Vol. 44, No. 1, January–February 2014, pp.

85–104
ISSN 0092-2102 (print) — ISSN 1526-551X (online) http://dx.doi.org/10.1287/inte.2013.0725
© 2014 INFORMS
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THE FRANZ EDELMAN AWARD

Achievement in Operations Research

Supply Chain Scenario Modeler: A Holistic Executive

Decision Support Solution
Kaan Katircioglu
IBM Thomas J. Watson Research Center, Yorktown Heights, New York 10598, kaan@us.ibm.com

Robert Gooby
McKesson Corporation, Dallas, Texas 75006, bob.gooby@mckesson.com

Mary Helander, Youssef Drissi, Pawan Chowdhary

IBM Thomas J. Watson Research Center, Yorktown Heights, New York 10598
{helandm@us.ibm.com, youssefd@us.ibm.com, chowdhar@us.ibm.com}

Matt Johnson
McKesson Corporation, San Francisco, California 94104, matt.johnson@mckesson.com

Takashi Yonezawa
IBM Global Services, Chuo-Ku, Tokyo 103-8510, Japan, yonezat@jp.ibm.com

McKesson is America’s oldest and largest healthcare services company. IBM Research developed an innovative
scenario modeling and analysis tool, supply chain scenario modeler (SCSM), for McKesson to optimize its end-
to-end pharmaceutical supply chain policies. Through integrated operations research (OR) models, SCSM opti-
mizes the distribution network, supply flow, inventory, and transportation policies, and quantifies the impacts
of changes on financial, operational, and environmental metrics. The modeling work spawned a roadmap of
projects with quantified opportunities, including a new air freight supply chain path, and provided new insights
that have been critical to improving McKesson’s performance as a pharmaceutical industry leader. A structured
data model supporting the OR models has provided a basis for additional improvement projects. The model
directly links OR modeling results to a detailed profit-and-loss statement by product category for the different
supply chain paths that McKesson uses. Since this effort began in 2009, McKesson Pharmaceutical division has
reduced its committed capital by more than $1 billion.
Keywords: supply chain; inventory optimization; network optimization; vehicle routing problem (VRP);
business analytics; common data model; enterprise planning; sustainability; profit-and-loss (P&L).

M cKesson distributes more than one-third of all

pharmaceutical products in North America.
Ranked number 15 on the Fortune 100 list, and with
more than $126 billion in revenue, McKesson ships
two million orders a day to more than 26,000 customer
locations, from small pharmacies to large retailers with
extremely high levels of inventory availability. Its dis-
tribution network consists of a hub in Memphis (i.e.,
a regional distribution center or RDC), another in
Denver (i.e., a strategic distribution center), and 28
85
local warehouses (i.e., forward distribution centers or
FDCs). The hub in Memphis does most of the redis-
tribution. The Denver hub does minimal redistribu-
tion; its main function is to store strategic purchases.
Henceforth, the term hub will refer to the Memphis
hub, and RDC and FDC will refer to the Memphis hub
and the local warehouses, respectively. McKesson uses
different supply chain paths (i.e., supply flow options)
for different vendors. Some vendors provide supplies
to the RDC, which McKesson distributes to FDCs.

