem. (McUury 2018)

2. C HECK SHEET: A simple way of gathering data so that decisions can be based on facts. Check sheets are commonly used to detern1ine the frequencies for specific problems. They could also be used to correlate the nu1nber of defects to other variables such as the day of the ,veek or 1nonth of the year, to see if there is any significant variation or pattern. ·n1e data gathered in a check sheet can also be used as input to a Pareto chart for analysis. See figure 8.7 for an exa,nple. 3. C ONTROL C HART: Plots representative san1ples of the selected values from a process, in sequence over tin1e. Control charts are used to study how a process changes over time. A control chart ahvays has a median line for the average, an upper line for the upper control limit, and a I0\\1er line for the lower control li,nit These lines are detennined from historical data. By comparing current data to these lines, conclusions can be dra,vn regarding ,vhether the process variation is in control or out of control. (Refer to "Statistical Process Control" later in this chapter.) A sa1nple 1neasure1nent outside the control !units therefore indicates that the process is no longer stable, and is usually a reason for corrective action. See ligu1·e 8.8 for an exan1ple. 242

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Check Sheet • Frequency of Customer Problems at a Movie Theater Problem

Sundly

Mondly

Tutedty

NoPer1clng

Wtdnt.:S.y

Thuirtdty

Frldty

S.IUfdoy

5

12

15

17

49

14

16

15

18

16

19

20

118

Tlc:ketsSoldOut

11

16

13

15

11

16

12

94

L""II w.. IOr CCnd1nity to ,vhere they are going to use it, ,vhether that is a v.•holesaler, a distributor, a retailer, or the actual end consu1ner. The real value delivered by the logistics function is en suring that the product is delivered at the right time and to the r ight location- everytlling else up to that point is a necessary but nonvalue added activity. Altl1ough logistics on the front end of the supply chain is necessary to n1ove 1naterials fron1 suppliers to 1nanufacturers and out to v.•holesalers, tl1e real value only occurs when the product is in the possession of the actual customer.

WAREHOUSING ..................................................................... A warehouse is a facility used to store inventory. \'Varehousing is all "the activities related to receiving, storing, and shipping 1naterials to and fro1n production or distribution locations:•• ,.varehousing is the function that allo,vs a con1pany to store all of the types of inventory (i.e., ra,\' materials, work in process, and finished goods) the company may have or need. Decisions driving ,varehouse n1anagement include site selection, the number of ,varehouse facilities in tl1e net\vork, tlle layout of tl1e ,varehouse(s), and tl1e 1netllods of receiving, storing, and retrieving products and n1aterials. eJ~\J>kt 9: Logistics: Warehousing, Transportation.and Reverse logistics

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Most companies \vill have son1e type of warehousing operation to store inventory, \vhether it is an internal co1npany o,vned \varehouse, or an external public or contract ,varehouse. These ,varehouses function in basically the sa,ne ,vay \vhether internal or external, allov.kt 9: Logistics: Warehousing, Transportation.and Reverse logistics

255

Fees are generally a con1bination of a monthly storage fee plus a pallet-in fee and a pallet-out fee. l11e storage and handling fees in a public ,varehouse \\•ill also vary based on exactly \,•hat is being stored and handled. So, Custo1ner A 1nay be d1arged 1nore than Custon1er B per pallet \\rithin tl1e sa1ne public ,,,arehouse. The reasons could include the size and ,,,eight of the palletized loads, ho,v high the pallets can be stacked, ho,v fragile they are, the risk of theft, the value of goods, any hazards associated \\•ith the goods, and so forth. Public ,varehouses n1ay also have son1e no1ninal transaction or docu1nent fees, and account n1anage1nent fees. The fee structure can be based on eadi pallet moved/stored or based on each square foot used by a client. Public \\rarehouses also offer a variety of al la carte services including order picking and order packing, order consolidation, cross docking, packaging services, kitting, returns processing, inspection services, inventory management, physical inventory counts, assen1bly operations, and shipping. They charge tl1eir clients a fee for each of tl1e senrices the client uses in addition to the fees for storage and handling. Although 1nost co1npanies see public \\•arehousing as a short-term solution, it can often turn into a long-tenn relationship as con1panies beco1ne accusto1ned to the convenience of the public ,varehouse services. Companies that o,vn and operate public ,varehouses \\•ill invest significantly in their facilities to remain competit ive. They offer clients increasing levels of flexibility in order to retain existing clients and to attract additional clients. Public ,va.rehouses offer co1npa.nies a range of labor solutions up to and including a dedicated ,vorkforce. In a longer term arrange1nent, they 1nay also allo,v clients to bring in their O\\•n ERP or ,varehouse sofuva.re so that the public \varehouse in essence becomes a satellite location of the client providing real -time data. PUBLIC \VA REHOUSING OFFERS A VARIETY OF ADVANTAGES BECAUSE OF ITS FLEXIB ILITY:

a. No CAPITAL INVESTl\1ENT: A major advantage is there is no capital investn1ent fron1 the user/client for ,,,a.rehousing. Public ,varehousing immediately takes a\vay the need for a company to o,vn and operate storage infra.structure, including the staff and security tl1at go along ,vith it. In this ,vay, public ,varehousing is a variable cost co1uponent. b. TAX AVOIDANCE: Because the user co1npany doesn't o,vn the property, the user is not subject to property taxes, which can be substantial. c. FLEXIBILITY: Because a con1pany can establish a short-tern1 public ,varehouse con1n1it1nent, if business conditions change, the con1pany is not tied into a long-tenn con11nitn1ent, and they can reduce or expand their storage needs accordingly. d. ACCOl\1MODATES SEASONALITY: Seasonal businesses have the option of expanding and contracting their public space on a n1onthly basis. You only pay for space in the month you are using it, a.llo\ving storage costs to vary directly ,vith seasonal volwne.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

e. CAPABILITY TO EXPAND: Public ,varehousing provides an econo1nical and practical n1eans to gro,v into ne,v markets and geographies for co1npanies that are expanding, particularly in the short tern1. f. Lo,vER COSTS AND REDUCED RISK: Compared to other types of ,varehousing, public \\•arehousing is usually less costly. Because tl1ere is no long-tern1 con11nit1nent, users can s,,,itch to another public ,varehouse facility in a short period of tin1e, often ,vithin 30 days, if tliere is another location that 1nay have lower rent or fees. g. ACCESS TO LOWER FREIGHT RATES: Because public ,varehouses handle the require111ents of a nun1ber of companies, their volume allo,vs them to negotiate consolidated freight rates rather than 1nuch higher less-than -truckload freight rates that result fro1n shipping small quantities at a pre1niwn. h. ACCESS TO SPECIAL FEATURES AND SERVICES: Most public warehouses can offer specialized services (e.g., broken-case handling, packaging services for 1nanufacturer products for shipping, breakbulk services, and freight consolidation services) because they can consolidation volu1ne ¼1ith noncompetitor clients ,vho use the san1e public ,varehouse. Most public \\•arehouses have son1e special features that 1nakes tlie1n unique. Exan1ples of special features are: Ternperature-controlled storage (cool, cold, and frozen) Crane capabilities Ultraclean segregated areas Guard service 24/7/365 Dedicated docking areas for special custo1ners Special staff fu nctions like custo1ner service, inventory ordering, etc. Office space to rent for custon1er's sales, accounting, etc. l.

KNO\VLEDGE OF EXACT STORAGE AND HANDLING COSTS: 'v\lhen a con1pany uses a

public warehouse, it kno,vs exactly ho"' much is being spent on storage and handling costs, because tl1e 1nontl1ly bill displays all necessary inforn1ation. This allo,vs tlie user to forecast costs for each different level of activity. Co1npanies that operate their o,vn private facilities often find it difficult to detennine the exact fixed and variable costs.

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P UBLIC WAREHOUSI NG ALSO HAS SOME DISADVANTAGES:

a. SYSTEMS C OMPATIBILIT Y: There is the potential of inco111patible con1puter systen1s. Public warehouses n1ay not have a system to suit the needs of a specific custon1er and they are unlikely to invest in a nev, system for just one client. b. LACK OF S PECIALIZED SERVICES: Most public ,varehouse facilities provide local services ,vhich may not be -.vhat the con,pany requires. The specialized services that a company needs n1ay not ahvays be available in a desired location. c. S PACE A VAILABI LITY: Public ,varehousing space may not be available ,vhen and ,vhere a con1pany ,vants it. Shortages can occur fro111 tune to tin1e, particularly duril1g a peak season, which may adversely affect the client co111pany. CRITERIA FOR C HOOSING A PUBLIC WAREHOUSE

Because of the increasing con1petition ben,•een the public v.•arehouse operators, con1panies should revie-.v the capabilities of each potential public v.•arehouse to identify v.rhich ,vould be the best fit. Each co111pany v.•ill have a nu1nber of factors that need to be considered ,vhen selecting a public warehouse. Co1npanies have a variety of reasons .,,,hy they require an outside v.•arehouse in addi tion to theii" short-tenn and long-tenn needs, and the price they ru·e v.rilling to pay for the service. Con1panies are likely to weigh criteria such as geographical location, the type of technology needed versus ,vhat is available, ,vhether the public ,varehouse has the capability to expand if more space is needed, and how flexible the public " 'arehouse is to respond to changes in volu111e or other needs.

Contract Warehousing A contract ,varehouse is a variation of public ,varehousing that handles the shipping, receiving, and storage of goods for a specific client on a contract basis. The contract can be for either an entire building or a defined portion of square-foot or cubic-foot space v.rithin a building. This type of ,varehouse usually requfres a client to comniit to services for a particular period of ti111e. The length of til"ne varies, often stated in years rather than n1onths. The fee structure also varies based on transactions; it n1ay be a fixed cost, cost-plus, or a co1nbination of both. ll1e company providing the space ha11elles the en1ployees, equip111ent, and n1ail1tena11ce expenses. ll1ey are also responsible for n1ost incidental expenses, ,vhich further reduces costs. Many of the advantages of pubic ,varehousing also apply to contract ,varehousing.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

ADDITIONAL ADVANTAGES OF CONTRACT WAREHOUSING: •

LOGISTICS EXPERTISE: Contract ,varehousing con1panies provide a great deal of expertise

for logistics den1ands. Contractors will be experienced in ,varehouse operations and supply chains. They often have kno,~•ledge that business o,vners don't Because there is a long-term associated setup, it is in their interest to see that the client co1npany's needs are 1net. •

SERV ICES: The longer tenn nature of contract ,varehousing generally results in the client com-

pany obtaining specialized services that are tailor-1nade to suit their needs. •

COST: Facilities and specialized services that are provided under contract \\•arehousing are

si1nilar to those provided by a private \\•arehouse; ho,vever, these facilities co1ne at a cheaper price, because significant capital costs are involved in the construction and n1aintenance of a private " 'arehouse, ,vhereas a contract warehouse is o,vned and operated by a third party that bears the burden of the capital costs. •

FEES: In the case of public ,varehousing, the client co1npany is charged storage fees, and in-

bow1d and outbound transactions fees, and the user is expected to pay for any additional services that are desired. Contract ,,,arehousing also requires the client con1pany to pay a fee for the services rendered; however, due to the longer comn1itn1ent, the services provided in the contract can be bundled and negotiated, usually at a lo,ver cost. •

CONTROL: A public ,varehouse results in the client con1pany having to relinquish control,

whereas contract ,varehousing offers a con1pro1nise by allo\\•ing the client co1npany a certain degree of control at a reasonable price. In contrast, a private ,.,arehouse allo,vs absolute control but at a higher capital cost than a contract " 'arehouse. DISADVANTAGES OF CONTRACT \VAREHOUSING: •

D URATION: Tl1e client co1upany is expected to enter into a contract for a specific period oftin1e

(generally three years). A public ,varehouse allows the client to store goods for both short and long periods of time, allowing flexibility when it comes to duration, ,vhich a contract " 'arehouse limits.

Private Warehousing A private \\•arehouse is a storage facility that is o,vned by the co1npany that 01vns the goods being stored in the facility. It is also known as proprietary ,varehousing. Private ,varehouses are generally established by companies that have a large volun1e or large value of goods being stored, or the need for son1e type of specialized storage or handling. Tl1ey can be operated as a separate division ,vithin a co1npany if desired, and they can be co-located onsite ,vith 1uanufacturing, or at an offsite location.

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ADVANTAGES OF PRIVATE WAREHOUSING: •

CONTROL: Private warehousing offers users significant control over their storage needs and

they can be constructed to meet user specifications. Companies can also control product place1nent ,vithin a facility providing access to products ,vhen an organization needs them. It allo,vs the co1npany to integrate the \\1arehousing function 111ore easily into its total logistics syste1n. The co111pany has clear visibility of inventory control, internal material flo,v, handling, supervision, and associated cost control. •

FLEXIBILITY: Offers the co1npany greater flexibility in designing and operating the " 'arehouse

to suit the needs of its custo1ners and the characteristics of the products. The co1npany can install specialized handling for its products if necessary and n1odify the facility through expansion or renovation to facilitate product changes, \\1hich is not possible in a public ,varehouse. •

COST: Operating cost can be 15% to 25% lo,ver if the con1pany achieves at least 75% utilization.

•

LABOR: l11ere is the prevailing belief that greater care goes into handling and storage ,vhen

the co111pany's o,vn ,vorkforce operates the " 'arehouse. This n1eans that the con1pany can utilize the expertise of its technical specialists. A con1pany 1nay also be able to better utilize its overall workforce. Du1·ing a down period in 111anufacturing, the co111pany could shift manufacturing ,vorkers over to the \\1arehouse temporarily to help. Or, vice versa, during a do"'n period in the ,varehouse, or a peak in 1nanufacturing, the co1npany n1ight be able to shift warehouse ,vorkers over to 1nanufacturing te1nporarily. •

TAX BENEFITS: Depreciation allo,vances on buildings and equipn1ent help to reduce taxes.

•

INTANGIBLE BENEFITS: V{hen a co1npany distributes its products through a private ,vare-

house, it gives its custon1ers a sense of pern1anence and continuity of business operations. The customer perceives the con1pany as a stable, dependable, and long-term supplier of products. DISADVANTAGES OF PRIVATE \YAREHOUSING: •

FLEXIBILITY: In the short term, it is very difficult for a private ,varehouse facility to respond

to changes in the external envirorunent, and expand or contract to 111eet increases or decreases in de111and. Flexibility in strategic location is also an issue as private ,varehouses can't respond quickly to changes in market location and preferences, and this may mean that excellent business opportunities n1ay be lost. If you o,vn the \\1arehouse, it is not easy to just pick up and n1ove to another location if the 111arket changes, ,vhici1 is an advantage in a public " 'arehouse setting. •

FIXED SIZE AND COSTS: When demand is low, the company still assumes the fixed costs as

,veil as the lo,ver productivity linked to unused ,varehouse space. Ho\\1ever, the disadvantages can be 111ini.Jnized if the con1pany is "'illing and able to rent out part of its space. 260

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

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HIGH OPPORTUNITY COST RISK: The ROI on other invest1nents may be greater if funds

are channeled into other profit-generating opportunities rather than investing in a v.•arehouse. Because the ROI is about the sa1ne as the co1npany's other invest1nents, rnost cornpanies find it advantageous to use a con1bination of public and private ,varehousing. It is best to use private warehousing to handle the basic inventory levels required for the least cost logistics in n1arkets ,,,here the volun,e justifies ownership. Any extra volu1ne can be stored in the public ,varehouse during peak periods if the private warehouse is full. TI1ere is also the potential of not being able to sell the ,varehouse in the future if it is no longer needed.

•

HIGH STARTUP COST: Co111panies have to generate enough capital to build or buy a ,varehouse. A v.•arehouse is often a long, risky investinent. In addition, there is the cost of hiring and training employees, and the purchase of material handling equipment. The high cost necessitates high and steady demand volu1nes for the investrnent to 1nake sense. In addition, a high fixed cost alternative becon1es less attractive in times of high interest rates, because it is n1ore costly to secure the necessary financing.