86
Supply flow and inventory
optimization
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2,500 Vendors
43,000 Items
30 Distribution centers Regional distribution
center (Hub)
Network assignment
optimization Local distribution
center
250 Cross-dock location
Vehicle routing
Cross-docks
problem
26,000 customer location
Customers
Figure 1: The SCSM solution provides integrated OR models to solve supply chain optimization problems.
We call this the hub-and-spoke supply chain path.
Some provide supplies directly to FDCs. We call this
the direct-ship supply chain path. In another supply
chain path, vendors ship supplies to the hub in Mem-
phis and McKesson sends customer orders directly
to customer locations via air. We call this the air-
centralized inventory and air ship. For such prod-
ucts, FDCs contain no inventory. McKesson serves
all of its customer locations daily. FDCs ship cus-
tomer orders to cross-docking locations (henceforth,
we will refer to these locations as cross-docks), where
third-party logistics providers receive the shipments
and start their truck routes to customer locations. Fig-
ure 1 shows McKesson’s distribution network. To stay
competitive, McKesson developed a culture of adopt-
ing advanced business processes and tools. As one
of the earliest users of a SAP transaction manage-
ment system, McKesson is a successful implementer
of Six Sigma quality management and Lean process
management methods. This culture is an ideal envi-
ronment for advanced, integrated operations research
(OR) modeling. Its collaboration with IBM Research
began in 2009 when IBM proposed to develop a
Katircioglu et al.: Supply Chain Scenario Modeler
Interfaces 44(1), pp. 85–104, © 2014 INFORMS
Vendors
Strategic distribution
center (Hub)
Local distribution Local distribution
center
Cross-docks Cross-docks
first-of-a-kind (FOAK) solution to assist McKesson
executives in making strategic and tactical supply
chain decisions by quantifying the company’s impacts
across operational, financial, and environmental per-
formance metrics. IBM’s FOAK initiative is a corporate
investment program, in existence since 1995, to sup-
port and bring novel and transformational ideas into
practice. In this paper, we describe the project, the sup-
ply chain scenario modeler (SCSM), which involves
an integrated OR modeling approach that eventually
impacted McKesson’s entire operations.
At the time this project started, McKesson was
already using state-of-the-art software for its opera-
tions, including transaction management, order ful-
fillment, warehouse operations management, demand
forecasting, and inventory optimization; however,
an integrated approach to decision making in its
supply chain operations was missing. McKesson
management had long been aware that key parts
of McKesson’s business operations, such as pro-
curement management, supply flow management,
network management, inventory management, ware-
house management, transportation management, and
 Katircioglu et al.: Supply Chain Scenario Modeler
Interfaces 44(1), pp. 85–104, © 2014 INFORMS
customer service management, all had direct or indi-
rect impacts on each other’s performance. While ini-
tiating an advanced OR exercise with IBM Research,
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McKesson’s executive management expressed a desire
to ensure that the policies governing key areas be syn-
chronized. This was one of the most important goals
of the IBM Research team’s OR work.
Early on, McKesson also made it clear that it did
not want a black-box solution to dictate a set of poli-
cies. In contrast, it wanted a solution that would
answer what-if questions by estimating the impacts of
potential actions on operational and financial metrics
spanning its key operations. The OR solution needed
to be credible and flexible in its ability to represent
operation details and interrelationships. McKesson
needed a balance between operational detail and
practical use by executives. In addition, it had an
interest in simultaneously quantifying the impact
of decisions on environmental factors, particularly
energy use and carbon emissions. Finally, the com-
pany had a strong desire to connect the outputs of
OR models to a profit-and-loss (P&L) statement, so
that the impact of operational policy changes could
be viewed in terms of its financial metrics.
Working with McKesson, IBM Research designed
and built an integrated OR solution that includes (1) a
comprehensive data model to represent the dynamics
of the company’s operations and capture McKesson’s
management processes and policies, (2) a user inter-
face to allow optimization and what-if analysis, and
(3) a flexible reporting module to create extensive
reports of scenario results. Completed in early 2010,
insights from scenarios run since then have led to a
number of actions in procurement, distribution, inven-
tory, and supply flow management. Changes made
in vendor, customer, and internal operations policies
have triggered initiatives that McKesson credits with
saving approximately $1 billion in working capital by
the end of 2012. In its comprehensive nature, the solu-
tion also brought together people across different lev-
els of management and from different operations for
overall enhanced collaborative decision making.
Background Solution Approach
Enterprise-Wide Optimization
Grossmann (2012) gives details of OR challenges
of enterprise-wide optimization and mentions the
87
specific challenges of nonlinearity, uncertainty, and a
mixture of continuous and discrete decision variables.
The author also points out that these challenges are
confounded by the complexity of dealing with large-
scale mathematical programming and that they col-
lectively defy monolithic solutions and off-the-shelf
tools. Similar to our approach, Grossmann simulta-
neously considers supply, manufacturing, and dis-
tribution activities for the process industry. Ivanov
et al. (2010) also provide an integrated enterprise
view of supply chain optimization. They use a mod-
eling approach that considers control theory, OR, and
agent-based modeling. Kristianto et al. (2012) provide
further evidence of trends to optimize holistically con-
necting product decisions to logistics and inventory
and out to product quality and service.
Although pharmaceutical distribution shares many
issues and challenges in supply chain decision mak-
ing with other industries, the distinct nature of bio-
pharmaceutical medication purchasing, distributing,
and selling throughout the supply chain is surveyed
in Rossett et al. (2011). Biological medications, in par-
ticular, often require temperature-controlled environ-
ments in transportation and storage, which has an
energy and thus sustainability implication. Xie and
Breen (2012) illustrates a similar style to SCSM, rein-
forcing the various greening objectives, in that they
take a cross-boundary approach while developing
and focusing on the environmental and sustainable
aspects of a pharmaceutical supply chain. In the past
decade, many global organizations have attempted to
minimize their environmental impact. For example,
Walmart set a strategy to use 100 percent renewable
energy toward zero carbon emissions (Plambeck and
Denend 2011).
Lee and Amaral (2002) address supply chain mate-
rial costs via the lens of purchasing and contract-
ing decisions within the electronics industry—issues
that SCSM addresses in the context of pharma. Gillai
(2012) provides useful descriptions of general sup-
ply chain types in the pharmaceutical industry, and
serves as relevant background for the reader. These
descriptions emphasize the variety of options that
companies such as McKesson have for supply flow
design. Viewing a supply chain through a financial
lens, such as a P&L report, appears to be evolving.