Consolidation Warehousing A consolidation \\•arehouse receives products fron1 suppliers, sorts the111, and tl1en co111bines then1 ,vith sinular shipn1ents fron1 other suppliers into larger, more econon1ical, shipping loads for further distribution. In other words, sn1all flexible shipments in, and large econonucal shipments out. TI1e goal is 1naxi1nizing transportation utilization ,vhile rninirnizing costs. The concept is similar to carpooling ,,,here several individuals in the san1e area con1e together and 1neet at one place, and then take one car to ,vork instead of taking several different cars. The cost to each person is significantly less tl1an it v.•ould have been if they ,vent separately. Consolidation of freight shipn1ents works in basically the same way. Consolidation ,varehouses are typically established at a strategic location benveen suppliers and custo1ners. Ideally, in order to mininiize the total transportation costs, the consolidation v.•arehouse should be located closer to the supply base so that tl1e smaller LTL shipments travel the shorter distance and can be consolidated n1ore quickly into the larger FTL shiprnents traveling tl1e longer distance to the custo111er. Usually a tliird-party logistics (3PL) provider n1anages and 111aintains the warehouse and the inforn1ation system needed to run ii, and these operations can either be client-dedicated or rnultiple-user facilities. Figure 9.1 provides an example of the flo,v of products through a consolidation warehouse. Products are shipped frorn three separate plants or suppliers into the consolidation ,varehouse, usually in less-than-truckload (LTL) shipn1ents. At tl1e ,varehouse, the products are received and con1bined together to be shipped out to a custon1er in a larger full truckload (FTL) shipment. eJ~\J>kt 9: Logistics: Warehousing, Transportation.and Reverse logistics

261

less-Than-Ttudlload (LTl) Shipments

Plant ., Supplier A

Full Ttudtload (FTl) Shipment

Customer A

I

(M cLaitrJ\ 2016)

Break Bulk Warehousing A break bulk ,varehouse is sin1ilar to a consolidation warehouse except that the inco1ning ship1nents are generally truckloads ofho111ogeneous items from a single plant or supplier. The break bulk ,varehouse sorts or splits the items into individual orders or shipn1ents and arranges for local delivery. Si111ilar to consolidation v.•arehouses, break bulk \\•arehouses are also typically established at a strategic location between suppliers and custon1ers. ln contrast to the consolidation ,varehouse location, in order to 1nini1nize total transportation costs, the break bulk ,varehouse should be located closer to the custo1ner base so that the sn1aller LTL shipn1ents travel the shorter distance to the custo111ers, ,vhile the larger FTL ship111ents fro111 the single supply source travel the longer distance before arriving at the break bulk ,varehouse. Figure 9.2 provides an exa111ple of the flo,v of products through a break bulk \\•arehouse. Products are shipped fron1 a single plant or supplier into the break bulk \\•arehouse, usually in FTL shipments. At the \\•arehouse, the products are received and sorted or split into individual orders to be shipped out to customers in LTL shipments. In both consolidation ,varehousing and break bulk v.rarehousing, a 3PL provider frequently 1nanages the ,varehouse and the infonuation systen1(s) needed to rlu1 it. These operations can either be client-dedicated or multiple-user facilities.

262

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

less•lh•n•Tl'ucltload (ll\) Shipments

Full Tl'ucldoad (ffi) Shipment

kt 9: Logistics: Warehousing, Transportation.and Reverse logistics

263

CROSS-DOCKING PROVIDES CERTAIN ADVANTAGES: •

OPERATIONAL EFFICIENCY: As the 1naterial does not have to be stored at the \\•arehouse,

and directly n1oves from the receiving docks to the shipping docks, the ,varehouse operations are more efficient. •

INVENTORY EFFICIENCY: As the inventory moves directly from the receiving to shipping

docks, there is no storage at the warehouses, and that reduces the total system inventory in the supply cl1ain. Figure 9.3 illustrates a cross-docking ,varehouse operation. On the left side of the diagram are inbound shipments of products fron1 four suppliers. Once these products are received and unloaded, they can be sorted, reconfigured, and moved across the dock to ship outbound to the four custo1ners, as shown on the right side of the diagram. Notice that each customer is being shipped a different configuration of the four products.

~EIBEi EIBEi,

kt 9: Logistics: Warehousing, Transportation.and Reverse logistics

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•

INTERMEDIATELY P OSITIONED STRATEGY; Warehouses are set up son1e,vhere nlid",ay

between the supply sources and the customers to try to balance costs, inventory, and custon1er service. Con1panies should use this strategy v.•hen distribution require1nents are high and product con1es fro1n various supply locations. A ,varehouse net1,•ork opti1nization study n1ay be needed to detennine the optilnal nu1nber and location of ,varehouses in this strategy. See "Warehouse Nehvork Optin1ization" ,vhich follo,vs.

Warehouse Network Optimization Co1npanies need to find the balance that will 1vork for their products and markets. ll1ere are n1any consulting con1panies that offer services to help a con1pany detern1il1e the optilnal nun1ber of ,varehouses and geographic locations for a given con1pany's situation by using a nu1nber of different optilnization software programs. The sofnvare analyzes the inputs including customer, 1nanufacturer, and supplier locations, then infonns the optin1al nu1nber of v.•arehouses and locations based on all the relevant factors. These progrruns try to 1ninilnize the an1ow1t of transportation on both endsinbound from suppliers and outbound to customers.

LEAN AND GREEN WAREHOUSING .......................................... . \.Varehouses and distribution centers ru·e continuing to develop their LEAN capabilities. The follo,ving are a few 1vays in ,,,hich ,varehousing is adopting and adapting LEAN principles.

Greater Emphasis on Cross Docking Cross docking is a LEAN concept and it is on the rise in business. Cross docking elin1il1ates the need to store il1ventory, v.•hich is ,vaste, and ,vaste reduction/elin1il1ation is the key ele1nent of LEAN. Cross docking is a fonn of consolidation that reduces transportation, which is also waste. The more cross docking a company can do, the '"leaner" their operations ,viii be.

Reduced Lot Sizes and Shipping Quantities Just as small batch scheduling is a LEAN concept, because it drives do,vn costs by reducing inventories and makes the con1pany n1ore flexible to meet customer demand, this same concept can be applied to ,varehouse operations. By reducing lot sizes and shipping quantities, a con1pany can actually il1crease the velocity or throughput il1 the 1va1·ehouse a11d get ship1nents out faster. Sn1aller lots or orders ,vill take less tin1e to pick and load for shipn1ent, ,vhich ,,,ill keep costs and mventories do1vn. Faster throughput and lo,ver inventories are LEAN concepts.

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FUNDAMENTALS OFSUPPLY CHAINMANAGEMENT

Increased Automation Companies are using automated systems like pick to light, voice picking, conveyor systems, auton1atized guided vehicles (AGV s), and robotics to irnprove efficiencies and throughput tirnes in the \varehouse. Auton1ation can help to speed up the picking process and n1ove products through a ""arehouse faster and more accurately than manual systems ,vith less resources, again reducing ,vaste.

ATendency to Be Green Co1npanies are looking at v.,hat green or sustainability progran1s they can i111plement in ,varehousing operations. Con1panies want to kno\v the size and impact of their carbon footprint. Ho"' can they reduce the amount of utilities and resources they use? Smaller, more efficient ,varehouses take up less physical space and use less energy to operate. One of the rnore sustainable goals for a green ,varehouse is to become a net zero energy user. In son1e cases, net zero buildings are able to sell excess energy back to the pov.•er grid, so much so that the cost of generating energy is neutralized by the excess energy sold. Son1e initiatives in this regard include lighting upgrades to use a n1ore efficient fluorescent syste111, the use of daylighting, using solar-assisted heat pun1p or cooling systen1s, and the type of windows, doors, roofing n1aterials, and insulation that are used, saving significant amounts of energy.

THIRD-PARTY LOGISTICS ........................................................ . Third-Party Logistics Company A third-party logistics (3PL) con1pany is an outsow·ced provider that n1anages all or a significant part of an organization's logistics requirements for a fee. S0111e of the typical services that are offered by 3PLs include but are not lirnited to inbound transportation, ,varehousing, pick and pack, outbound transportation, freight forwarding, freight bill auditing/payrnent, custorns brokerage, custon1s clearance, order taking, billing/invoicing, and inventory auditing. 3PLs are used by large and srnall business but are particularly favored by srnall businesses that do not have their o,vn logistics operations. Sn1all business 111ay not ,vant to invest in activities outside their areas of expertise, and the 3PL company can bring their substantial logistics expertise into the engagen1ent. 3PLs are also used to a significant degree for international logistics. A company is more likely to use a 3PL internationally rather than to try and establish an in-house operation in each foreign rnarket

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then1selves. Also, 3PLs likely know more about the logistics in those international markets, and they ,viii have local contacts and local contracts already established. It is potentially n1uch more cost effective and efficient for a con1pany to ship product internationally using the services of a 3PL than to handle this activity internally, unless this is a major part of the business, and the company decides to invest significant resources and n1anpo\\1er into developing this expertise. MAJOR ADVANTAGES OF USING 3PLs:

There are a nun1ber of benefits co111panies gain by outsourcing logistics activities to a 3PL. Utilizing a 3PL provides businesses with a reliable logistics advantage, and maximizes profitability through a combination of kno,vledge and resources. •

CosT: Eliminates the need for a company to invest in ,varehouse space, technology. transpor-

tation. and staff to execute the logistics process. •

LOGISTICS EXPERTISE: 3PLs are kno,vledgable of industry best practices, and stay up to date

,vith the latest develop1nents in technology. This is their core con1petency. •

EFFICIENCY: Improved efficiency by exploiting a 3PI.:s econo111ies of scale. 3PLs can leverage re-

lationships and volu1ne discounts, v.•hich results in lo,,•er overhead and the fastest possible service. •

FLEXIBILITY: Ability to rapidly scale space, labor, and transportation according to business needs.

•

Focus ON CORE COMPETENCY: Outsourcing logistics allo,vs your company to focus on

your core co111petencies. MAJOR DISADVANTAGES OF USING 3PLs:

There are also son1e issues and concerns that con1panies should consider before n1aking a logistics outsourcing decision. •

CONTROL: A con1pany ,vill not have direct control over the logistics operation. They are rely-

ing on the 3PL to consistently deliver the pro1nised services. 1l1is lack of direct control means that con1panies are at the 111ercy of any proble1ns the 3PL faces. •

DEPENDENCY: Outsourcing logistics to a 3PL is a large com1nitn1ent. When businesses con-

tract with 3PLs it creates a dependency ,vhich can be significant. This dependency puts the con1pany in an uncomfortable situation if pricing or service from the 3PL is not as expected. Logistical do,vnti1ne can translate into large amounts of lost productivity and revenue. Although the free n1arket dictates that a business dissatisfied ,vith its 3PL could s,vitch to another 3PL,

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

the reality is not so sin1ple. $\vitching logistical support can create great problems in unforeseen costs and higher risks resulting frorn the transition.

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PRICING: Contracting ,vith a 3PL means that the company is locked into the pricing model specified in the business agreernent. By outsourcing logistics to a 3PL, cornpanies are forgoing the possibility that an in-house logistics depart1nent could discover a less expensive or n1ore efficient solution.

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Loss OF EXPERTISE: Con1panies that outsource in-house logistics to a 3PL n1ay lose their own expertise in logistics by outsourcing.

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RISK: Sharing confidential information ,vith an outside partner such as a 3PL n1ay leave son1e companies feeling vulnerable.

Fourth-Party Logistics Company Fourth-party logistics (4PL) is an interface bet\veen the client cornpany and multiple logistics service providers. A company will select a lead logistics partner (referred to as a 4PL) that is then charged ,vith managing the activities of all the other 3PLs being used by the company. Ideally, all aspects of the client cornpany's supply chain handled by 3PLs \\'Ould be rnanaged by the 4PL organization.

TRANSPORTATION

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Transportation is "the function of planning, scheduling, and controlling activities related to mode, vendor, and rnovernent of inventories into and out of an organization:•• Transportation attempts to fulfill three of the seven Rs-to get the right product, to the right place, at the right tin1e by ensuring that the product is 1noved as efficiently and effectively as possible from point of origin to point of destination.

Transportation Objectives Transportation has three objectives: l.

To MAXIMIZE THE VALUE TO THE COMPANY THROUGH PRICE NEGOTIATIONS. In simple tenns this 1neans that the transportation function adds value by getting the best price to transport goods \Vhether the goods are coming fron1 the supplier or going out to the custon1er.

2.

To MAKE SURE SERVICE IS PROVIDED EFFECTIVELY. If you n1ove product from a supplier, move product around internally, or rnove product out to a customer, you \\•ant to do it in

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as few n1oves as possible, and n1aking sure the product is not dan1aged or someho"' other,vise negatively affected. 3. To SATISFY CUSTOMERS' NEEDS. Ensure that the product gets to the right place at the right tin1e. If you n1oved the product efficiently, effectively, and at the lo,vest possible cost, but it is not at the place ,vhere custo1ners ,vant it, "'hen tlley need it to be there, tl1e transportation function is not actually adding value.

Transportation Company Classifications Co1npanies transporting freight or cargo regardless of tile 1node of transportation are classified according to the follo,ving categories:

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COMMON CARRIER: A person or con1pany tl1at transports freight for a fee tllat can be hired by anyone to transport goods. Com1non carriers transport tile 1najority of tile freight shipn1ents that you see on the road, rail, air, an1ong other methods.

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CONTRACT CARRIERS: A person or company that transports freight under contract to one or a lin1ited number of shippers. These carriers are not bound to serve the general public. Contract carriers establish an agreen1ent ,vith a shipper(s) tllat spells out tile kinds of shipn1ents tl1e carrier will accept, where tile carrier ,vill take tlle1n, and tl1e shipping fees tile shipper ,vill be obligated to pay. Shippers may in turn collect these fees fron1 their customers.

•

EXE!\1PT CARRIERS: A person or co1npany specializing in certain services (such as taxi service) or certain con1modities (such as farm products or bulk cargo) exen1pl fron1 regulation by the Interstate Com1nerce Act. The exe1npt com1nodities usually include w1processed or un1nan ufactured goods, fruits and vegetables, and other iten1s of little or no value. The exe1nption under the interstate comn1erce act is to help the silnple service groups such as taxis, farmers, and school bus drivers to operate ,vithout any interference fron1 government regulations, as tl1ere is no th real of n1onopolization in these services.

•

PRIVATE CARRIERS: A person or company that transports its o,vn cargo, usually as part of a business that produces, uses, sells, and/or buys tile cargo tl1at is bei11g hauled. The private carrier's prilnary business is not transportation, but perfonnmg a transportation function to facilitate the primary busmess. These carriers n1ay refuse to sell their services at their O\\•n discretion, ,vhereas com1non carriers 1nust treat all custo1ners equally.

Carriers, regardless of the classification type, may be prohibited by la"' from carrymg cert am types of ite1ns, including illegal and dangerous 1naterials.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

MAJOR MODES OF TRANSPORTATION ....................................... Mode refers to the way in which goods are transported; carrier refers to the company or service provider that actually transports the goods or materials. There are five major modes of transportation: •

Motor carriers (trucking)

•

Rail carriers

•

Air carriers

•

v\later carriers

•

Pipeline carriers

Motor Carriers Trucking is the 1nost prevalent n1ode of transportation and the one people are probably 1nost fa1niliar. It is also the 1nost flexible mode of transportation in that it carries the most varied kinds of freight to the n1ost locations. Motor carriers (trucks) are involved in more than 80% of U.S. freight transportation annually. This doesn't rnean that the rest of the carriers only transport the re1naining 20%. TI1ere is actually a significant overlap ,vith other n1odes of transportation, because n1ost product that is n1oved by rail, air, or water is also moved by truck to and fro1n the railyard, airport, or seaport. Motor carriers are also heavily involved ,vith what is kno,,rn as the "last mile" of transportation. The last rnile is the final leg of transportation in the supply chain ,vhen the product is delivered to its final destination. In the 1najority of shipn1ents, the last n1ile is handled by truck. Motor carriers transport nearly anything fro111 packaged household goods, to building n1aterials, to liquids. Motor carriers compete directly v,ith rail and air for short to mediun1 distance hauls. There are two n1ajor categories of rnotor carrier: short haul and long haul.