88
For example, Longinidis and Georgiadis (2011) intro-
duce a mixed-integer linear programming model that
integrates financial considerations with supply chain
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design decisions under demand uncertainty and links
the analyses directly to financial statement analysis.
The increasing appearance of OR closer to boardroom
decision making, again with a view to making deci-
sions that attempt to optimize at the enterprise level,
is evidenced by Everett et al. (2010), who argue that
OR is particularly key in giving senior executives con-
fidence in the choices they pursue.
Challenges and Requirements
We faced a number of technical, managerial, and
political challenges in creating and implementing an
effective OR solution for McKesson. The technical
challenges include the necessary sophistication of the
mathematical models and algorithms for each ana-
lytics engine, and the complexity of integrating and
bridging engines to provide a coherent solution for
decision support for operational, financial, and sus-
tainability objectives. The ability to run and eval-
uate what-if scenarios, while optimizing the inven-
tory, supply, distribution, and transportation, required
developing a sophisticated mathematical model and
processing huge amounts of data for 43,000 items,
26,000 customer locations, 30 distribution centers, and
over 250 cross-docks. Each scenario needs to compute
and store operational metrics (e.g., inventory levels,
warehouse utilization, lead times), financial metrics
(e.g., transportation and warehousing costs, accounts
payable and receivable), and sustainability metrics
(e.g., energy use and carbon emissions for each piece
of equipment used in each operation in each location).
McKesson’s finance organization wanted to see a
complete P&L statement for each stock-keeping unit
(SKU), which represents a unique item or prod-
uct number. The data model needed to support the
computation of the P&L metrics and the calculated
baseline values needed to match McKesson’s actual
P&L statements. We developed reasonable approxi-
mation techniques to allocate costs related to occu-
pancy, administrative expenses, and accounts payable
and receivable to SKUs. For example, we allocate site
occupancy costs using throughput amounts. Similarly,
we attribute carbon emissions to SKUs using both
throughput and inventory levels, while considering
whether the SKU must be refrigerated or frozen.
Katircioglu et al.: Supply Chain Scenario Modeler
Interfaces 44(1), pp. 85–104, © 2014 INFORMS
Implementation challenges include a requirement
to provide a hosted service. To meet this require-
ment, we designed SCSM with a service-oriented
architecture, which is accessed and used remotely
through a common Web browser. Because the data
have extremely sensitive elements, such as financial,
sales, and procurement transactions, we also imple-
mented commercial-grade security measures.
Managerial challenges include a user commu-
nity with diverse needs and interests. For exam-
ple, McKesson executives sought P&L statements that
could be divided in different ways, whereas trans-
portation managers wanted to see truck routing and
shipment cost details. Supply chain managers wanted
cost-to-serve, safety stock levels, and supply flow
details, whereas warehouse managers wanted to see
cross-dock allocations to warehouses and warehouse
capacity details. Procurement management wanted
to see the impacts of supplier contract terms and
conditions; sustainability management wanted to see
energy use and carbon emissions reports. To satisfy
all these requirements, we developed comprehensive
models at the item detail level and reporting metrics
for different role players. On the political side, it took
many months of intensive work on the part of project
team members from McKesson and IBM to convince
McKesson’s executive management directly respon-
sible for the P&L statement of the benefits of the
SCSM solution and analysis results. This was espe-
cially apparent when a recommendation involved a
direct change to the budget of an executive, or a
change to the target performance of an entire group
responsible for an operation.
Model and Solution Credibility
Three factors were key to establishing credibility.
The first was a decision to collect data at a detailed
transaction level. We collected procurement, sales,
and internal transactions, and uploaded them into
SCSM’s data model. We collected warehousing costs
by activity (e.g., receiving, storage, pick-pack-ship),
accounts payable by each vendor, and accounts
receivable by each customer group. Because each item
had different characteristics, we collected item data
by SKU, which included information such as item
dimensions, weight, price, cost, vendor name, cur-
rent supply chain-path inventory levels by site, and
total sales in units by site and customer location.
 Katircioglu et al.: Supply Chain Scenario Modeler
Interfaces 44(1), pp. 85–104, © 2014 INFORMS 89

We developed complex queries to generate all input calculations as well as inputs to all analytics engines.
needs and rigorously tested them. The resulting data Next, because the analytical models need a connec-
model has over 200 tables with a combined size of tion to transfer required data to analyze the end-
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tens of millions of records. to-end supply chain, a scenario management layer

Second, to ensure the OR models accurately repre-
sent business dynamics, we held several workshops
to understand McKesson’s processes in managing its
operations. The team documented these processes,
including key elements of procurement contacts,
inventory management policies, supply flows at a
SKU level, customer service level targets and their
definitions, the nature of minimum inventory require-
ments, and warehousing and transportation opera-
tions and their cost structures. Third, the final step in
establishing credibility for the models was to finan-
cially match the base case. That is, model results had
to match McKesson’s standard P&L report, working
our way up from the model’s SKU-level P&L reports.
Solution Architecture
The solution design for SCSM involves five essential
components. A common data model supports metric
orchestrates data flow and algorithms in an orderly
sequence. Each analytics engine handles its part of the
optimization algorithms and calculations, correspond-
ing to inventory, network, supply flow, and vehicle
routing problems, calculating sustainability metrics
and P&L elements, and answering what-if questions.
Architecturally, to enable a Web service, SCSM follows
a software-as-a-service framework. To avoid over-
whelming the user with the complex details of the data
model and algorithms, a friendly Web user interface
allows the construction of what-if scenarios. Finally, a
comprehensive and flexible reporting module allows
users to easily see the results of scenarios at the
selected level of detail. We use IBM Cognos software to
meet this objective. Figure 2 shows an overview of the
supply chain analytics available for use by different

Supply chain CFO

management Financial office
Supply chain
metrics metrics

Transportation Supply
What-if analytics analytics What-if
scenarios scenarios
Sustainability Cost
analytics analytics

Common
data model
Revenue
Inventory
management
analytics
analytics
Global
What-if metrics
Customer Procurement
scenarios
analytics analytics

Sustainability What-if CEO

Sustainability
metrics scenarios office
management

Figure 2: As this solution overview shows, the SCSM solution provides a variety of supply chain analytics to
different users.