•

SHORT HAUL is defined as operating ,vithin 200 1niles of the driver's hon1e terruinal. Drivers operate a day cab unit, and are perfonning short transportation legs, n1aybe "rithin the state;

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these are sn1all, local type routes, and for the most part, drievers are home every night. Shorthaul drivers can make four or n1ore stops per day, loading and unloading at each location. With 1nore stops and local \\Tork, short-haul drivers also spend 1nore tilne driving on sn1aller streets, with difficult turns, and going to places ,vith challenging loading docks. This requires n1astering different driving skills than with long-haul trucking. Driving short haul is not as profitable as long-haul trucking; hov,rever, the quality of life is considered to be better than long haul. •

LONG-HAUL is defined as anything over 200 miles from the driver's home tenninal. Long-haul

truck drivers transport goods over hw1dreds and even thousands of 1niles. Long-haul drivers spend a lot of tin1e traveling on large high\,rays and they generally carry loads for nvo or n1ore days before unloading. They may drive flatbed rigs, \vhich are used for carrying things like steel, or drive tankers, or tractor trailers. ll1ey usually drive at night ,vhen traffic is light. Long-haul routes are driven by the 1uost experienced drivers because it is challenging "'Ork and the cargo can be extren1ely vah1able. GENERAL FREIGHT CARRIERS AND SPECIALIZED FREIGHT CARRIERS

Motor carriers can be further categorized into general carriers and specialized carriers: •

GENERAL FREIGHT CARRIERS comprise the n1ajority of the trucks you see out on the road -

,vay, carrying 1uost of the goods. ll1ese are trucking co1upanies that engage in shipping packaged, boxed, and palletized goods that can be transported in standard, enclosed tractor-trailers, generally 40 lo 48 feet in length. General freight carriers include comn1on carriers as ,vell as other kinds of carries discussed in this chapter. •

S PECIALIZED FREIGHT CARRIERS transport articles that, because of size, weight, shape.

or other inherent characteristics, require specialized equip1nent for transportation. S01ne in1portant types of specialized equip1uent are bulk tankers, dun1p trucks, refrigerated trucks, and 1uotor vehicle haulers (i.e., car carriers). Shipn1ents by 1uotor carrier can be divided into either less-than-truckload (LTL) or full-truckload (FTL), generally indicating whether the volume of the shipment fills the truck trailer/ container or not. Motor carriers n1ay offer LTL or FTL, or both services. LESS- THAN-TRUCKLOAD CARRIERS

LTL carriers are those that n1ove s1nall ship1nents-that is, \vhen you don't have enough to fill a truck. There are 1nany carriers that offer LTL service. Some further specialize in services such as lift gate and residential pickups and deliveries, guaranteed services, and freeze protection, just to na1ne a few.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

They stop at depots and transfer locations to match loads to the final locations. \.Yhat that n1eans for shippers is their cargo is likely going to be cornbined v.•ith other shippers' cargo because the carrier needs to fill up the truck as 1nud1 as possible to n1ake rnoney. Therefore, n1uJtiple shippers' con1lllodities will get loaded onto the san1e truck, going in the same direction, and there n1ight be multiple handoffs along the way. An individual shipper's product could be picked up at the " 'arehouse, then go to a depot or n1ttltiple depots, and be handed off fron1 one carrier to another, n1aking its ,vay fron1 point of origin to the final destination. The shiprnent ,vill be subject to rnuJtiple stops and starts while other product is being picked up and dropped off, and because of that, LTL usually takes longer to get fron1 origin to destination than FTL shipments. LTL is also ,nore costly in terms of price per unit, or price per ,veight, than FTL because carriers cannot ahvays guarantee that they will fill the truck up and they rnay need to spread their fixed costs out over a sn1aller nurnber of units/\\•eight. FULL TRUCKLOAD CARRIERS

FTL is used v.•hen a shipper has enough volume (or value) to fill the truck. "These carriers generally contract an entire trailer out to a single custorner. Thus, the carrier actually spreads its fixed costs out over the ,vhole ship1nent and generally the individual per unit cost of shipping is lo"•er than for LTL ship1nents. A shipper 1nay also decide to pay for a fuJI truckload even if the volun1e being shipped doesn't actually fill up the \,•hole truck. The reason n1ay be to avoid having another shipper's cargo on the sarne truck for security reasons or for faster delivery. By paying for the full truck even if the shipper's cargo doesn't fill it up, the shipper can probably get a faster delivery tilne because the shiprnent ,,,on't go to a depot or 111ake other stops along the ,vay. Additionally, the shipper could potentially avoid any cargo n1ixups or cross contanlination by using a dedicated truck.

Rail Carriers A rail carrier is a co1npany v.•hose business is transporting persons or goods or both by railroad. Rail transportation is best used for very heavy shiprnents such as building 1naterials, constTuction equipment, and coal, particularly ,vhen the transport distance is long.

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ADVANTAGES OF RAIL TRANSPORTATION:

•

Rail is better structured than any other fonn of transportation. It has fi.xed routes and schedules n1aking its service n1ore certain and regular co1npared to other modes of transport.

•

Rail is the 1nost dependable n1ode of transportation as it is the least affected by \\•eather conditions compared to other n1odes of transport.

•

Rail transport is econo1nical, quicker, and best suited for carrying heavy and bulky goods over long distances.

•

Rail has the best speed over long distances except for air transport, but it can carry heavy bulky goods making it 1nore versatile than air.

•

Rail is a less expensive n1ode of transport con1pared to other n1odes. It has lo,ver variable costs and most of the operating expenses are fixed costs. Rail is econon1ical in tern1s of labor as one driver and one cre,vn1an can handle a 1nuch larger shipping load than other n1odes of transportation, such as n1otor carriers.

•

The carrying capacity of rail is ex·tre1nely large and can be easily expanded even further by adding n1ore railcars.

•

Rail is also the safest fonn of transport.

D ISADVANTAGES OF RAIL TRANSPORTATION:

Although rail transport has a number of advantages, it has a nun1ber of disadvantages as ,veil: •

Rail requires a large capital investment in infrastructure and this investment is fixed, meaning that it is not easily adaptable to changing volume requirements. Construction costs, maintenance, and overhead expenses are very high co1npared to other 1nodes of transport. Railroad infrastructlu·e and aging equipn1ent in the United States are also proble1ns for the railroads. The rails, bridges, and other aspects are old and deteriorating, and require a lot of upkeep and further capital expenditure. So,ne of the infrastructure in1prove1nents the rail carriers can n1ake the1nselves; ho,vever, other in1prove1nents rnust be handled through local, state, or the federal governn1ent.

•

Rail transport is inflexible. Trains rw1 on a specific tilnetable and schedule and therefore must arrive and depart according to their set timetable. Its routes and tin1ings cannot be adjusted to individual requirements.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

•

Rail transport cannot provide door-to-door service. Instead, rail provides tern1inal-to-terminal service, which requires loading and reloading of products at stocking points, involving greater cost, 1nore ,vear and tear, and additional ti1ne. Therefore, rail carriers are generally paired ,,,ith trucks for door-to-door delivery. To overcome this disadvantage, son1e rail carriers have begun purchasing n1otor carriers and nov.• offer point-to-point pickup and delivery service.

•

Rail is unsuitable and unecononlical for short distance and sn1all volu111e goods. Rail transport by its nature is considered slo"' and inflexible and con1pares unfavorably ,vith rnotor carriers in tenns of transit tirnes and frequency of service in short to 1nediu1n distance hauls.

•

Due to the high capital investlnent, rail cannot be operated economically in rural areas, creating an inconvenience for this 1node of transportation in those areas.

•

·n1e tirne and labor necessary to book and take delivery of goods is unfavorable compared to n1otor carriers.

•

Rail rnust fully utilize all of its available capacity to operate econornically, and it has a very large carrying capacity, '"hich can create a significant financial problern.

•

Rail cornpanies use each other's railcars to build a rail transport, so keeping track of railcars and getting then1 ,vhere needed can be proble1natic.

•

The tirne and cost of tenninal operations can also be a great disadvantage.

Some nev.• ra.il technologies include articulated cars, unit trains, and double-stack cars. •

Ar ticulated cars are railcars that share an axle or are suspended by other railcars. They are operated as a single unit, often called a trainset. Articulated cars reduce cost, ,veight, noise, vibration, and rnaintenance expenses. Ho"•ever, they reduce flexibility as additional railcars cannot easily be added to the trainset ,vhen there is additional volume.

•

Unit trains transport a single conunodity sud1 as coal or steel. A unit train is sirnilar to the concept of a dedicated truck.

•

Double-stack cars are railcars specially designed to carry intern1odal containers, ,vhere the ir1tern1odal contair1ers are stacked t\vo high on each railcar.

Air Carriers Air carriers are organizations transporting passengers and cargo by aircraft. Air is the ne,vest transport 1node and the least utilized. eJ~\J>kt 9: Logistics: Warehousing, Transportation.and Reverse logistics

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••••••••

CARGO

Air shipn1ents are relatively expensive compared to the other modes of transportation, partially because the fuel is expensive, they have a limited an1ount of cargo space, and they have to deal "'ith \Veight and balance issues on the plane itself. Air is the fastest 1node transportation for 111ediun1 and long distances. If a cornpany has an ite1n that is urgently needed or being expedited by a custo1ner, air shiprnent 1night be ilie \,•ay to go. Many co111panies use air ship111ents if they have had a backorder or stockout to try to get the replenishment inventory back into the n1arketplace or to a customer quickly. Air carriers usually transport high-value goods (i.e., iten1s witl1 a high cost-to-,veight ratio). These are very light, high-value goods that need to travel long distances quickly, and include such products as je,velry, fine ,vines, pharn1aceuticals, and racehorses. Air carriers can't transport extremely heavy or bulky cargo because of the \\•eight and balance restrictions. There are also cornmodities that are restricted from air shipments due to the nature of tl1e product (e.g., son1e n1aterials tl1at are hazardous, cornbustible, explosive, even if it is a cargo-only aircraft). Air transport represents about 5% of the total U.S. air freight. Internationally, according to rnultiple sources, afr cargo represents less than 0.5% of ilie \veight of all international cargo, ,vhile at ilie san1e time this seg1nent represents around 30% of the total v,orldwide shipment value. Half of the goods transported by air are carried by cargo-only airlines such as FedEx and UPS, and tl1e other half goes by passenger planes along \vitl1 passengers and their luggage. Cargo is loaded on the main deck or in tl1e belly of tl1e airplane by n1eans of nose loading, ,vhere the whole nose is opened, or side loading, through a large cargo door. When a package is shipped on a passenger plane, it is usually consolidated ,vith other packages and freight and packed into special containers that fit in the storage area under the passenger co1npart1nent (i.e., the belly of the plane). Since there often 278

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

isn't room to drive a forklift truck into the plane to load the pallets, the load floor is equipped ,vith electric rollers. Once a pallet is pushed through the doonvay, the electric rollers are used to n1ove it to the front or rear of the cargo hold. Sin1ilar to rail. air is also paired ,vith trucks for door-to-door delivery.

Water Carriers Water carriers are organizations transporting goods or people using ,vaterways. \,Vater carriers cover a broad range of " 'ater transportation routes including ocean / deep water, coastal and intercoastal. and in-land waterways such as rivers and lakes. Transportation by \Yater is the oldest forn1 of transport in the United States, dating back to the birth of the nation. \-Vater transport plays an ilnportant role in foreign trade. Like rail, transportation by water is slow and inflexible, but is also inexpensive compared to the other 1nodes of transportation. Water transportation is an efficient fonn of transportation in tenns of energy costs per dollar of gross output, or co1npared to the 1narket value of the goods. Water transport is prilnarily used for heavy, bull.7, and lov;-value n1aterials (e.g., coal, grain). Ho,Yever, because transport by water is so comparatively inexpensive, almost any iten1 may be shipped by \Yater, including auto,nobiles, petroleum, containerized cargo, and produce. Don1estic water carriers compete ,vith railroads for the 1novement of bulk commodities such as grains, coal, ores. and chen1icals, and ,vith pipelines for the n1ovement of bulk petroleu1n, petrolewn products, and che1nicals. As ,vith air and rail, ,vater transportation is paired ,vith trucks for door-to-door delivery.

Pipeline Carriers Most people don't think of a pipeline as a mode of transportation, but any type of pipeline that 1noves ,naterial from one place to the other is a fonn of transportation. Pipeline costs are extre1nely lo"', dependability is very high, and there is lilnited risk of dainage to the product being trai1sported. It is actually the most efficient forn1 of transportation. Once the pipeline is set up, there is very little

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maintenance, very little additional infrastructure that you have to build around it, and it is a continuous flov.•. It's also the most reliable fonn of transportation, not subject to the v.•eather, traffic congestion, or breakdo,vns along the way. The pipeline industry is unique in a number of important aspects, including the type of con1n1odity hauled, the o,vnership, and visibility. The industry is relatively unknov.•n to the general public, ,vhich has little appreciation for the role and i1nportance of pipelines. Pipelines are li1nited in the n1arkets they serve and very linuted in the conunodities they can haul. Furthennore, pipelines are the only n1ode ,vith no backhaul; that is, they are unidirectional ,vith products that only move in one direction through the line. A n1ajor advantage offered by the pipeline industry is lo,v rates. Pipeline transportation can be extren1ely efficient ,vith large-dian1eter pipelines operating near capacity. Average revenues for pipeline con1panies are belo,v one-half of a cent per ton-1nile, ,vhich is indicative of their lo,v-cost service. l\\•O additional user cost advantages complement the lo"' rates. First, pipelines have a very good loss and damage record. Second, pipelines can provide a ,varehousing function because their service is slo,v. Another positive service advantage is dependability. Although the service ti1ne is slow, scl1eduled deliveries can be forecasted very accurately, din1inishing the need for safety stock. Additionally, the risk of terrorism is reduced ,vhen the pipelines are buried in the ground. Although the pipeline's slow speed can be considered an advantage due to its use as a free form of ,varehousing, in some instances the pipeline's slow speed can be considered a disadvantage. Pipelines are also at a disadvantage ,vhen it co1nes to co1npleteness of service, because they offer a fixed route of service that cannot be easily ex-tended into a door-to-door service. That is, they have linuted geographic flexibility or accessibility. The use of pipelines is liinited to a rather select number of products: crude oil, oil products, natural gas, ,vater, and a liinited number of chen1icals.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Ranking ofTransportation Modes Figure 9.5 is a chart that compares and ranks the various modes of transportation against key transportation service elernents on a scale of I (best) to 5 (worst). •

Truck ranks the best overall but only ranks nun1ber 1 i11 the accessibility category.

•

Pipeline is the lowest cost and the n1ost reliable.

•

Air is the fastest.

•

Rail has the rnost capability.

•

Water does not corne in first in any category but is \videly used for international shipments.

1 to 5 = Best to Worst Capability Accesslblllty

Truck

{con hcndlt tht most kinds of freighl. te.. wt'iQhl, Utt~ ()Pt, ttcJ

lowest Per-unit Cost

Reliability

Speed

Total

2

4

2

2

11

3

3

3

I

I

12

Rail

2

1

Pipeline

5

5

1

Air

3

4

5

4

1

17

Water

4

3

2

5

5

19

16

(Mc.l..,,..,,.2011)

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lntermodal lntermodal is sometin1es referred to as the sixth mode of transportation, but it is really the use of rnultiple n1odes of transportation to execute a single transport shipn1ent. lntern1odal is gro,ving substantially because it is fairly cost efficient and cost effective. Sorne of the more co1nrnon exan1ples include: •

RAIL AND MOTOR CARRIERS:

Offer point-to-point pick-up and delivery service kno,vn as trailer-on-flatcar (TOFC). •

RAIL AND WATER CARRIERS:

Offer point-to -point pickup and delivery service k.110,.vn as contaiI1er-on-flatcar (COFC). •

WATER AND MOTOR CARRIERS: Offer point-to-point pickup

and delivery service for overseas rnanufacturers.

•

ROLL-ON/ R OLL-OFF (RO/ RO ) S H IP: This is one of the 1nost suc-

cessful types of cargo ships operating today and its flexibility, ability to integrate ,vith other transport systen1s, and speed of operation have rnade it e1..1:ren1ely popular on 1nany shipping routes. A RO/ RO ship is specifically designed to carry wheeled and tracked vehicles as all or n1ost of its cargo. Vehicles are driven or towed on and off the ship by rneans of either the ship's o·wn ran1ps or shore-based ran1ps. Because it is designed to accomJnodate cargo that cannot be stacked 282

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

but varies in height, belo"•-deck space and volwne utilization is generally less efficient than on a containership. RO/RO ships are thus con1n1ercially viable only in certain specialized trades.

TRANSPORTATION PRICING AND CONSIDERATIONS ................... Since deregulation in the transportation industry, the negotiating of transportation prices is con11non. The main transportation schen1es are as follows:

•

COST OF SERVICE PRICING: TI1e setting of a price for a service based on the costs incurred in providing it. The carrier esti111ates the cost of providing the service and then adds on a percent profit margin. Co1nn1only used for pricing transportation of lo\,, value goods or in highly con1petitive situations.

•

VALUE OF SERV ICE PRICING: A pricing strategy that sets prices primarily, but not exclusive-

ly, in the value, perceived or esti1nated, to the customer rather than on the cost of the product or historical prices (i.e., "priced at " 'hat the market ,viii bear"). Depends on the value of the goods being shipped. Used for high value goods or \vhen no co1npetition exists.

•

COMBINATION PRICING: Price setting at a value behveen cost-of-service 1nini1nun1 and value-of-service n1axiinu1n. Most carriers use son1e fonn of co1nbination pricing. Co1n1non in highly volatile 1narkets and changing co1npetitive situations.

•

NET-RATE PRICING: Established discounts and accessorial charges are rolled into one all-inclusive price. Pricing is tailored to the individual custorner's needs.

Terms ofSale The delivery and payinent tenns agreed behveen a buyer and a seller. In international trade, tenns of sale also set out the rights and obligations of buyers and sellers as applicable in the transportation of goods.

EXAMPLES: •

F.O.B. Origin: Seller states price at point of origin and agrees to load a carrier. Buyer selects the carrier and pays for the transportation. Title passes to the buyer when the shipment originates. Buyer assumes the risk for in-transit loss or dan1age.

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•

F.O.B. Destination: Seller arranges for transportation and adds charges to the sales invoice. Seller asswnes the risk for in-transit loss or dan1age. Title does not pass to the buyer until delivery is con1pleted.

Transportation Rate Categories Price charged by transportation carrier for moving an item or commodity fron1 point A to point B. Actual a1nount charged varies based on ,veight of object being moved, type of con11nodity being 1noved, and distance traveled. Classified as line haul rates, class rates, exception rates, co1nn1odity rates, and n1iscellaneous rates.