90
McKesson organizations. The analytics are enabled by
the following solution components:
• Integration information service: Uploads inputs,
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executes extraction, transformation, and loading
(ETL), correlates and integrates the data, and stores
the data into the SCSM data warehouse.
• Data warehouse: Stores all the input data, output
data, and metrics, and keeps track of their rela-
tionships to business operations. It also stores all
processed data required by the analytics engines.
A flexible design allows the integration and support
of additional analytics and information reporting.
• Scenario management layer: Manages the inter-
action between various components. It minimizes the
negative impact of data inflation by representing sce-
narios as delta information (i.e., it records only the
changes to the base case). It also orchestrates the
execution of the analytics engines that need to run
in a specific order based on the scenario, and man-
ages the output of the analytical models for reporting
purposes.
• Business analytics service: Hosts all analytics
engines with their interfaces and data structures
clearly defined as an application programming inter-
face. The analytics engine data adaptor prepares the
input scenario data for each analytics engine. The out-
puts of the engines are then sent to the adaptor to be
stored in the database.
• Dashboard: Consists of a Java Servlet Page and
Dojo-based user interface for intuitive scenario cre-
ation and management, and a Cognos business intel-
ligence module that provides flexible reporting from
the vast amount of output data generated by the ana-
lytics engines.
Analytics Engines with OR Models
In this section, we describe the analytics engines and
underlying OR models developed for the SCSM solu-
tion. Figure 1 provides a conceptual overview of
McKesson’s supply chain and relates layers of dis-
tribution to OR models, which we describe in more
detail next.
McKesson requires an integrated model that can
enable the company to identify opportunities not
available through local optimization. An alternative
approach for the team would have been to create
one large, all-inclusive model for global optimization.
Katircioglu et al.: Supply Chain Scenario Modeler
Interfaces 44(1), pp. 85–104, © 2014 INFORMS
However, this approach would have created serious
issues in managing data size and computational per-
formance. Because an important requirement is to
interact with the users and enable them to sequen-
tially run many scenarios, fast computation time is
essential. A typical scenario must run within five min-
utes and the most complicated scenario must com-
plete in around 20 minutes. This has to include both
the run time of algorithms and the data transfer time
between the database and the analytics engines and
the report creation; the data transfer time alone would
take several minutes because millions of records are
involved. After many discussions, the team came up
with a method to separate the overall problem into
four connected pieces, each of which can be solved
separately.
The first piece is the vehicle routing problem (VRP)
model. Because vehicle routing starts at the cross-
dock and covers the customer locations, modeling the
VRP for all the cross-docks of a given FDC (i.e., for-
ward distribution center or local warehouse) is rea-
sonable. The VRP starts with the region of customer
locations supported by an FDC, clusters customer
locations, allocates each cluster to a cross-dock, and
optimizes the vehicle routes. The purpose of opti-
mizing vehicle routes is not to plan routes actively
because, as we mention previously, McKesson uses
third-party logistics providers for this. The purpose
is to provide McKesson with a benchmark to assess
the efficiency of the third-party operations. One of
the key results of the VRP is the assignment of cus-
tomer locations to cross-docks, which is an input to
the network problem. Then, the network assignment
problem finds the minimum-cost assignment of these
cross-docks to the RDC and the FDCs. A key result
of this assignment is the SKU-level demand in each
FDC and the RDC. Then, based on this demand data,
the inventory problem calculates the best inventory
policy for each SKU in each location. The key out-
put of the inventory model is the optimum inventory
levels for SKUs depending on the supply chain path
used. Then, the supply flow optimization chooses the
best supply chain path to minimize the total cost.
Finally, the sustainability engine and the P&L engine
use these results to calculate the financial, operational,
and environmental metrics. Therefore, all models are
connected with each other; although each solves its
 Katircioglu et al.: Supply Chain Scenario Modeler
Interfaces 44(1), pp. 85–104, © 2014 INFORMS
own piece of the puzzle, each also produces the key
inputs the other engines need (see Figure 3). We will
now briefly describe each model; the appendices pro-
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vide the mathematical details.
Inventory Optimization Model. We use a one- or two-
echelon mode, depending on whether the vendor
ships directly to FDCs, with service constraints at the
inventory location closest to the customer. The objec-
tive is to minimize total inventory to meet the ser-
vice constraint. We optimize independently for each
of the 43,000 SKUs. Random lead times are not easy
to handle even for single-echelon inventory problems,
because using the inventory position to derive long-
run average cost and service is not very useful. A two-
level distribution makes formulating and solving the
problem more difficult. Therefore, many researchers
resort to heuristic techniques or approximations.
The work that is closest to our model is Schnei-
der et al. (1995), which extends Ehrhardt’s power
approximation to a two-echelon problem with ser-
vice constraints, as Ehrhardt (1979) and Ehrhardt and
Mosier (1984) describe. They assume a single ware-
house, which has a probability-of-no-stock-out service
constraint and that supplies multiple stores, each of
/UTBOUND
TRANSPORTATION
6EHICLE
3USTAINABILITY
ROUTING
#USTOMERTO
TO
SERVE
CROSS
DOCK /PTIMAL
)NTERNAL
ASSIGNMENT TRANSPORTATION
AND
WAREHOUSING
THROUGHPUT
$EMANDBY
PRODUCTAND
LOCATION
.ETWORK
ANALYSIS
Figure 3: The SCSM analytics engines work together to provide a holistic model of the supply chain scenarios
and optimize policies.
91
which has a fill-rate constraint. All locations use (s1 S)
policies. The warehouse has a fixed replenishment
lead time from the outside supplier, and the stores
have stochastic replenishment lead times from the
warehouse. In our case, both lead times are stochastic
and our service definition is close to a probability-
of-no-stock-out constraint for both echelons. We use
a simulation-regression approach for a quick solution
of the inventory problem. Bashyam and Fu (1998)
also provide a simulation-based procedure that calcu-
lates near-optimal inventory policies with costs within
five percent of the optimal for the tested problems.
We give the details of the formulation of our problem
and our solution approach in Appendix A.
Supply Flow Optimization Model. This model consid-
ers multiple supply chain paths (i.e., different ways
supply can flow through the distribution network).
The objective is to choose the best supply chain path
to minimize the total net cost. The net cost consists of
the cost to serve, inventory carrying cost, and a redis-
tribution fee. Note that the redistribution fee is an
income to McKesson; hence, we record it as negative
cost. It materializes whenever a vendor actively uses
McKesson’s distribution. The cost to serve consists
#/METRICS
ANDENERGYUSE
0,
#OST
INVENTORYPOLICY INVENTORY
ALLFINANCIALS
ANDOPTIMAL
SUPPLYCHAIN
TYPE
/PTIMAL
INVENTORY
POLICIES
)NVENTORY 3UPPLYFLOW
OPTIMIZATION OPTIMIZATION