TRANSPORTATION REGULATION

•••••••••••••••••••••••••••••••••••••••••••

TI1e early days of transportation in the United States ,vas like the Wild West. Transportation carriers could charge whatever they ,vanted for their services and there ,,rasn't n1uch con1petition to keep the market in check. As a result, there really v.•asn't good service to the public, so the government began to i1npose a series of regulations. Some of those n,ajor regulati ons include:

•

THE GRANGER LA,vs (1870s), v.•hich regulated the railroads

•

INTERSTATE COMl\1ERCE ACT (1887), which created the Interstate Con1.merce Commission (ICC)

•

TRANSPORTATION ACT (1920), v.•hich made changes to the Interstate Commerce Act

•

MOTOR CARRIER ACT (1935), ,vhich brought 1notor carriers under the Interstate Co1nn1erce Co1nnlission control

•

TRANSPORTATION ACT (1940), ,vhich established ICC control over dornestic ,vater transportation

•

FEDERAL AVIATION ACT (1958), v.•hich created air traffic and safety regulations and the national airport system

•

D EPARTl\1ENT OF TRANSPORTATION ACT (1966), ,vhich established the U.S. Department of'lransportation to coordinate all U.S. transportation-related matters

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

One of the most important was the 1887 Interstate Conunerce Act, ,vhich also established the 1n: terstate Commerce Comn1ission (ICC). The 1nain reason for i1nplen1enting this regulation ,vas due to the rnonopolies in the railroad industry. The governn1ent stepped in to break those n1onopolies, stop the profiteering in that industry, and in1prove service offerings to the public.

TRANSPORTATION DEREGULATION

•••••••••••••••••••••••••••••••••••••••

Eventually the pendulu111 s,vung back the other ,vay. Transportation regulation becaine too onerous, and the rest of the ,vorld started to catch up in tenns of transportation. Foreign tTansportation con1panies started to in1pact the ability of U.S. transportation companies to n1ake money. As a result, the government started to deregulate the industry allo\\•ing U.S. cornpanies n1ore freedorn so they could beco1ne rnore cornpetitive in the United States as " 'ell as in other countries. S01ne of those 1najor deregulation initiatives include:

•

RAILROAD REVITALIZATION AND REGULATORY REFORM ACT (1976), ,vhich allo\\•ed railroads to change rates ,vithoul ICC approval

•

AIR FREIGHT DEREGULATION (1977)

•

MOTOR CARRIERS DEREGULATION (1980), ,,,hich helped pro1note con1petitive, safe, and efficient n1otor transportation

•

SHIPPING ACT ( I 984), \\•hich allo"•ed ocean carriers to pool ship1nents, assign ports, publish rates, and enter into contracts with shippers

•

ICC TERMINATION ACT (1995), ,vhich eli1n inated the ICC

•

OCEAN SHIPPING REFORM ACT (1998), ,vhich ended the requirernent for oceai1 carriers to file rates

Regulation Pros and Cons PROS •

Regulation tends to ensure adequate transportation service throughout the country.

•

Regulation protects consun1ers fron1111onopoly pricing, unsafe practices, and liability.

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CONS

•

Regulation discourages co111petition.

•

Regulation does not allow prices to adjust based on den1and or through negotiation.

In contrast, deregulation actually encourages competition and allO\\'S prices to be set by the market. Prices are adjusted by de1nand and an individual's ability to negotiate rates. Today, the U.S. transportation industry ren1ains n1ostly deregulated.

OTHER TRANSPORTATION INTERMEDIARIES ............................. . •

FREIGHT FORWARDERS are the "111iddle 1nan" between the carrier and the organization ship-

ping the product. They take s1nall shipments (e.g., LTL) fron1 numerous con1panies and consolidate the1n to 1nake larger ship1nents (e.g., FTL). TI1ese larger consolidated ship1nents can take advantage oflo,ver transportation rates associated \\•ith volu1ne. Son1e of these savings can then be passed along to the individual shippers. •

LOAD OR TRANSPORTATION BROKERS find shipn1ents for carriers for a fee. They bring

shippers and carriers together. •

SHIPPERS' ASSOCIATIONS are a group of shippers that consolidates or distributes freight on

a nonprofit basis for the n1embers of the group to obtain volume rates or service contract rates. Associations \Viii contract for the physical 1nove1nent of the cargo fro1n n1en1bers ,vith 1notor carriers, railroads, ocean carriers, air carriers, and others. •

INTERMODAL MARKETING COMPANIES (IMC) purchase blocks of rail and truck trans-

portation services, utilize equipn1ent fro111 111ultiple SOlu·ces, and provide other value added services under a single freight bill to the ultimate shipper. lbey purchase rail capacity and sell it to shippers. Often, an IMC co1npany ,viii require a minimum number of shipments from a client, to guarantee that shipping equipn1ent \\•ill be available.

TECHNOLOGY AND TRENDS IN TRANSPORTATION ••••••••••••••••••••• As technology has continued to evolve in tl1e trucking sector, it is no\v essential for companies to re111ain current v,rith tJ·ends. According to a recent report fro1n tl1e A111erica11 Journal of Transporta-

286

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

lion, technological trends have disrupted the trucking industry to the extent that early adopters are

set to becorne the rnost effective and efficient operators. Everything from driver stalling and recruiting, to driver monitoring and traffic coordination, to safety and con11nunications are no,v driven exclusively through technology for many companies. Follo,ving are sorne of the n1ost pron1inent ,vays in ,vhich companies are no"' leveraging technologies to irnprove their operations and logistics. •

DRI VER MON ITORING

With the onset of data sharing technology in the trucking sector, companies are able to keep track of driver and vehicle progress. Mileage, distance routes, and all other behaviors can be rnonitored rernotely no,v, v;hich gives cornpanies the ability to 111ake real-tune cllanges and improvernents. •

TRAFFIC COORDI NATION

With the ability to con1municate and access fleet information remotely, companies and drivers are no\\• able to irnprove delivery tin1es. TI1is is acl1ieved by coordinating driving patterns, deliveril1g real-tune traffic reports, updating infonnation on surroundmg areas, and even telling a driver about s01nethil1g i11 his or her blind spot. Traffic coordination technology has resolved many road transport issues for truckers as a result. •

SAFETY TECHNOLOGY

Safety technology has perhaps been the n1ost significant disrupter in the trucking industry. This facet of the sector is constantly experiencing changes " 'ith: Stability control Antilock braking systems Collision avoidance systems Lane departure warning Interior cameras Rearview cameras Blind spot ,varnmg devices Side monitor cameras and sensors eJ~\J>kt 9: Logistics: Warehousing, Transportation.and Reverse logistics

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Investments in safety technology not only reduce accidents, injuries, and fatalities, but they have been shown to cut costs as ,veil. For instance, according to research cited by Truckinglnfo. con1, it costs ben,•een $100,000 and $200,000 in payouts for property damage, up to S455,000 for accidents with injuries and close to $885,000 and $1.3 nilllion for accidents that end in fatalities. The high costs of accidents have pron1p1ed many con1panies to adapt to ne"' technologies. The same research shov.•ed that just on the adoption of lane departure ,varning systen1s alone, there is significant return on investn1ent. TI1e average cost is around $800, ,vhich rneans it generates an ROI of sorne,vhere behveen $1.37 and $6.55 for each dollar spent (ProDrivers, 2016). •

PLATOONING

i)

SAVINGS

Vehicle-to-vehicle con1munication is tackling ru•o of the trucking industry's largest problen1s-fuel and safety. By using radar sensors, intelligent braking, video screens, and a ,vireless link, vehicle-to-vehicle con1111unication n1akes it possible for tv.•o trucks to connect in a "platoon;' or "closer together than v.•otild norn1ally be safe:•

i ) SAVINGS

The hvo trucks are able to get as close as 20 feet fro111 eacl1 other ,vhile platooning in order to take advantage of fuel-saving aerodynanucs. lne industry reports fuel savings of I0% for the second truck and 4.5% for the lead truck in a platoon. The trucks are able to get this close thanks to an active safety syste111 that ,virelessly links the trucks. The v.rireless link controls the truck's acceleration and braking, ,vhile radar detects potential dangers up ahead. The linked trucks react ,vithin a "fraction of a second" " 'hereas a truck driver needs up to nvo seconds to react to changes in conditions. While the \\1ireless link controls acceleration and braking. drivers still have co1nplete control of the truck (Gold,vasser, 2015). •

ADVANCED VEHICLE EXPERIENCE- NEW C ONCEPT TRUCKING

A collaboration behveen Peterbilt, Capstone Turbine, and Great Dane Trailer has created a ne,v concept truck-the Walrnart Advanced Vehicle Experience, or V>/.A.V.E. W.A.V.E. is a rneans to shake up the ,vay things are done in the trucking industry as it con1bines rnany revolutionary ideas in tractor and trailer design. 288

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

The advanced concept tractor has a streamlined, aerodyna,nic body, thanks to the driver's seat placed in the center of the cab. Furthermore, the tractor has a microturbine-po"'ered series hybrid electric drivetrain, prognunn1ed to find the 1nost efficient balance bet\veen its turbine and electric drivetrains. The trailer is equally as advanced, made aln1ost entirely of carbon fiber, and \Veighing 4,000 pounds less than a nonnal trailer. TI1e side"ralls and roof are single, 53-feetlong pieces, held together with advanced adhesives, ellininating the need for rivets. Finally, the trailer has a convex nose that maintains cargo capacity and inlproves aerodynamics. v\lh:ile the WA. V.E. is still a prototype, Waln1art is not only attempting to in1prove its own fleet efficiency, but also advance the future of the entire trucking industry with this application transportation technology (Gold,vasser. 2015). •

VERTI CA LLY FOLDING SH IPPI NG CONTAINERS

For decades, empty cargo containers have led to inefficiencies at ports. A ne\v innovation hopes to bring a sustainable alternative to nonnal, rigid cargo containers tlu·ough vertically folding, retrofitted containers.

The goal is to reduce tl1e nu1nber of container ship movements as well as intrastate truck 1nove1nents at ports related to e1npty containers. TI1ese foldable containers "'ill reduce the cost and inefficiencies involved in moving e1npty intennodal containers. TI1e containers are folded vertically by collapsing the doors of tl1e container and pushing the outer ,valls of the container in to,Yard each other. \.Vith this 111ethod, five empty, collapsed containers can fit into the same space as one norn1al, nonfolding container. Retrofitting old containers to be collapsible rather tl1an designing and building con1pletely eJ~\J>kt 9: Logistics: Warehousing, Transportation.and Reverse logistics

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ne,~, containers is another hallmark of this initiative. With an idea as simple as folding containers, you don't have to build intricate software or design ne,v trucks to have a huge i1npact on the logistics industry (Gold,vasser, 2015). •

DRIVERLESS TRUCKS

According to the American Trucking Association, there are so1ne 3.5 1nillion truck drivers in the United States alone. That's 3.5 million people ,vho n,ay be i1npacted once driverless trucks hit the roads in full force. A convoy of these trucks recently d1·ove across Europe and arrived without incident at their destination at the Port of Rotterda111 for 75% cheaper than it "'ould have cost had hu1nan beings been driving them. A large part of the econo1nic efficiency boost ,viii include the fact that driverless trucks never get tired and can drive for 24 hours straight, non stop, whereas hu1nans obviously need to eat, take breaks, and sleep. Drivers are restricted by la\\' fro111 driving 111ore than 11 hours a day and are required to take breaks each day. That 1neans the technology ,vould effectively double the output of the U.S. transportation net\,,ork at 25% of the cost. In addition, truck drivers drive faster because they are paid by the n1ile and they're trying to get more done, a situation that thrO½'Sfuel efficiency out the ,vindo,v in a ,vay that ,von't happen ,,,ith robotrucks, ,vhicl1 will drive at a steady, set pace the entire trip (Dykes, 2016).

LOGISTICS MANAGEMENT SOFTWARE APPLICATIONS ............... . Companies that have a lot of inventory and make a lot of shipments may find it necessary to have son1e type of syste111(s) in place to n1anage logistics activities such as ½'arehousing and transporta290

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

lion. The following are the basic logistics systems that companies in1plen1ent beyond the standard inventory 1nanage1nent system or enterprise resource planning (ERP) system. •

WAREH OUSE MANAGEl\1ENT SYSTEl\1S (WMS): Software application that supports the

day-to -day operations in a \\•arehouse. \f\TMS prograins enable centralized 1nanage1nent of tasks such as tracking inventory levels and stock locations. \.VMS syste1ns 1uay be standalone applications or part of an enterprise resource planning (ERP) system. The goal of a ,varehouse manage1nent syste,n is to provide management " 'ith the information it needs to efficiently control the 1nove1nent of n1aterials ,vithin a ,varehouse. •

TRANSPORTATION MANAGEMENT SYSTEMS (TMS): Sofu,,are that facilitate interactions

between an orgai1ization's order 1nanagen1ent syste1u (OMS) ai1d its \\•arehouse 1uanage1nent system (\.VMS) or distribution center (DC); it is used to select the best n1ix of transportation services and pricing. TMS systems may be standalone applications or part of an ERP system. TMS products serve as the logistics 1nanage1nent hub in a collaborative nenvork of shippers, carriers, and custon1ers. Conunon Tt-1S sofu"are 1nodules include route planning ai1d optilnization, load optilnization, execution, freight audit and payment, yard n1anagen1ent, advanced shipping, order visibility, and carrier n1anagement. The business value of a fully deployed TMS should achieve: Reduced costs through better route planning, load optin1ization, carrier mix, and n1ode selection In1proved accountability ,vith n1ore visibility into the transportation chain Greater flexibility to n1ake changes in delivery plms

REVERSE LOGISTICS

••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••

What Is Reverse Logistics? In supply cham n1anagement we are concerned with the efficient, effective, and cost conscious use of resources to n1ove a product from concept to consun1er. \/\Te rnust be equally concerned ,vith the reverse flo\\• of products back through the supply chain, kno,vn as reverse logistics. Reverse logistics involves the process of moving a product from the poiIH of customer receipt back to the point of origin to recapture value or ensure proper disposal.

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Keys to Reverse Logistics: Visibility, Efficiency, and Service Con1panies n1ust address a diversity of issues ,.,hen trying to detennine '\.,hy is there a need for reverse logistics." l11ey n1ust establish return policies, processes for identifying quality issues, ,,,ays to handle defective materials, poorly packaged products, shipped errors, and the Like. An additional point of i.Jnportance often overlooked in reverse logistics is the possibility of ren1anufacturmg, refurbish1nent, and resale of goods. In today's "'orld of sustainability and green supply chains, questions arise as to the volun1e and level of ,vaste involved ,vith disposal of both products and packaging 111aterials. There is also a question as to the possibility of the repurpose of products and the reuse of containers and package materials, ,vhich of course vary " 'ith every con1pany and 111anufacture. One of an organization's concerns should be "'hat types of 1naterial are being used, and if they are recyclable or "green:• Additional concerns include \vhich packagi.J1g materials can affect pollution, in1pact energy issues, and require hazardous 1naterials progra111s?

Product Returns Are on the Rise It is becoming painfully apparent that reverse logistics is on the rise. All n1anufacturers and retailers would be 1nore con1fortable if all of their products ,vere based on a fonvard flo,v only; ho,vever, this will never be the case, as there will ahvays be the need for a back\kt 9: Logistics: Warehousing, Transportation.and Reverse logistics

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•

Co1npanies transporting freight or cargo regardless of the mode of transportation are classified accordi ng to the follov.•ing categories: Con11non Carrier: A person or con1pany that transports freight for a fee that can be hired by anyone to transport goods Contract Carriers: A person or con1pany that transports freight under contract to one or a lin1ited nwnber of shippers

Exempt Carrjers: A person or company specializing in certain services (such as taxi service) or certain co111n1odities (such as farn1 products or bulk cargo) exe,npt frorn regulation by the Interstate Con1111erce Act

•

Prjyate Carrjers: A person or company that transports its o,vn

cargo, usually as part of a business that produces, uses, sells, and/or buys the cargo that is being hauled

There arc five n1ajor 111odes of transportation: Motor carriers (trucking) Rail carriers -

Air carriers

-

V\later carriers Pipeline carriers

•

Motor Carriers (1):ucks): The most prevalent n1ode of transportation and the one people are probably 111ost fan1iliar. It is also the rnost flexible rnode of transportation in that it carries the 1nost different kinds of freight to the n1ost locations. -

There are two n1ajor categories of motor carrier: short haul and long haul. •

Short haul is defined as operating ,vithin 200 n1iles of the driver's horne tenninal.

•

Long haul is defined as anything over 200 miles from the driver's home terminal.

Motor carriers can be further categorized into general carriers and specialized carriers: •

300

General Freight Carriers: Trucking companies that engage in shipping packaged, boxed, and palletized goods that can be transported in standard, enclosed tractor-trailers, generally 40 to 48 feet in length. FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

•

Specialized Freight Carriers: Transport articles that, because of size, \Veight, shape, or other inherent characteristics, require specialized equip1nent for transportation.

Ship1nents by n1otor carrier can be divided into either less-than-truckload (LTL) or f11ll-truckload (FTL), generally indicating whether the volume of the shipment fills the truck trailer/container or not. Motor carriers may offer LTL or FTL, or both services.

• LTL carriers are those that n1ove small shipments-that is, \\•hen you don't have enough to fill a truck.

• fIL carriers generally contract an entire trailer out to a single customer. •

Rail Carriers: A con1pany whose business is transporting persons or goods or both by railroad. Rail transportation is best used for very heavy shipn1ents such as building n1aterials, construction equipn1ent, and coal, particularly \\•hen the transport distance is long.

• Air Carriers:

Organizations that transport passengers and cargo by aircraft. Air is the ne,vest transport n1ode and the least utilized. Air ship1nents are relatively expensive con1pared to the other 1nodes of transportation, partially because the fuel is expensive, they have a Limited a1nount of cargo space, and they have to deal ,vith weight and balance issues on the plane itself.

•

\Nater Carriers: Organizations that transport goods or people using \vaterv.•ays. Vl'ater carriers cover a broad range of \\•ater transportation routes including ocean / deep ,vater, coastal and intercoastal, and in-land ,vaterways such as rivers and lakes

• Pipeline Carriers:

Most people don't think of a pipeline as a n1ode of transportation, but any type of pipeline that n1oves 1naterial fro1n one place to the other is a forn1 of transportation. Pipeline costs are extre1nely lo,v, dependability is very high, and there is lin1ited risk of dan1age to the product being transported. It is actually the n1ost efficient form of transportation.

•

Intennodal is son1eti.Jnes referred to as the sixth 1node of transportation, but it is really the use of1nultiple 1nodes of transportation to execute a single transport shipn1ent. Intermodal is gro,ving substantially because it is fairly cost efficient and cost effective.

• Transportation Pricing and Considerations: Since deregulation in the transportation industry, negotiating transportation prices is common. TI1e main transportation schen1es are as follo\\•s:

Cost of Service Pricing; The setting of a price for a service based on the costs incurred in providing it

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Value of Service Pricing: A pricing strategy that sets prices primarily, but not exclusively, in the value, perceived or estirnated, to the custorner rather than on the cost of the product or historical prices (i.e., "priced at \'7hat the n1arket \viii bear") Con1bination Pricing: Price setting at a value bet\,reen cost-of-service n1inin1u1n and value-of-service 1naxi1nu1n. -

Net-Rate Pricing: Established discounts and accessorial charges are rolled into one all inclusive price

•

Tenns of Sale: The delivery and payrnent tenns agreed bet\veen a buyer and a seller. In international trade, tern1s of sale also set out the rights and obligations of buyers and sellers as applicable in the transportation of goods.

•

Transportation Rate Categories: Price charged by transportation carrier for moving an iten1 or con11nodity from point A to point B. Classified as line haul rates, class rates, exception rates, co1n1nodity rates, and n1iscellaneous rates.

•

Transportation Regulation: The early days of transportation in the United States was like the Wild West. Transportation carriers could charge ,vhatever they " ranted for their services and there ,vasn't n1uch con1petition to keep the 1narket in check. As a result, there really \\1asn't good service to the public, so the government started to in1pose a series of regulations.

•

Transportation Deregulation: Eventually the pendulun1 s,vung back the other ,vay. Transportation regulation beca1ne too onerous, and the rest of the world started to catch up in tern1s of transportation. Foreign transportation companies started to impact the ability of U.S. transportation cornpanies to rnake rnoney. As a result, the govenunent began to deregulate the industry allO\ving U.S. co1npanies n1ore freedo1u so they could become n1ore con1petitive in the United States as well as in other countries.

•

Other transportation intern1ediaries include: Freight For\varders are tl1e "rniddle n1an" ben,reen the carrier and the organization shipping the product. They take sn1all ship1uents (e.g., LTL) fron1 nun1erous companies and consolidate them to make larger shipments (e.g., FTL). Load or Transportation Brokers find ship1uents for carriers for a fee. They bring shippers and carriers together. -

302

Shippers' Associations are a group of shippers t11at consolidates or distributes freight on a nonprofit basis for the rnembers of the group to obtain volume rates or service contract rates. FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

lnterntodal Marketing Companies (lMC) purchase blocks of rail and truck transportation services, utilize equipn1ent fro1n n1ultiple sources, and provide other value added services wider a single freight bill to the ultitnate shipper. ln other "'ords, they purchase rail capacity and sell it to shippers. •

As technology has continued to evolve in the trucking sector, it is 110\\1 essential for con1panies to remain current ,vith trends. Some of the n1ost pron1inent ,vays in ,vhich con1panies are no"' leveraging technologies to improve their operations and logistics are: Driver n1onitoring Traffic coordination Safety technology Platooning Advanced vehicle experience, or ne\Y concept trucking Vertically folding shipping containers Driverless trucks

•

Con1panies that have a lot of inventory and 111ake a lot of ship111ents 111ay find it necessary to have son1e type of logistics 111anagen1ent sofhvare application in place to 111anage logistics activities such as \varehousing and transportation. The following are the basic logistics systems that co1npanies in1ple1nent beyond the standard inventory management system or ERP system:

Warehouse Management Systems (\,YMS}: Software application

that supports the day-to-

day operations in a ,varehouse.

Transportation Managen1ent Systems (TMS}: Sofhvare that facilitates interactions between an organization's order 111anage1nent syste1n (O?v(S) and its ,varehouse n1anage1nent syste1n (WMS) or distribution center (DC). •

Reverse Logistics: We n1ust be concerned ,vitl1 the reverse flo,v of products back through the supply chain, known as reverse logistics. It involves the process of1noving a product fron1 the point of customer receipt back to tile point of origin to recapture value or ensure proper disposal. The keys to reverse logistics are visibility, efficiency, and service.

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Product returns are on the rise. Reverse logistics and returns are a significant part of the supply chain. •

Vvhen considering reverse logistics, it pays to i111prove returns 111anage1nent in five key areas: I. Returns 2. Recalls 3. Repair (and refurbishment, reuse, and remanufacturing) 4. Repackaging (for restock or resale in secondary channels) 5. Recycling, disposal, and disposition

REFERENCES ......................................................................... 'APJCS Dictionary (14th ed.). (2013). Chicago, IL: APICS. ,v,"'v.apics.org Ackennan, Ken. ( I994). Warehousing profitably. Author. Ackennan, Ken. (1997). Practical handbook of warehousing. London: Chapn1an & Hall. Bolten Ernst, F. (1997). Managing tirne a11d space in the 1noder11 warehouse. Ne,v York, NY: AMACOM, a division of American Management Association. Dykes, M. (2016). Driverless trucks already being tested; TI1ree 111illion-plus truck drivers to lose their jobs soon. The Daily Sheeple. Retrieved fron1 http://,v"''"·thedailysheeple.co1n/ driverlesstrucks-already-being-tested-three-nilllion -plus-truck-drivers-to-lose-their-jobs-soon_ 042016 Goldwasser, B. (2015). Trends in transportation technology. UseReload.com. Retrieved fro1n http:// blog.usereload.co111/trends-in-transportation-technology/ Jenkins, Creed H. (1990). Co111plete guide to n1odern warehouse ,na11age111e11t. Upper Saddle River, NJ: Prentice Hall. Lan1bert, Douglas M. (1998). Fundan1entals of logistics 111a11agen1e11t. Ne"' York, NY: McGra,v-Hill; ProDrivers. (2016). 4 ,vays technology is changing the trucking industry. Retrieved fron1 https:// www.prodrivers.con1/ ne'"'•s/2016/ 4/ 40121518/ 4- ,\rays-technology-is-changing-the-trucking-industry Ryder Exchange. (2014). Reverse logistics, supply chain, sustainability, technology. Van Riper, T. (2005). Reseller sees n1any happy returns. Forbes (Dece1nber).

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Global Logistics and International Trade CHAPTER OUTLINE Global locations Global Facilities-Strategic Roles Globallocation Factors Global location Decisions International Trade Management Major U.S. International Trade legislation U.S. Customs and Border Protection U.S. Department of Homeland Security Trade Compliance Global logistics Intermediaries Import Process Export Process Penalties for Violations

305

GLOBAL LOCATIONS

••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••

Why would a con1pany want to manufacture products outside of their domestic n1arket? There are a number of significant reasons why this might be an attractive strategy, including: •

Reducing costs (direct, indirect, capital, logistics, etc.)

•

Reducing taxes, and overco1ning tariff barriers

•

Access to n1ore custon1ers, and in1proved custo1ner service

•

Mitigating certain risks

•

Establishing alternative sources of supply

•

Gaining an advantage over competitors

•

Obtaining kno,vledge fron1 foreign suppliers, co1npetitors, custon1ers, and research institutions

•

Securing access to global talent

In today's business environ1nent, con1panies can locate an)"vhere in the ,vorld due to such aspects as increased globalization, advance1nents in technology, ne,v transportation options, and open n1arkets. Therefore, facility location n1ust be part of the company's supply chain strategy. Global location decisions involve: I.

Defining each facility's strategic role (i.e., the purpose of each facility)

2.

Determining the location for each facility (i.e., ,~•here in the ,vorld to locate)

3.

Identifying the market(s) that each facility ,vill serve (i.e., local, regional, global)

GLOBAL FACILITIES-STRATEGIC ROLES

••••••••••••••••••••••••••••••••

Manufacturing facilities can be categorized based on ,vhat they produce, ,vhere they are located, how n1uch decision-making authority they have, what technical activities they perforn1, ,vhat n1arkets they serve, and 1nore. Research done by Professor Kasra Ferdo"'S, Georgeto\\•n University, identified six specific strategic roles that a 1nanufacturing facility can asstune. 6

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

1. Offshore Factory An offshore factory is a very basic factory set up for rnanufacturing or assen1bly in a country ,vhere labor and/or ra,..., rnaterials are less expensive, typically for ilnport back i11to the manufacturer's hon,e country. An offshore factory can also be defined as "a plant that ilnports or acquiJ-es locally all co1nponents and then exports the finished product'.''

■---

OFFSHORE FACTORY CHARACTERISTICS:

•

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•

A fe\v years back, Brazil bad 1,000% annual inflation rate. It is nearly i1npossible to determine costs and set prices in that type of currency environ1nent.

Environmental Considerations Another global location consideration involves understanding and evaluating the environ1nental situation ,,rithin each potential location. Co1npanies n1ust consider the local environn1ental itnpact on their organization and employees, as well as the impact that their operations 1nay have on the local e1nriron1nent. Countries and specific locations 1nay have differiI1g envit'o1unental la,vs, regulations, and resources ,vhich may restrict con1pany operations and i1npact costs. Air and v.•ater quality, carbon e1nissions, and disposal of ,vaste, a111ong other environmental factors, could be issues a con1pany encounters depending on the global location selected.

Labor Availability and Cost Availability of the type of labor, iI1 the volumes needed, and at the desired cost are n1ajor drivers for many con1panies v.•hen evaluating one potential global location over another. \•Vhen a company is evaluating a global location, it should consider labor factors such as the availability of skilled or unskilled labor, labor productivity, unemployment and undere1nploy1nent rates, \Vage rates, turnover rates, and labor force co111petitors. Depending on the company's needs, one or more of these factors could make or break the decision. Another factor to consider is the longtern1 prognosis for the labor market in a particular global location. Labor costs and availability may be favorable in the short term, but could change significantly over tit'ne. If the con1pany is evaluatiI1g locations \vithin the United States, another consideration n1ay be the right to \vork la,vs. A right to work la,v guarantees that a person cannot be required to join or not 314

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

join (or to pay dues to) a labor union, as a condition of en1ployn1ent. There are currently 26 U.S. states that have right to "'Ork laws protecting the rights of ernployees.

Land Availability and Costs A con1pany considering various global locations may also be considering building a ne,v facility or buying an existing one. ln either situation, the availability and cost of land could potentially be an issue, and must be a consideration in the location decision. Many popular areas around the global have scarce land resources available and/or the land prices are extren1ely high. Con1panies have expanded their focus beyond the rnajor cities to include son1e of the rnore suburban and rural areas \\•here land rnay be n1ore readily available and at a lower cost, while still being close enough to the urban areas ,vhere suppliers, custorners, and service providers are located.

-

Quality-of-Life Factors A higher quality of life in the ,vorkplace and also in the surrounding environn1ent leads to higher en1ployee morale, satisfaction, and retention. Cornpanies that establish facilities in various global locations ,viii need people to " 'ork at these locations. Sorne of the ,vorkforce ,,,ill likely be local, and son1e personnel n1ay transfer frorn other locations either from inside or fron1 outside the con1pany. In all cases, the quality of life in each global location ,vill be a factor in attracting and retaining skilled and unskilled ,vorkers to that location. Con1panies should therefore understand and evaluate the follo"'ing quality of life factors in terms of rnaturity, sophistication, robustness, and so forth, in each location before rnaking a location decision:

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315

l. Culture

2. Econo111y 3. Education 4. Govern1nent / Politics 5. Healthcare 6. Mobility 7. Natlu·al Environment 8. Public Safety 9. Recreation 1O. Social Environment

Taxes and Incentives Taxes and govenunental incentives are significant considerations when Tax 1ncentiv~ con1paring potential global loca,,,,,,_,,-, tions. Fron1 a tax perspective, 111ultiple levels of governn1ent 111ust be considered as there may be federal, state/region, and/or local co1n111unity taxes, any or all of v,,hich could in1pact the business and influence the location decision. Import tariffs, ,vhich are designed to generate revenue and/ or protect local businesses, 1nay also be imposed in various countries. Countries with high tariffs encourage ,nultinational corporations to produce locally, and discourage importing goods into the country.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Countries may provide tax incentives (e.g., reductions or deferments) to attract businesses to locate operations within their borders. These incentives 1nay also be tied to the volun1e of business done v,ithin the country, ho,v 111any local labors are e1nployed, ,vhether 1uaterials are purchased fro111 local suppliers or not, among others.

Trade Agreements Regional trade agree1nents i.Jnpact global location decisions. A location n1ay be 111ore favorably vie"•ed if there is one or n1ore trade agree1nents in place providing a financial incentive and a better business environ1uent than another country location. TI1e following are a fe"' exa1nples of regional trade agree1nents: •

European Union (EU):

I I 950)

Follov.,ing \,VWJJ, consists of 27 1ne1nbers countries in Europe •

North An1erica11 Free Trade Agree1nent (NAFTA):

I 1994) Removed most barriers to trade and investment an1ong United States, Canada, and Mexico •

Southern Common Market (MERCOSUR): [1991) Argentina, Brazil, Paraguay, and Uruguay

•

Association of Southeast Asian Nations (ASEAN): [1967) 10 n1e1n ber countries in SE Asia

•

Con11non Market of Eastern and Southern Africa (COMESA):

I 1993) 19 n1en1ber countries in East and South Africa

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WORLD TRADE ORGANIZATION

These regional trade agreements, and 1nany n1ore, are monitored by the v\/orld Trade Organization (WTO). "The \ \f\Torld Trade Organization. (2016). Retrieved from bttps:/"VW\v.,vto.org/ 4 U.S. Customs and Border Protection. (2016). Retrieved from https:/"""'""·cbp.gov/about 5 U.S. Depart1nent ofH01neland Security. (2016). Retrieved fro1n https:/"""'""·dhs.gov/history 6 Ferdows, K. (1997). Making the n1ost of foreign factories. Harvard Busi11ess Review (March-April), 73-88. Retrieved fron1 hit ps://hbr.org/ 1997/03/ making-t he-most-of-foreign-factories ' US Custo1ns and Border Protection. (n.d.). hnporting into the United States, A guide for com1nercial ilnporters. Retrieved fron1 https://W\vv.•.cbp.gov/sites/default/files/ .. ./hnporting%20 into%20the%20 U.S. pdf 8 § 734.13 EXPORT, Export Administration Regulations, Bureau of Industry and Security, September 2016, page 10, retrieved fro1n https://,,"vw.bis.doc.gov/index.php/docwnents/regulation-d ocs/412-part-734-scope-of-the-export-adn1inistration-regulations/file) 330

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

Customer Relationship Management CHAPTER OUTLINE Introduction Why Do Companies Need (RM? Goals and Benefits of CRM Focus on Strategically Significant Customers CRM limitations Building and Maintaining long-TermRelationships Being Successful Key Components of CRM Managing Customer Service Customer Service-Transaction Elements Customer Service and the l ogistics Function Call Centers Additional Components of CRM Six Steps to aSuccessful CRM Program Current Trends in CRM Summary 331

INTRODUCTION

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Customer relationship management (CRM) is the transforn1ation of the people, processes, and technology required to becorne a customer-centric organization; a philosophy of putting the custo1ner first. It involves acquiring, retaining, and partnering v.•ith selective custo1ners to create superior value for both the co1npany and the custo1ner. CRi.\1 is about building and 1naintaining profitable long-term customer relationships beyond the one-off buy and sell transaction. It provides a 111eans and a method to enhance the experience of individual custo1ners so that they \\fill ren1ain custo1ners for life.

WHY DO COMPANIES NEED CRM?