92
of warehousing and transportation costs. The ware-
housing cost consists of order costs, material handling
costs, and storage costs. The transportation cost con-
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sists of the transportation cost from the RDC to the
FDCs and from the FDCs to the cross-docks (cross-
dock to customer costs are used by the VRP model).
We independently do the optimization for each SKU.
Appendix B shows the modeling and solution details.
Network Assignment Optimization Model. This model
assigns cross-docks to the RDCs and FDCs to mini-
mize the total network cost of a two-echelon system
to meet demand. The total network cost consists of
transportation, warehousing, and inventory carrying
costs. To solve this problem, we developed two alter-
native formulations. The first is a mixed-integer pro-
gramming formulation and the second is a heuristic.
We chose to use the heuristic for two reasons: it is
more flexible and robust in handling infeasible prob-
lems with soft constraints, and it can handle nonlinear
inventory costs. We provide modeling and solution
details in Appendix C.
Vehicle Routing Model. This model considers each
site separately, and solves the problem one site at a
time. The average number of customer locations per
distribution center is approximately 900. The aver-
age number of cross-docks per distribution center is
approximately eight. The VRP has the objective of
minimizing the transportation costs on a given day
from all the cross-docks of a distribution center to all
the customer locations that it serves. We formulate
and solve the problem for each of the 28 distribution
centers independently.
We use an existing and mature IBM solution,
which the IBM Research Lab in Tokyo developed
to solve the well-known VRP with time windows.
Okano (1999) and Osogami and Okano (2003) pro-
vide detailed descriptions of the model and their local
search heuristic algorithm to solve it. The VRP com-
ponent of SCSM sets a baseline for transportation
costs and serviceability by finding optimal routes of
delivery and pickup, simulating a transportation ser-
vice provider’s attempt to be as efficient as possible.
Sustainability Model. This model quantifies the envi-
ronmental impact of different scenarios by computing
the carbon emissions, energy usage, energy cost, car-
bon cost, and other energy and carbon efficiency met-
rics. It calculates energy and carbon for all equipment
and transportation vehicles used in each distribution
Katircioglu et al.: Supply Chain Scenario Modeler
Interfaces 44(1), pp. 85–104, © 2014 INFORMS
center. Then, it aggregates energy and carbon to the
site level. It also allocates energy and carbon to the
operations and ultimately to each SKU. The model
also evaluates the costs and benefits of sustainabil-
ity actions, such as overhauling existing equipment to
make it more energy efficient, investing in new and
more energy-efficient conveyor belts or forklifts, using
natural gas-powered trucks or generators, and putting
solar panels on warehouse rooftops. It computes all
sustainability metrics for each distribution center,
equipment and vehicle type, supply chain operation,
and SKU to enable a multidimensional analysis of the
supply chain sustainability. Incorporation of the sus-
tainability model in SCSM helps McKesson’s corpo-
rate citizenship organization see how decisions made
in different parts of the supply chain impact sus-
tainability performance. This facilitates making sus-
tainability managers a part of the discussion on the
trade-offs, policies, and target setting for operational,
financial, and environmental performance. Sourirajan
et al. (2009) provide another application of model-
ing and measuring the impacts of supply chain poli-
cies on sustainability metrics. We provide modeling
details in Appendix D.
P&L Model. This model takes the outputs from the
analytics engines and calculates all the elements of
the P&L statement. It does this at the SKU level first.
The ability to see a complete P&L statement (e.g., by
item, product group, product type, vendor, site) helps
McKesson to understand which products are more
profitable than others and why.
Although the most demanding scenario may re-
quire all the engines to run, a typical scenario requires
a subset of the engines to run. For example, when
a scenario is about supply lead-time change, only
the inventory engine needs to run. Similarly, when
two sites are consolidated, the VRP results of their
cross-docks are still valid; therefore, only network and
inventory engines need to run. Our method ensures
that the complex relationships of the engines do not
inhibit the performance of the solution and the results
are still acceptable.
Common Data Model
Typically, organizational data are spread out in dif-
ferent systems, such as SAP, Siebel, accounting, and