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Co1npanies need a CRM progran1 in order to ( l) acquire ne\" custo1ners, and 1naybe even ..., more ilnportantly, (2) to retain their existmg custon1ers. Loyal customers are the source of '-I rnost profits, and a relatively srnall percent'-/\ , 1 age of tl1ose custorners n1ay generate 1nost of the profits for the co1npany. Co1npanies can expect to lose approximately 50% of their ---. ~ custo1ners every five years (Reich held, 1996}, -' ~ so any effort to slo,_. the rate of defection ,_.ill -~\ gro,\• the customer base. Satisfied customers tell others about their experiences; unfortu,r. nately, so do dissatisfied custon1ers, " 'ho tell others about tl1eir experiences to an even greater extent. It typically costs five to ten tilnes n1ore to acquire a ne,_. custon1er, ,vhile the 1narketmg costs and efforts are relatively low for retainmg existing customers. "In general, the longer a customer stays ,vith a cornpany, the 1nore that custo1ner is \vorth. Long-tern1 customers buy more, take less of a cornpany's tirne, are less sensitive to price, and bring in ne,v custorners. Best of all, they have no acquisition or start-up cost. Good long-standmg custon1ers are ,vorth so n1uch that in son1e industries, reducing customer defections by as little as five points-from, say, 15% to 10% per year-can double profits" (Reichheld, 1996).

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Additionally, a CRM program \viii help con1panies n1eet the changing expectations of customers in general due to aspects such as social and demographic factors, econornic situations, con1petitor's products and rnarketing efforts, and other 1narket experiences.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

I ~

@

GOALS AND BENEFITS OF CRM

••••••••••••••••••••••••••••••••••••••••••••••

You must have a clear set of goals in order to get the most fro111 your CRM program. Making customer satisfaction the printary goal of the CRM program is the best ,vay to irnprove the bottom Ii ne. A successful well-designed CRM program can provide companies with many in1provements and benefits. Some of the 1nost irnportant are: 1. increased customer salisfact ion

2. increased customer loyalty and retention by offering value and service to encourage repeat business; con1peting on the service experience in addition to price 3. Better custon1er service and faster responses to customer inquiries 4. increased custo1ner revenue 5. Gro,vth of the custon1er base through referrals 6. A simplified and 1nore cost-effective marketing and sales process 7. increase sales effectiveness; closing sales faster 8. increased sales through cross-selling, and/or up-selling 9. Access to updated custo1ner infonnation in a centralized location and personalized custo1ner interactions l 0. Auton1ation of repetitive tasks

FOCUS ON STRATEGICALLY SIGNIFICANT CUSTOMERS ................. Not all 1narkets and custo1ners are equally irnportant. Relationships should be built " 'ith strategically significant custon1ers that are likely to provide the 111ost value for the effort. Building relationships ,vith custon1ers that provide little value can be counterproductive.

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Strategically significant custon1ers fall into one or more of the following categories: •

Custon1ers with high lifetilne value (i.e., custon1ers that \viii constantly buy the product[s) or use the service[s) in the long-term)

•

Customers who serve as role 1nodels or benclunarks for oilier custo1ners

•

Custo1ners ,vho inspire change iI1 tl1e supplier and/or the supply chain

Co1npanies should pursue developing and building custo1ner relationships \\•itl1 custo1ners "'ho n1eet any of ilie abovementioned criteria.

CRM LIMITATIONS

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CRM is not feasible for every 1narket and every custon1er. Son1e custo1ners don't ,vant to be co111mitted to every brand and/or relationship. CRM is not practical for lo,v-involvement, routine purchasing in B2B or B2C situations. Son1e n1arkets/ custon1ers n1ay have lo,v "personalization potential:' Therefore, as noted, con1panies should only focus their CRM progra1n on strategically significant custo1ners.

BUILDING AND MAINTAINING LONG-TERM RELATIONSHIPS

•••••

Of all the components of supply chain n1anage1nent, building and maintaining profitable long-term custo1ner relationships is one of the n1ost critical considering tl1e fact that a co1npany produces products and/or services to sell, and tl1erefore, requires custo1ners ,vho " 'ant to buy iliose products and/or services. The long-term retention of those custon1ers is a critical issue, ,vhich n1ust be confronted by every organization that provides a product or service. \.Vhen considering the '\vhat" and the "ho\v" of CRM, the lirst in1portant issue to focus on is," \~fhat are the custo1ner's requiren1ents for delivering products and services in a tnanner resulting in a high level of custon1er satisfaction?" Custotner ex11ectations have been and are likely to contmue rising for the foreseeable future, which i11 turn drives the need for custon1er satisfaction efforts to go well beyond just the actual on-time delivery and best price. Companies like Amazon help to fuel the 334

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

escalation in customer expectations and shape customer satisfaction, because they can be thought of as "supply chain disruptors;' continuing to chaHenge the norms and push against the traditional boundaries of the supply chain-setting the bar ever higher. The "ho\v" in CRM starts \.\rith talking to the customer, and even 1nore importantly is supported by listening to the custon1er. Co1npanies ,von't be able to find out ,vhat custo1ners \Vant unless tl1ey co1nn1unicate ,-.rith thetn. They 1nay choose to interact ,vith custo1ners directly or indirectly, or botli. Companies can speak directly with custo1ners in person or through a phone interview. Some companies may decide to conduct focus groups where s1nall sets of custon1ers are brought in and asked a series of questions to get tl1eir input and feedback. Co1npanies rnay also opt to interact \.\•itl1 custorners indirectly by sending out a 1nail or electronic survey. Each of these con1n1w1ication n1etliods has its pros and cons. Understanding custo1ner behaviors and their requirements is not just about collecting initial data and information; you have to collect that data over the long term, because as the market evolves and the business environ1nent changes, customer behaviors and requiren1ents change over tin1e as ,vell. It is in1portant to analyze the data and infonnation for trends. If you create a product or service and the associated support functions to satisfy customers today and allo,v it to stagnate, you may find out tl1at some\.\•here in the not too distant future, your customers are no longer satisfied. CRN1 is an iterative and ongoing process, not a one-off exercise that you cornplete and put on tl1e shelf. All ele1nents of CRM should be considered fluid.

BEING SUCCESSFUL ............................................................... . A CRM progran1 is both sirnple and con1plex. It is sin1ple in that it involves training users in treating customers right, to 1nake them feel valued. It is con1plex in that it also n1eans finding affordable ,vays to identify (potentially thousands if not 1nillions of) custorners and their needs, and then designing customer contact strategies geared to,vard creating custorner satisfaction and loyalty a1nong seg1nents of custorners. If you as the custo111er are satisfied with the product, the service, the treatment that you received from tl1at supplier, you are likely to cotne back over and over again as a custon1er. Therefore, you becon1e 1nore valuable to tl1at business.

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It has been well docun1ented by several significant advertising agencies that one satisfied customer will tell at least five other people of the experience, whereas a dissatisfied customer in turn " 'ill tell 50 people about a bad experience. To be successful, a co1npany rnust find " 'ays to n1eet its custorner's needs; othenvise, just as any finn ,vould react ,vith a nonperfonning supplier, the custo1ner goes else,vhere and takes years' \\•orth of future purchases along. Just as co1upanies n1ust create methods for finding and developing good suppliers, companies 1nust also create methods for becoming and staying a good supplier them selves. Co1npanies should evaluate then1selves fron1 their custon1er's perspective, as a supplier. In that light, you are the supplier to your custon1ers and you need to do all the san1e things for your custon1ers that you require and expect from your suppliers, if you ,vant to be considered a topquality, preferred supplier to your customers. Because many companies do not sell their products directly to the end consumer, companies may also need to train and certify that their intern1ediate custon1ers are able to adequately represent their con1pany's products. If a con1pany sells their products through a ,,,holesaler, distributor, or retailer, then those entities are representing the co1npany and their products in the n1arketplace. If they do not do the job adequately or appropriately, it ,viii have a negative in1pact on the company. It is the rnanufacturing con1pany's nan1e on the product and their reputation at stake. Therefore, it is in the con1pany's best interest to ensure that any do,vnstrean1 supply chain partners are appropriately infonned, trained, and incentivized as necessary to ensure good custon1er service is provided and custon,er satisfaction is achieved.

KEY COMPONENTS OF CRM

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For a CRM progran1 to be effective there are a number of components that n1ust be developed and ilnple1nented as part of the progran1. The key components of a CRM progra1n are outlined as follo,vs: •

PREDICTING

CUSTOMER

BEH AVIORS: If a con1pany is

in the business of selling products and/or services to custon1ers, they can also collect inforn1ation from these customers' buying history, preferences, and trends, ,,,hich could then be used to predict customer buying behaviors going for\\•ard. This inforn1ation could also be used to detennine ho,v effective 1nar-

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

keting efforts, advertising and pron1otions, and so forth, have been in the past, and ,vhether these practices should be continued or altered for the future. This predictive infonnation could be used by the con1pany to potentially create a 1nore accurate forecast and a n1ore effective 1narketing and sales budget. The current trend is to use predictive custon1er behavior 1nodeling techniques, instead of just looking at historical data. These n1odels use a n1athen1atical construct to represent the common behaviors observed an1ong seg1nents of customers in order to predict ho,v si1nilar customers ,viii behave under si1nilar circu1nstances. The 1nodels are typically based on custo1ner data1nining, and each n1odel is designed to ansl>l•er one question at one point in tinie. If a n1odel can be used to predict what a segn1ent of custon1ers l>l•ill do in response to a particular marketing action, then the co1npany should see that 1nost of the customers in the segment responded as predicted by the 1nodel. •

PERSONA LIZING CuSTOl\1ER COMMUN ICATIONS: Effective n1arketing that 1nakes an i1n-

pact on the custo1ner is crucial to business success, but 1narketing is n1ore than just advertising the co111pany's products and services. It is about 111eeting the needs and expectations of custon1ers through focused, personalized communications. A proven and effective approach involves ensuring that custon1ers feel that their preferences and needs are being taken into consideration ,vhen they interact ,vith a co1npany. When a co1npany co111111w1icates ,vith their custon1ers they need to use the customer's "language" and co111municate ,vith then1 in a meaningful ,vay. Conununication that is personalized sends a 1nessage to the custo1ner that the con1pany cares about the customer. It is a po,verful l>l•ay to differentiate the co1npany fron1 its co1npetitors and it helps to build custon1er loyalty. In today's business environment, custo1ners expect businesses to understand their needs and provide relevant and desirable information. They tend to apply the san1e principles ,vhen evaluating a business relationship as they do l>l•hen evaluating a personal relationship. If the interaction is pleasing, engaging, and satisfying, then there's a good d1ance they'll build on that relationship through future interactions. TI1e goal is to reach custon1ers on an emotional level so that they feel a genuine personal connection ,vith the co1npany and their products and services, like a friendship. Once custon1ers are co1nfortable in the relationship, they tend to re1nain loyal and even recommend others to the brand. Considering today's technology and the use of the internet in the buying habits of people through catalogs, etc., it is easy to track ho,v custo1ners navigate a website and the types of things they buy.

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"Clickstream" is one way to do that. It is a method to track the parts of the computer screen a user clicks on .vhile web browsing. It can help a company tailor a ,vebsite's irnages, ads, or discounts based on past usage of the site. This type of process allo,vs an organization to personalize its conununications to the various custon1ers not only to categorize the buying habits of customers in what they buy, but also when they buy, and at ,vhat price levels they buy. •

CUSTOMER SEGMENTATION: "The practice of dividing a customer base into groups of indi-

viduals that are sin,ilar in specific "'ays relevant to ,narketing. Traditional segmentation focuses on identifying custon1er groups based on dernographics and attributes such as attitude and psycllological profiles:•• In sin1ple tern1s, it is grouping custo,uers to create specialized conuuunications about products. There are n1any different ways to group custon1ers (by demographics, incorne, geography, buying preferences, etc.). Segrnenting customers allo,,•s a con1pany to 1..ero in on a particular population of custon1ers to sell a specific product, or to define a specific product(s) for a particular seginent of custon1ers. If a con1pany can identify different segn1ents of customers, it can potentially be n1ore efficient and effective in the use of its resources by tailoring progran1s and initiatives for each seg1nent. •

TARGET MARKETING: A target n,arket is a segment of customers to\\•ard ,vhich a company

has decided to ai.Jn its rnarketing efforts and ulti1nately its products and/or services. A ,velldefined target n1arket is the first ele111ent of any n1arketi.J1g strategy. Target 111arketing is the process of pron1oting products and services via media that are likely to reach the potential target 1narket (i.e., customer segn,ent), by building a rnarketing strategy ain,ed at that specific customer seg1nent. It is usually rnuch n1ore effective than rnass rnarketing, ,vhid1 tends not to focus too deeply on the qualities, preferences, or characteristics of the custon1er, and allo",s the co,upany to focus efforts on marketing to those customers n1ost likely to respond. Generally, it is a more efficient use of the con1pany's resources and it reduces the chances of being a nuisance to those potential custon1ers ,,,ho do not fit the targeted criteria (i.e., the "\\•rong" custo1ner seg111ent). •

EVENT-BASED

MARKETING:

Event-based rnarketing is a forn1 of 1narketing that identifies key events in the custorner and business lifecycle. \"/hen an event occurs a custo1ner specific 111arketing activity is undertaken. An event can be sornething basic and predicted, like the end of a contract, a holiday, a season, or something 111ore detailed and personal, like a birthday, a n,ar-

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

riage, or a graduation. Event-based marketing is a n1ore personalized form of marketing, ,vhich can help to fonn personal connections ,vith the custon1ers. A great event-based rnarketing strategy allo,vs you to respond to yow· custorners at precisely the right 1110111ent. It can irnprove brand recognition and drive profits quickly and efficiently. Many con1pany n1arketing progran1s are tied to specific annual events (e.g., Memorial Day, Fourth of July, Hallo"•een, Black Friday, Cyber Monday, Christrnas). l\ifany cornpanies also generate a significant arnount of their annual revenue associated with these events. Cornpanies such as Toys 'R Us n1ake n1ore than 50% of their annual sales in just the six " 'eeks leading up to Christmas. •

CROSS-SELLING AND UP-SELLING CROSS-SELLING; I ain sure that at

so1ue pomt we have all heard the fa- • n1ous cross-sellmg phrase, "Vvould you like fries "rith that?" Cross-selling occw·s "'hen a compai1y sells an additional related or coruplementary product(s) or service(s) to an existing custorner after the initial purchase. Exarnple: If you're buying an iten1 on Atuazon.com, you may be sho,vn other similar items to the one you are looking at, or con1pai1ion products to the itern that you are considering. Cross-sellir1g cai1 occtu in a nun1ber of different ,vays. It can be blatant as ir1 the exa1nples above or it can be subtle as occurs ill s01ne stores. Exan1ples: If you go to a grocery store to buy ,vaflles or pancake ntlx, you n1ay see the syrup on the shelf right next to it. If you go to a grocery store to buy coffee, you n1ay see coffee filters, coffee creainer, stirrers, cups, and other related iterus ir1 the sa1ne general area next to the coffee. On the one hand, it is a convenience to you because you may in fact have intended to buy sorne or all of those items anY'vay, but on the other hand it is still a fonn of cross-sellmg. UP-SELLING: You rnay have also heai·d the co1n-

n1on up-selling phrase, "\lvould you like to super-size your order?" Up-sellir1g involves persuading a custorner to buy a rnore expensive iten1 or upgrade a product or service to rnake the sale 1nore profitable. It also mvolves sellir1g the customer extra features or add-ons to the product he or she is already buying or considering. Incentives are crucial eJ~\J>kt 11: Customer Relationship Management

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features of up-selling, because incentives such as discounts or free shipping give the customer good reasons to purchase something extra right a\vay. Not atte1npting to cross-sell or up -seU" 1hen the customer is already in a buying frame of mind is a ,vasted opportunity.

•

RELATIONSHIP OR PERl\11SSION MARKETING: Relationship or pern1ission marketing is an approach to selling products and services in which a custon1er explicitly agrees in advance to receive marketing infonnation. Exan1ple: An "opt-in" e-111ail, \,,here a potential custon1er signs up in advance for infonnation about certain products or services. The customer is giving pennission to the con1pany to provide thern witl1 n1arketing and sales inforn1ation. Pern1ission rnarketing is about building an ongoing relationship of increasing depth ,vitl1 custon1ers. According to Seth Godin (,vho coined the tenn), "pern1ission 111arketing is the privilege (not the right) of delivering anticipated, personal, and relevant n1essages to people who actually want thern:' Pennission rnarketing does not typically create i1nn1ediate sales, but ratl1er grabs a custon1er's attention and preserves a business relationship. If you've ever accessed a \\1ebsite to buy son1etl1ing, you n1ay have been requested to set up an account. You enter yow· infonnation and son1e,vhere, probably near the botton1, there is likely a little checkbox that asks your pennission for the con1J>any to send you additional information, advertising, promotions, and the like, going forward. You can self-select in or out of that particular pern1ission rnarketing prograrn. Usually the box is already checked, and if you don't "'ant to give pennission, you can uncheck the box and self-select out of that n1arketing program. So1ne companies may also silnultaneously or separately ask for your permission for their partner organizations to send you advertising and prornotional information, and you can again self-select in or out of that 1narketi11g prograrn as ,veil. These exainples are typical of ho,v you can opt-in or opt-out of pennission 111arketing programs. Another " 'ay 1night be for you to choose to use a QR code displayed on a product or on company advertising n1aterials, to voluntarily find out more about the cornpany or a particular product or service by using your sn1artphone and the internet. In tl1at situation you are actively indicating that you ,vant to find out more mformation, and you are using a n1echanism that the company provided to self-select into (i.e., give your permission for) that marketing program.