numerous spreadsheets, and may also be spread
across regions. The common data model is the area
 Katircioglu et al.: Supply Chain Scenario Modeler
Interfaces 44(1), pp. 85–104, © 2014 INFORMS
in which we perform all data reconciliation, estab-
lish consistency, and test integrity. It also facilitates
data transfer between engines by storing intermediary
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data. We complete the data storage and processing in
four phases, as follows:
Staging phase: In this phase, we keep the data
retrieved from several sources in their original form
in the database. We perform checks to verify the
completeness of the data (e.g., sales by all SKUs,
warehouse, and cross-dock locations, customer infor-
mation, product information, customer to cross-dock
mapping). At this stage, the database tables represent
the raw data by design, and we do not perform any
correlations.
Intermediate phase: In this phase, the data models
represent the master tables with appropriate primary
key and foreign keys and interim tables that have
processed raw data (e.g., sales by cross-docks, supply
lead times, operational cost data by SKU-warehouse
combination). We now correlate the raw data and run
ETL queries to populate the intermediate tables.
Execution phase: In this phase, we further pro-
cess the data from intermediate data tables to gen-
erate content to data tables for the input and output
data requirements of the analytics engines. For exam-
ple, we calculate the SKU warehouse demand, mean
and standard deviation, order cost, throughput cost,
lead times, lead-time variability, and cross-dock level
demand, and make these calculations ready for exe-
cution by the engines. We store the results from each
engine run with reference to the scenario index to
facilitate scenario comparisons.
Reporting phase: In this phase, the logical model
represents the engine outputs at various levels of
aggregation to facilitate quick execution of reports.
We design the tables to keep the aggregation at the
appropriate level and let the business intelligence tool
handle the summarization of data.
Solution Implementation and
Business Impact
It took one year to develop the SCSM solution; more
than a dozen people were actively involved in the
development effort. In early 2010, IBM began host-
ing the completed solution, and assisted McKesson
to perform scenario analyses for business insights.
The solution provides extensive scenario analysis
93
opportunities. Scenarios include changing, removing,
and adding distribution centers, changing procure-
ment contract terms (e.g., supply lead times, service
fees, receivables, shipment policies), changing the sup-
ply flow of any product group (e.g., direct shipments
from suppliers to McKesson’s FDCs or shipments to
McKesson’s RDC, which ships to FDCs, using air
rather than truck transport), service level agreements,
warehousing and transportation costs by location, and
demand trends for products. Figure 4 provides a sum-
mary of SCSM’s scenario usage. As the figure illus-
trates, we designed the scenarios in four areas. In each
area, SCSM has a number of levers to change the ser-
vice level in the product scenario, and to change the
energy price in the sustainability scenario. A scenario
constitutes changes in values of a group of levers and
factors. Depending on their interest, different users
choose different levers and factors to create their sce-
narios. The user community includes people from pro-
curement, finance, supply chain, inventory, distribu-
tion, and corporate citizenship.
Scenarios Analyzed by McKesson
McKesson’s primary interests are to understand how
its network can be structured better, how the supply
flows can be optimized at an item level, and how such
changes impact inventory levels. The following sce-
narios are essential for answering these questions:
• Base case,
• Optimized base case,
• Optimal supply flow,
• Optimal network,
• Optimal network and supply flow.
We establish the base case by merely crunching the
data that represent business as usual. The purpose of
the base case is to see if the data uploaded to the
solution accurately reflect McKesson’s current supply
chain metrics.
Once we establish the base case, the data in the
solution are ready to run new scenarios. One impor-
tant issue, however, is the inventory in the system.
Several factors determine the levels of inventory. One
factor is the large purchases McKesson makes outside
its regular replenishment process for various reasons,
such as special discount opportunities. These pur-
chases cause temporary inventory increases. Because
we do not want to include such irregular bumps in
inventory levels, we delete them. This leads to the
 Katircioglu et al.: Supply Chain Scenario Modeler
94 Interfaces 44(1), pp. 85–104, © 2014 INFORMS

Add new scenario

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Product scenario Site scenario Network scenario Sustainability scenario

Select products Select sites Select sites Select sites

Specify products actions Specify site actions Specify network Specify sustainability
• Change lead time • Change capacity actions actions
• Change demand • Change labor cost • Add site(s) • Upgrade equipment
• Change service level • Change demand • Remove site(s) • Change energy source
• Change redistribution fee • etc. • Consolidate sites • Change energy price
• etc. • etc. • etc.

Select analytics
• Inventory
• Vehicle routing
• Network
• Sustainability

Run scenario

Analyze results

Figure 4: The scenario manager interface allows users to build scenarios in which changes in levers and external
factors are specified in the supply chain.

creation of the optimized base case in which we let
the solution determine the optimal inventory levels
in the base case rather than using McKesson’s inven-
tory data. That is, the optimized base case is exactly
the same as the base case, except for the inventory
levels, which we optimize without changing the cur-
rent network structure and supply flows. Therefore,
the optimized base case scenario runs the inventory
optimization engine.
The optimal supply flow scenario picks the optimal
supply flow from among the alternative types of sup-
ply flows. As we discuss previously, the optimal sup-
ply flow is the flow that minimizes the total net cost.
This scenario is important to allow McKesson to see if
the supply is flowing through the company’s distribu-
tion network in the most cost-effective way possible
at a SKU level. The detailed output of the scenario
gives McKesson the ability to see its current supply
flow and the optimal supply flow for any given SKU.
The report can be sorted to see which SKUs currently
have the least cost-effective distribution and hence are
the top candidates for supply flow change. This sce-
nario runs both the inventory optimization and sup-
ply flow optimization engines.
The optimal network scenario optimizes the net-
work to minimize the total cost of the distribu-
tion network. The total cost consists of warehousing
and transportation costs and inventory carrying cost.
The decision variable is the assignment of cross-docks
to warehouses. This scenario runs both the network
engine and the inventory optimization engines.
The optimal network and supply flow scenario is
the combination of the last two scenarios we men-
tioned. It runs the network, the inventory, and the
supply flow optimization engines.
In addition to these scenarios, which require opti-
mization engines, McKesson is also interested in the
following what-if scenarios:
• Supply lead-time change
• Redistribution-fee change
• Site change
• Network change
 Katircioglu et al.: Supply Chain Scenario Modeler
Interfaces 44(1), pp. 85–104, © 2014 INFORMS
The supply lead-time change scenario allows the
user to change the inventory replenishment lead times
for selected items (or vendors), including both the
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mean and variance of lead times. The purpose is to
understand how lead-time changes impact the inven-
tory levels and distribution costs of selected items.
This scenario runs the inventory optimization engine.
The redistribution-fee change scenario allows the
user to change the redistribution fee for selected
items or vendors. McKesson offers two alternatives to
its vendors for supply shipments. Vendors can ship
directly to FDCs, or they can ship to McKesson’s RDC
in Memphis and let McKesson redistribute the sup-
ply to the FDCs. If a vendor chooses to send supply
to the RDC, it pays a redistribution fee to McKesson.
Although this is a source of income for McKesson, the
company understands that it must carefully negotiate
the redistribution fees with its vendors. The purpose
is to see the impact on the total net cost, as we define
earlier. McKesson can also calculate the break-even
redistribution fee, thus making the two alternatives
(i.e., direct shipment versus redistribution) indifferent.
The site-change scenario is a change in the oper-
ating characteristics of a distribution center. These
parameters include capacity, labor cost, energy cost,
demand, and supply lead times. The purpose of this
scenario is to understand the impact on the total cost
to serve (i.e., total distribution cost) when such char-
acteristics of some sites change.
The network change scenario adds, removes, or
consolidates sites. McKesson regularly analyzes its
network under changing demand, supply, and cost
conditions to assess if the current network structure
is cost efficient. Doing this analysis by hand is time
consuming, because McKesson must consider many
alternative network changes. This scenario runs the
network optimization engine and inventory optimiza-
tion engine.
Finally, note that the user can execute a combina-
tion of scenarios within a single run. For example,
a user may be interested in analyzing the impact of
two or more changes within one run.
Implementation and Impact
As of the end of 2012, McKesson estimated that it
achieved a working capital reduction of just over a
$1 billion as a result of business decisions identi-
fied, evaluated, and supported by SCSM. The projects
95
that were launched are in three major areas: vendor
actions, customer actions, and internal actions. Ven-
dor actions mainly address improving the procure-
ment contract terms and conditions, such as mini-
mum inventory requirements, supply lead times, and
redistribution fees. Customer actions include contract
pricing decisions, assignment of customer locations to
cross-docks and to FDCs for cost effectiveness, and air
shipment of selected products to all customer sites.
Internal actions focus on improving inventory replen-
ishments, safety stocks, and lot sizes, streamlining
delivery and receiving processes, and optimizing the
network structure by adding, removing, or consoli-
dating sites.
Table 1 provides the list of actions McKesson took as
a result of insights and recommendations generated by
SCSM, their short descriptions, key performance indi-
cators (KPIs) that were impacted, and business bene-
fits that McKesson realized. We do not provide ben-
efits for warehouse actions, because the changes are
still pending, and the benefits are in the process of
materializing. We cannot provide some of the quan-
titative benefits because they are highly confidential.
Readers can see the details of those items in the table.
We provide some benefits for a combination of actions
because they were taken simultaneously; therefore, we
cannot attribute specific benefits to each action.
Next, we explain in detail some actions McKesson
took.
• Because McKesson has a well-established ground
transportation-based distribution network, it did not
consider alternatives to trucking as potentially sub-
stantial opportunities. The solution, however, showed
that the benefits of air transportation were signifi-
cant. Although air shipment costs are approximately
10 times higher than those of ground transportation,
McKesson’s ability to reduce inventory levels, while
improving service through inventory centralization,
resulted in savings that surpass the cost of air trans-
portation for hundreds of selected products. Hence,
SCSM recommended air shipment for a set of prod-
ucts as a new supply chain opportunity and esti-
mated its savings. In June 2010, McKesson started
piloting air shipment for selected products to cus-
tomers from the Memphis RDC. The air shipment
option initially seemed too expensive; however, the
inventory savings surpassed the increased cost of
 Katircioglu et al.: Supply Chain Scenario Modeler
96 Interfaces 44(1), pp. 85–104, © 2014 INFORMS

Scenario type Scenario description Business action description Impact on operational KPIs Financial benefits

Vendor actions Use better supply chain Optimize the supply flow that minimizes Reduced cost-to-serve Improved profit before
paths cost-to-serve at the SKU level (combination of inventory tax for each supply
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carrying, transportation and chain by

warehousing costs) vendor—Confidential
data not provided
Renegotiate vendor Find the break-even redistribution fee for each Improved PBT for each supply chain
redistribution fees vendor so McKesson is indifferent between for each vendor
direct shipments and shipments to hub
Reduce minimum Show vendors that inventory availability Reduced total inventory $550 million inventory
inventory targets can be achieved with inventory reduction
requirements levels lower than the current inventory
requirements
Reduce vendor supply Negotiate with the vendors supply lead time Reduced safety stock
lead times and variability reduction to reduce safety
stocks
Reduce in-transit Work with suppliers to reduce time between Reduced vendor to McKesson $300 million reduced
inventory from shipping and receiving working capital in-transit working
suppliers capital
Align supply order days Pick the order days of the week to minimize Reduced vendor to McKesson
within a week shipping time working capital
Customer actions Improve national Calculate the cost-to-serve for both Improved customer profitability Improved profit before
account pricing hub-and-spoke and direct shipment supply taxes—Confidential
flow, pick the optimal policies for serving data not provided
national accounts
Change cross-dock Reassign customer locations to cross-docks Higher capacity utilization, lower $50 million local
assignments to smooth warehouse capacity needs, and cost-to-serve warehouse and
to reduce cost-to-serve in-transit inventory
reduction
Provide air shipments Consolidate inventory in RDC for high value Reduced inventory, improved
products with high demand uncertainty and customer service, with increased
air-ship to customer locations shipping costs
Internal actions Streamline supply Put more resources on receiving to Reduced inventory and supply lead $100 million local
receiving process accommodate variations in receiving times warehouse inventory
workload reduction
Increase internal Schedule more frequent shipments from Reduced safety stock
delivery frequency hub to local warehouses
Optimize inventory Optimize the safety stock and lot size for each Reduced safety stock, reduced lot
policies SKU, taking into account SKU specific sizes, higher inventory availability
inputs
Optimize warehouse Consolidate warehouses and assign Optimal total net cost Changes
locations cross-docks optimally to warehouses pending—Benefits
not yet materialized
Change warehouses Reassign cross-docks to warehouses to Optimal total net cost
assignments smooth warehouse capacity needs, and
reduce cost-to-serve

Table 1: This table shows the mapping between scenarios, the actions they support, and the impact on KPIs and
financial metrics.

shipments. The products that SCSM identified for air
shipment have high value and high demand vari-
ability. Although these products required McKesson
to carry significant amounts of inventory in FDCs,
inventory availability was still not at the desired
levels because of highly uncertain demand. Central-
izing inventory in one location helped reduce the
impact of demand uncertainty; hence, it simultane-
ously reduced the stock-outs and safety stocks. After
a few months of running the air pilot, McKesson
 Katircioglu et al.: Supply Chain Scenario Modeler
Interfaces 44(1), pp. 85–104, © 2014 INFORMS 97

observed that inventory levels had decreased by

approximately half and on-time delivery for these #ENTRALIZED
products had increased to 99 percent from less than INVENTORY
 ANDAIRSHIP 
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90 percent. The success of the pilot verified the sav-

ings estimated by SCSM and convinced McKesson to
make air shipment a new permanent process in its
supply chain operations. McKesson annually sends
products valued at $300 million to its customers by
air. As of this writing, the company’s