•

CusTOMER DEFECTION ANALYSIS AND CHURN REDUCTION:

Custon1er Defection

Analysis is the process of analyzing the custorners ,vho have stopped buying to detennine ,vhy. Churn is the process of custo1ners d1anging their buying preferences because they find better and/or cheaper products and services elsewhere, and Churn Reduction is all of the efforts companies develop to stop losing custorners to the competition. Customer defection analysis and churn reduction go hand in hand. It's irnportant to detern1ine \\1hy custon1ers leave a11d then finding v.rays to retain thern. 340

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

What is causing your custon1ers to defect to your con1pelitor? ls ii because they don't like the quality of your product? Is your price too high? Is there son1e other service not being offered? Are you having shortages? Detennining the root cause of your custo1ner defections and then working to resolve those issues will help you retain custon1ers. You've already spent tilue and 1uoney identifyi11g custo1uers and getting the1n to buy. One of the worst thmgs that can happen is to lose them as a customer. If you lose customers, you have to go out and replace then, to stay in business. Replacing customers costs a lot of money. Finding a nev,. custon1er costs on average five tin1es as 1nuch as keeping an existing custon1er. You have to spend 1nore 1noney going out and identifying ne\v custo1uers and then gettil1g those new customers to buy fron1 you. According to Harvard Business Review (2006), a 5% improvement in customer retention can result in a 75% increase in profits. ·n1e more customers you can retain, the greater the profitability you "'ill have as a result. •

CUSTOMER VALUE DETERMINATION: Detern1ining the custorner lifetin1e value is vital, so

that appropriate con1111w1ications, benefits, services, or policies can be established for each custon1er seg1nent. CUSTOMER LIFETIME VALUE (CLV) is a prediction of the net profit attributed to the entire

future relationship \Yith a particular cus1on1er. Son1e customers are \VOrth a lot n1ore than others, and identifying your key or top-tier customers can be extrernely valuable to your business. CLV is an ilnportant rnetric for detenuining ho\Y n1uch n1oney a company is ,villi11g to spend on acquiring ne\v customers and hO\V much repeat business a cornpany can ex-pect fron1 particular custon1ers. The CLV can affect n1any different areas of the busmess, because it emphasizes efficient spendi11g to maximize custon1er acquisition and retention practices.

MANAGING CUSTOMER SERVICE .............................................. . What is customer service? ll can have multiple meanings even ,vithin the san1e organization. Generally, custo111er service is vie,ved in three different ,vays: •

CUSTOMER SERVICE AS A PHILOSOPHY: Customer service is a con,pany-,vide comn,it-

ment to providing custorner satisfaction through superior custo1ner service by placing en1phasis on quality and quality n1anagernent.

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•

CUSTOMER SERVICE AS AN ACTIVITY: Customer service is a particular task that a firn1

1nust accon1plish to satisfy the customer's needs. Order processing, billing and invoicing, product returns, and clai1ns handling are all typical exainples of the custo1ner service activity. •

CUSTOMER SERVICE AS PERFORMANCE MEASURES: Customer service is a category of

perfonnance 1neasures, such as the percentage of orders delivered on ti1ne a11d con1plete, ai1d the nun1ber of orders processed \\•ithin acceptable tin1e llinits. For our purposes in CRM, \Ve \\•ill define custo1ner service as the process of ensuring custon1er satisfaction with a product or service. Often, customer service takes place \vhile perfornung a transaction for the custon1er, such as making a sale or returning an item. lt is the act of taking care of the custorner's needs by providing and delivering professional, high -quality service before, during, and after the custon1er's require111ents are 1net. Custo1ner service perfonnance 1neasurernents are designed around the "Seven Rights Rule": 1.

Right product

2. Right quantity 3.

Right quality

4.

Right place

5.

Right time

6. Right customer 7. Right costs 8.

Right documentation

A ne,\•er custon1er service trend is to add on one n1ore right, the Right docun1entation, ,vhicl1 includes elen1ents such as the right labeling, infonnation, returns instructions, and invoice. This, combined with the other seven rights, is con1monly referred to as the "perfect order'.' lf a company can deliver on all eight rights, then it's creating the perfect order. Everything that the custon1er \VaJ1ts and everything that you as a supplier \\•ant to deliver is encon1passed in the perfect order. Con1panies that can do this consistently are dee1ned to be providing excellent custo111er service. These kinds of services only con1e at a significant cost, ,vith a lot of planning, careful imple1nentation, and appropriate and proper training of all personnel involved. 342

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

CUSTOMER SERVICE-TRANSACTION ELEMENTS

•••••••••••••••••••••

When you complete a sales transaction, there are three different ele1nents that you n1ust consider as part of the transaction; the pre-transaction, the actual transaction itself, and the post transaction. Each element involves different aspects of customer service. •

PRE-TRANSACTION ELEMENTS: These are

ele1nents of the sales transaction that precede the sale, and include such things as the custon1er service policies, the co1npany's 1nission staten1ent, organizational structure, and systen1 / flexibility. Before any customer service can take place, the organization 1nust first define its custon1er service policies. Organizations should have nlission, vision, and value staten1ents, and it is from these that its customer service policies are derived. TI1e infrastructure (i.e., people, process, and technology) to support a company's sales n1ust also be in place prior to tl1e sales transaction to achieve ilie con1pany's custo111er service goals. As wiili other aspects of the CRil1 progra111, this is not a one-off exercise. Organizations change and so do the needs, desires, and trends of the custon,er con1munity. Therefore, all processes, custo,ner service policies, and the syste111s that deliver custo1ner service have to be designed and itnple1nented ,vith flexibility it1 1nind to acconunodate Ulose changes as and when they occur.

Ji

'JI

•

TRANSACTION ELEMENTS: These are elen1ents of the sales transaction iliat occur during ilie

sale, and include such things as the order lead tin1e, order processing capabilities, and the distribution syste1n accuracy. It is during t11e actual sales transaction ,vhere the Seven Rights Rule outlined above is really ituple1nented and n1easured. Noiliing \\•ill destroy custo111er satisfaction faster than custo111ers finding out that iliey cannot get ilieir order(s) satisfied in an agreed upon length of tune, or finding out that their order(s) " 'as not filled accurately. Example: A customer identifies a specific item in the co111pany catalog that spells out color, size, and ite1n number, and then places an order. When Ule ite111 is delivered tl1e custo111er discovers that is tl1e ,vrong color and the wrong size. The ite111 nu111ber ·was correct on both ilie shipping label and in the catalog, but the item ,vas improperly picked fron, stock, packaged, and shipped inaccurately. •

P OST-TRANSACTION ELEMENTS: These are elements of the sales transaction that occur afte1:

the sale, and include such things as "'arranty repair capabilities, con,plaint resolution, product returns, and operatit1g infonnation. In tl1e age of e-co1runerce, post-transaction ele111ents are eJ~\J>kt 11: Customer Relationship Management

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beco1ning an even n1ore in1portant part of the CRM process. They must be carefully defined by the cornpany ,vith appropriate instructions for both the custon1er to understand at the time of the sale, and for the custorner representatives '"ithin the con1pany to w1derstand at the tirne the custo111er contacts the con1pany about an issue. Hiring of appropriate staff and proper training are key clernents in the success of post-transaction issues. A customer service representative has to be able to n1ake judgn1ent calls as to the level of service to be provided. There are ti1nes ,vhen an ilern may be out of \\•arrant)' by only a short tin1e and the custon1er service representative has to rnake a decision as to '"hether to accept or deny the custon1er's request for '"arranty. These types of decisions and interactions "'ill have a significant iinpact on the long-term relationship ,vith the customer.

CUSTOMER SERVICE AND THE LOGISTICS FUNCTION

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Fron1 the point of vie,v of the supply cham rnanagen1ent/logistics function, custorner service can be described as having four traditional diinensions: time, dependability, con1munications, and convenience:

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TIME: Fron1 the co1npany/seller's perspective, the tin1e diinension is the order cycle tin1e. Fron1 the customer/buyer's perspective, the time din1ension is the lead time, or replenishment time.

•

DEPENDABILITY: Dependability can be 111ore important than lead ti1ne. The custon1er can potentially ntinintiie its inventory levels if lead time is fixed and kno,vn. Cycle tilne: A seller that can assure the buyer of a specific lead tune. can differentiate the company and its product(s) from its competitors. A seller that offers a dependable lead ti111e allo,vs the buyer to 111ini111ize the total cost of inventory, stockouts, order processing, and production scheduling. -

Safe delivery: If products arrive dan1aged or are lost, the custon1er cannot use the products as mtended. A ship1nent containing da1naged products aggravates several custo1ner cost centers (e.g., inventory, production, and 111arketing) and negatively in1pacts the long-term relationship. Correct orders: An in1properly filled order forces the custon1er to reorder, assunling that the custo1ner is not angry enough to buy from another supplier. If a custon1er '"ho is an intennediary in the distribution channel experiences a stockout, the stockout cost also d.irectly affects the seller.

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COMMUNICATIONS: The tv.•o logistics activities vital to order-filling are the conununication of custon1er order infonnation to the order-filling function and the actual process of picking

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the iten1s ordered from inventory. ln the order information stage, the use of EDl or internetenabled comrnunications can reduce errors in transferring order information from the order to the ,varehouse receipt. •

Convenience is another ,vay of saying that the logistics service level rnust be flexible. Basically, logistics require1nents differ ",ith regard to packaging, the ,node of transportation, the carrier the custon1er requires, routing, and delivery times. CONVENIENCE:

CALL CENTERS ...................................................................... A Call Center is "a facility housing personnel " 'ho respond to custon1er phone queries. These personnel ,nay provide custo1ner service or technical support. Call center services 1nay be in-house or outsourced:'• A call center links a customer and an organization together. It gives custorners quick access to the inforrnation they ,vant and enhances the custo,ner-to-business relationship. Call centers have helped 1nost organizations focus on growing their business and concentrating on custorner building. TI1ey can eli,ninate the need to hire and train ne,v staff 1ne1nbers to provide customer support, and thereby save money as ,vell. Call centers help to continuously 1nonitor different custorner service para,neters in an effort to gauge performance and ulti.Jnately i.Jnprove quality and efficiency. Maybe most importantly, by utilizing a call center, the company's internal resources can be freed up to focus on the co1npany's core competencies. Call centers have becon1e a significant part of the CRM program in many companies. A call center can actually handle a nun1ber of different activities/tasks. TI1ey handle basic tasks like answering custon1er's inquiries and resolving custon1er's issues. They can also categorize the calls (placing orders, information, complaint, question, request for repair, etc.). Data collected by the call center can be used to detennine such things as ho"' long it takes to answer a call, how long it takes to resolve an issue, or to track the type and frequency of issues or eJ~\J>kt 11: Customer Relationship Management

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inqu1nes. Call centers can use inforn1ation collected to help determine the root cause of issues that ,night be occurring on a frequent basis. A properly designed database for gathering the information fron1 a call center can support dernand forecasting for future sales as \veil as rnanufacturing requirements and resource allocations. If they are well set up and n1anaged, call centers can increase custorner satisfaction levels. One of the most successful custo1ner service call centers is that of the Lands' End Company, \\•here customer service satisfaction levels over the ye.ars have been among the highest in the country. They can also decrease custorner satisfaction levels if you don't do then1 \Yell. As positive as good custorner satisfaction can be, equally bad custon1er service can dearly destroy a con1pany's reputation even faster. In today's business \vorld, the internet has provided an imlnediate source for customers to not only complain but to tell the world through social rnedia ho,v bad service \Vas in a given situation ,vith any company. '"TI1ere's nothing \Vorse than calling your service provider and finding out you k.r10"' rnore than the person on the other end of the line:• said Neil Arn1st:rong, 1narketing director at UK broadband service provider PlusNet.

ADDITIONAL COMPONENS OF CRM

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Measuring Customer Satisfaction Measuring customer satisfaction is about custorners being given opportunities to provide feedback about product(s), service(s), the organization, and so forth. Depending on the types of products and services offered, there is potentially a significant a1nount of infonnation to be captured and analyzed. This can be done through surveys, questionnaires, and in n1any cases direct phone calls to custorners asking thern their opinions on the service they have been provided. Most cornpanies will need son1e type of a database to 1nanage the data. Decisions have to be n1ade regarding ho\,, to capture the data, and ho"' to analyze the information so you can use it productively going fonvard. It is of very little value until it can be analyzed and acted upon.

Website Self-Service \,Vebsites act as support 111echanis111s for call centers. Many companies provide these portals for custon1ers to be able to access their account information, check operating hours, ask questions, see product information, find contact information, check on placed orders, and get shipping inforn1ation. Custorners can not only access this information but in son1e cases, edit and rnodify the information accordingly. Customers can put their o,,rn customer inforn1ation into the systen1, to save on company lin1e and to potentially elinlinate errors. These sites also aUO\\' for customers to opt out of future e1nails and infonnation they ,nay not \\rish to receive, and conversely, it allo\\•s the custon1er to access or opt into future sales, subscriptions, and corporate infonnation if desired.

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Field Service Management Field service management involves setting up the company operations to allo\\• customers to interact directly with the con1pany's service personnel. Custo1ners can call the service people directly and 111ake an appointn1ent v,ith the service person to con1e out to service the product. Because custon1ers are co1nmunicating directly ·with product specialists for service issues, it is n1ore likely that ilie right diagnosis can be made quickly, ,vhich \\•ill help to ensure custo1ner satisfaction.

Sales Force Automation Sales force auto1nation (SFA) tools are used for docun1enting field activities, and keeping track and managing ,vhat your sales force is doing in the field. These tools provide conununication \\•ith the horne office, and facilitate retrieving sa.les history out in the field. Depending on the type of product or service, the co1npany 1nay have a huge sales force. TI1ere are 1nany different tools and 1nechanisms that 1nanagen1ent can use to 1nanage a sales force. The follo,ving are a fe,\• exan1ples:

SALES ACTIVITY MANAG El\1ENT: Tools that offer sales reps a guided sequence of sales activities, in addition to the fact that it provides a step,vise approach on ho,v to sell ilie con1pany's products and/or services. lf there is a series of sales activities that the sales reps have to go through, the tool can help to make sure sales reps take all tl1e steps that are appropriate, including docu1nentation. It can also be used to capture ne,\• buying habits fro1n a custo111er, ne,v custon1er contact infonnation, ne"' location infonnation, or ne"' phone nun1bers. SALES ToRRITORY MANAGEMENT: T ools used by sales 111anagers to obtain inforn1ation on each sales rep's activities. These tools identify which sales reps are productive and ,vhich ones are not in tern1s of generating sales, ho"' n1any sales calls they n1ake per day/\veek/month, " 'hether they distributed the sales and product inforn1ation they ,vere supposed to leave, ,vhether they scheduled a follow-up appoint111ent, and so forth. All that infonuation can be captw·ed and used by sales 1nanagers or district 1nanagers to manage the sales force. lf there is a certain segment of customers that are not being adequately covered, sales 1nanagers can use this information to redirect some of tl1e sales force to iliat custo111er segrnent. LEAD MANAGEMENT: A technique used to help sales reps folio\\• some specific tactics that ,viii help then1 close the deal. Exa111ple: lfyou are trying to sell a particular conunodity and the custorner is not ready to n1ake a buying decision, what techniques have " 'Orked in sin1ilar situations in the past which the sales reps could use to try and close the deal? Do they offer the custon1er free delivery, extended financing, a discount? TI1ere 1nay be 111any tactics or activities tl1at a sales rep could use to try to close a sale and these n1ay vary by custon1er seg111ents. Understanding ,vhat iliose tactics are

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and what tactics work on which customer segn1ents is all part of lead managen1ent. This could be a significant a1nount of inforrnation to 1nanage and a tool and database 1nay be needed to be able to provide that infonnation to your sales force.

KNOWLEDGE MANAGEJ\1ENT: It is basically a database and sofuvare tool to n1anage all of the above, plus 111ore. This is could be a significant ainount of inforn1ation about your custo111ers, your con1pany's sales policy, ,varranty inforn1ation, even things like expense reimbursen1ent. A company may have several different types of solhvare packages that need to be integrated. A kno"•ledge 1nanagen1ent tool ,vill help to do this, so sales reps and 1nanagen1ent can have i111n1ediate access to all that infonnation. A tool that enables quick decision n1aking, better customer service, alld a better-equipped and happy sales staff makes for a much more effective and satisfied sales team.

SIX STEPS TO ASUCCESSFUL CRM PROGRAM

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Step 1: Creating the CRM Plan TI1e first step to a successful CRM progra111 is to create the CRM plan itself; that is, do all of the planning. It's important to address the follov.•ing questions: What are the objectives of the progra1n? \,\That an1 I trying to achieve? Does it lit with my corporate strategy? It is i1nportant for the plan to have flexibility because the market and the custon1er ,vorld will change periodically based on the den1ographics, the nature of the product, the time of year, and so forth. The plan should consider that the CRM progra1n will likely need so1ne type of sofnvare application(s) to help n,anage the program and all the infonnation. TI1e soft"•are tools ,viii have to be identified, purchased, developed, ai1d i1nple111ented. TI1is n1ay also require that the con1paJ1y's legacy syste1ns are integrated or replaced. It is not unusual for the technology currently being used to change frequently and require upgrades and modifications to 1neet the needs of an evolving CRM program. The CR.i\1 progra1n, process, policies, and tools should be revie"•ed on a regular basis and upgraded based on changes to product service requiren1ents, \varranties, guarantees, and how these should be 1nanaged by a CRM staff.

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FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

To implen1en1 a CRM progran1 an organization has to understand that there are costs involved in hiring the right people, and that it \viii take time to train and prepare staff for CRM positions. Equally, it ,vill take tilne for itnple1nentation of any new syste1n(s) and upgrades along \\•ith educating ne"' employees on CRM practices, policies, and procedures.

Step 2: Involve CRM Users from the Onset The second step is to involve the people "'ho are actually going to be \\•orking \\•ith the CRM syste1n(s) right fro1n the very beginning. It actually n1ight create a lot of controversy ,vithin the con1pany if you set up a CRM progra1n and people are not a,vare of ho\v ii could impact their jobs. They may feel threatened and there ,,,ill likely be some resistance. Gelling the people who are actually going to be ,.,,orking ,vilh CRM system(s) involved ,vill help in several ways: a.

'They have the most information and this ,vill n1os1 likely help you set up a better system.

b. They will potentially fe.el less threatened because they ,viii understand n1ore about ,vhat's happening directly. c.

They will start to take ownership. They will feel it is their sys1en1 that is being in1plen1ented, not so1nething being imposed on then1.

d. You will get some early buy-in upfront and potentially need less training later on. Many co1npanies will do a pilot or test before doing a full in1plen1entation. They don't ,vant to expose the entire company, their entire product line, or all their customers to a new process or untested systern, so they do a srnall test to rnake sure everything ,vorks before they rnove on to e>.i>and it to all their products in their portfolio.

Step 3: Select the Right Application and Provider The third step is selecting the right application and the right provider. ·n1ere are lots of different potential applications and sofuvare packages out there to pick frorn. You ,viii have to find an appropriate application and deternune the extent of custo111ization. Son1e of the best ,vays to get information on \\•hat is available, and to begin the evaluation process, is to visit tradesho,vs, read literature, and/ or hire a consultant. It 1nay be ,vise to have a co1npany team of cross-functional individuals help define not only the require1nents for a CR11 prog:ran1, but also to ,vork as a focus group iI1 finding an application that will satisfy the requirements as defined by that focus group. Then identify the potential alternatives out there and do some comparisons based on ho"' "'ell the system performs,

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security, reporting, capabilities, and systen1 availability, before n1aking a final decision to purchase and in1ple1nent.

Step 4: Integrate Existing CRM Applications The fourth step is integrating any existing CRM systen1s. This can be a n1ajor tune-consuming undertaking. CRM is generally a collection of various applications implen1ented over time, both ne,v and legacy. Your existing CRM applications (if any) " rill already have custon1er infonnation, product il1forn1ation, and other data that " 'ill be needed in any ne,v application that you install. Custon1er contact mechanis1ns need to be coordinated so that every CRM user in the fun1 kno,,rs about all of the activity associated ,vith each customer. You 1nay have son1e centraiized database or a data ,varehouse containing all custo1ner inforrnation. You ,vant to be able to take that data, easily access it, synthesize it, and analyze it so that you can use the data to benefit your business gomg forward. There's no sense collecting a lot of data if you can't use it to actually inlprove your business. It would be highly unlikely for the company to buy a ne,v application, custon1ize it to 1neet its needs, and then in1mediately in1plement it and have it ,vork exactly as expected. Checking for errors during i111plen1entation and integration and n1aintaining the current business at the san1e tin1e is an exceptionally difficult task. TI1erefore, it is likely to requu-e a significant tean1 of ,vell-trained personnel to integrate any ne,v systen1s along with support from the provider.

Step 5: Establish Performance Measures TI1e fifth step is to establish perfonnance n1easures. TI1is allo"rs the fun1 to deternili1e if objectives have been 1net, and to co1npare actual to plan variances so that corrective actions can be taken if necessary. vVhat are the objectives of the program and are they being achieved?

Step 6: Providing (RM Training for All Users The si>..'th step is to provide training for all users of the CRM progran1 and tools. You ,viU need to have the initial training for all users, and you ,vill need to have ongoing training ,vhen changes are made, upgrades, etc. Potentially, you ,viii also have ne"' employees over time and they \\•ill have to be trained as ,vell. One n1istake that con1panies n1ake is that they do the initial training, but they don't have a budget and progra1n set up for ongoing trainil1g. \¥hat happens is that the progran1 starts to fail, and they end up blaming the systen1 rather than recognizing that they don't have a key process in place. You can also use the training to convi11ce key users such as sales, call centers, and others, of the value of the CRM progran1. The training not only provides inforn1ation on ho"' to use the progran1, but it ,viii also sho,v the1n the value of the syste1n itself. You can use the training to take people ,vho are

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not early adopters (i.e., those who are resistant to the system) and help them get on board 'Nith the systen1 and become productive n1e1nbers of your organization in the nev,, environtnent.

CURRENT TRENDS IN CRM

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Customer Data Privacy Privacy is one of the current trends in CRM. You may have personally received privacy notices in the n1ail fro1n so1ne accow1t that you have or fro1u a supplier. TI1ey state things like '\ve collect certain inforn1ation fro1n you, but ,ve don't share that inforn1ation outside of our organization or "'ith our trading partners:· for exan1ple. People and organizations are understandably worried about giving out personal or confidential cotnpany inforn1ation. Protecting custo1ners' data and information is critical. There are rules and la,vs that co1npanies 1nust follo,v regarding invasion of privacy. TI1ese include the U.S. Patriot Act and EU's Internet Privacy La,v. One of the ele1nents to consider ,vhen you're looking at an application or a system, n1ay be the security features. What type of security does that system have?

Social Media Many co1npanies have expanded the use of social n1edia. Creating and cultivating virtual conununities around product or brand is a powerful way to engage customers in terms of selling and advertising, in providing information to customers, and also getting information back fron1 custon1ers on their buying preferences and require1nents.

Cloud Computing Cloud computing is basically an alternative to buying the soft~vare package. You can actually buy "sofuvare as a service" through the cloud instead of purchasing the actual CRM sofu,,are. TI1erefore, if there are upgrades, 1uaintenance, and the like, you don't have to go through the expense and exercise of actually doing the upgrades and maintenance yourself. The company that is n1anaging the soft:v.•are in the cloud ,viii actually do those activities. Many companies ,viii start out this ,,,ay, because it's a ,vay to "dip your toe in the v.•ater" v.•ithout getting fully inunersed. You can n1ake sure that the system v.•orks for you, perforn1s as you expect it to perfonn, and gives you the value that you are expecting before making a major investment.

SUMMARY •

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Customer relationship 1nanagen1ent (CRM) is the transfonnation of people, process, and tech nology required to beco1ne a custo1ner-centric organization; a philosophy of putting the cus-

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tomer first. It involves acquiring, retaining, and partnering \\•ilh selective customers to create superior value for both the cornpany and the custo1ner. •

Companies need a CRJ.\1 progran1 in order to (1) acquire ne\Y customers, and maybe even more irnportantly, (2) to retain their existing custorners. Loyal custorners are the source of rnost profits, and a relatively sn1all percentage of those custorners n1ay generate n1ost of the profits for the company.

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You n1ust have a clear set of goals in order to get the 1nost fro1n your CRJ.\1 prograrn. Making custon1er satisfaction the prin1ary goal of the CRM progran1 is the best way to improve the botton1 line.

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Relationships should be built ,vith strategically significant customers that are likely 10 provide the most value for the effort.

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CRM is not feasible for every market and every customer. Some customers don't want to be con11n itted to every brand and/or relationship.

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Of all of the components of supply c11ain management, building and maintaining profitable longtenn custo1ner relationships is one of the 1nost critical considering the fact tl1at a con1pany produces products and/or services to sell, and tl1erefore, requires custo1ners ,vho ,vant to buy those products and/or services. The first important issue to focus on involves the customer's require1nents for delivering products and services in a n1anner resulting in a high level of customer satisfaction. It starts ,vith talking to the custon1er, and even rnore ilnportantly listening to the custo1ner.

•

CIU-1 involves finding affordable ways to identify customers and their needs, and tl1en designing custorner contact strategies geared to,vard creatiI1g custon1er satisfaction and loyalty ainong segn1ents of custo1ners. Just as con1panies n1ust create 1uetl1ods for finding and developing good suppliers, companies 1nus1 also create methods for becoming and staying a good supplier themselves.

•

Key con1ponents of CRM: Predicting Custo1ner Behaviors: If a con1pany is in the busiI1ess of selling products and/or services to customers, it can also collect information fron1 these customers' buying history, preferences, and trends, ,vhich could then be used to predict custon1er buying behaviors going fon,•ard. Personalizing Custo1ner Co1nn1unications: ls about 1neeting the needs and expectations of customers through focused, personalized comn1unications. A proven and effective approach involves ensuring that custo1ners feel tllat their preferences and needs are being taken into consideration ,vhen they iI1teract ,vith a con1pany.

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Customer Segmentation: Grouping customers to create specialized conllllunications about products. Target Marketing: TI1e process of pron1oting products and services via 1nedia that are likely to reach the potential target market (i.e., customer segment). Targeted n1arketing builds a n1arketing strategy ain1ed at that specific customer seg1nent. Event-Based Marketing: ls a fonn of n1arketing that identifies key events in the custo111er and business lifecycle. When an event occurs, a custon1er-specific 1narketing activity is undertaken. Cross-Sell ing and Up-Selling: Cross-selling occurs ,vhen a cotnpany sells an additional related or co1nple1nentary product(s) or service(s) to an existing customer after the initial purchase. Up-selling involves persuading a custon1er to buy a more e>..1Jensive iten1 or upgrade a product or service to make the sale more profitable. It also involves selling the custo1ner extra features or add-ons to the product they are already buying or considering. Relationship or Pennission Marketing: ls an approach to selling products and services in which a customer explicitly agrees in advance to receive marketing information. Custo1ner Defection Analysis and Churn Reduction: Custon1er defection analysis is the process of analyzing the custo1uers ,vho have stopped buying to detennine ,vhy. Churn reduction is all of the efforts companies develop to stop losing customers to the competition. Custon1er Value Detennination: is detern1ining the custo1ner lifetin1e value so that appropriate conunw1ications, benefits, services, or policies can be established for each custo1ner segn1ent. Custon1er lifetime value (CLV) is a prediction of the net profit attributed to the entire future relationship "'ith a particular custorner. •

Custo1ner service is a philosophy, an activity, and a perforn1ance n1easure. Custon1er service perfonnance 1neasure1nents are designed around the "Seven Rights Rule": The right product, quantity, quality, place, tin1e, custon1er, and costs. A nev.rer customer service trend is to add on an eighth right, the right docwnentation. This, con1bined ,vith the other seven rights, is referred to as the perfect order.

•

v\/hen you complete a sales transaction, there are three different elements that you n1ust consider as part of the transaction; the pre-transaction, the actual transaction itself, and the posttransaction. Each ele111ent involves different aspects of custo1ner service.

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From the point of view of the supply chain n1anagement/logistics function, customer service can be described as having four traditional ditnensions: ti1ne, dependability, co1n111unications, and convenience.

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•

A call center links a customer and an organization together. It gives custon1ers quick access to the infonnation they ,vant and enhances the custorner-to-business relationship. Call centers have helped 1nost organizations focus on gro,\kt 1~: Supply Chain Management in the Service Industry

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2. END PRODUCTS: Services that offer tangible components along ,vith the service component (e.g., restaurants; food along with the dining service) 3. STATE UTILITY: Services that directly involve things owned by the custon1er (e.g., car repair, dry cleaning, haircut, healthcare)

The Goods-Services Continuum Aln1ost every product offering is a co111bination of goods and services. Figure 12. l illustrates this concept along a continuun1 spanning from Pure Goods to Pure Services. •

PURE GOODS are generally lo,v-n1argin COilllnodity businesses that, in order to con1pete against one another, often add some services (e.g., extended ,varrantees, consulting).

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CORE GOODS suppliers provide a significant service co111ponent (e.g., spare parts, repairs) as part of their businesses.

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CORE SERVICES suppliers 111ust integrate tangible goods (e.g., cars for rental, food at a restaurant, planes for air travel) in order to provide their services.

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PURE SERVICES do not need n1uch in terms of facilitating goods, but what they do use is essential to providing the service, thus facilitating goods (e.g.. sofuvare, diagnostics tools).

Purt Goods

Cort Goods

Cort Sen ikt 1~: Supply Chain Management in the Service Industry

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•

There are n1a1hematical models available lo help predict customer arrivals for planning purposes, such as the Poisson distribution model.

QUEUING SYSTEM ASSUMPTIONS:

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Most queuing 111odels assu111e that custon1ers enter the queue, and stay in the queue until served. Balking is \\•hen custon1ers refuse to join the queue. They arrive and detern1ine that the queue is too long and decide to go else\\•here or return later. Reneging is ,vhen custon1ers decide to leave the queue. They are already in the queue and then decide that it is taking too long, or they change their mind about the service, and decide to leave the queue.

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Queuing models, for the purposes of calculations, assun1e an infinite length of a queue.

QUEUE SYSTEM DESIGN:

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Queue discipline describes the order in ,vhich custon1ers are served. Exan1ples: first-con1efirst-served, greatest need such as in a hospital emergency roon1.

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Queuing configurations can be con1prised of single or n1ultiple queueing lines.

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Queue lines can be serviced by either a single server or n1ultiple servers.

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Multiple servers can also act in series or in parallel.

Choosing the correct design and queueing layout is a n1at1er of individual service provider or organization design. Depending on the nature of the service and the desired flo,v of people, an organization ,viii create and change the flo,\• as needed. l11e follo\\•ing gives a brief idea of several types of layouts: •

Single channel, single phase, single server (figure 12.4) Potential Customers

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Queueing System

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1:r Project Management

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THE PRELI M INARY P ROJ ECT R EQUI REMENT S DOCUMENT THE ABC CORPORATION - - - - S UP PLY C HAIN MANAGEMENT

Project Title:

Preliminary Project Requirements Document

Date:

General Information

Loca-

Co1npan y:

tion:

Contact Person: Phone No.:

Date:

E1nail:

Preliminary Project Overview Statement (Project Specifics and Focus Statement) Provide as specifically as possible an overview state1nent of the projects objective(s) and agreed results.

Project Assumptions: What high-level assu111ptions have already been made about the project?

Approval and Authority to Proceed to a Requirements Document Using Project Process Approach Vie approve the project as described above, and authorize the tean1 to proceed. Name

Item 1 2 SCM PMOIA

392

Title

Date

Add Attachments As Needed

FUNDAMENTALS OF SUPPLY CHAIN MANAGEMENT

THE PROJECT REQUIREMENTS DOCUMENT

The project requiren1ents docun1ent contains greater detail as defined by the project 1nanager and teain of supply chain functional n1embers. This docun1ent is presented to the stakeholder for approval (prior to the actual start of a project) but is often rejected for modification prior to its final signed approval. THE AB C CORPORATION - - - - S UPPLY C HA IN MANAGEMENT

Project Title: Project Requirem ents Document

Date:

General Information Created by: Phone No.:

Date:

Email:

Project Overview Statement (Project Title and Focus Statement)

Answer the question, v\lby is it iluportant to achieve the project objective? \\That do you hope to achieve by executing this project?

I I

Pro ject Scope (l ist Inclusions)

Project Scope (List Exclusions)

Project A,rreed Results (Expressed with Measurabilitv and Verifiabilih,) ~'hat will the project actually produce? Project Assumptions: \ \ 1hat bie.h-level assu1nvtions have already been 1uad about the proiect? Project Approach (Project Management Guidelines, PMG) Include: communication, risk manai:ement, and reoortini: plans. list the Project Stakeholders Name

Title

Name

Title

Approval(s) and Authority to Proceed

\Ve avDrove the pro·ect as described above, and authorize the tean1 to proceed. Name Title D ate

1 ltem 1

Attachments

SCM - PM 01 eJ~\J>kt 1:30 Project Management

393

THE P ROJECT P HASE A P PROACH

To better 1nanage a project, divide it into several phases providing better 1nanage1nent control and appropriate ways to 1neasure and verify accuracy of the project performance and progress. THE ABC CORPORATION - - - - S U PPLY CHAIN MANAGEl\1ENT

Project Title:

Phase Number One: Title:

Chart Project Phase

Phase Number Two: Title:

Phase Number Three: Title:

Phase Number Four: Title:

Phase Number Five: Title:

Phase Statement:

Phase Statement:

Phase Statement:

Phase Statement:

Phase Statement:

Sun1mar y Level Task List

Sun1mar y Level Task List

Sun1mar y Level Task List

Summary Level Task List

Summary Level Task List

Phase agreed results are:

Phase agreed results are:

Phase agreed results are:

Phase agreed results are:

Phase agreed results are:

Buy off this phase: Yes No

Buy off this phase: Yes No Buy i.n to nc.pmfflt

·Pt..2 ..ct: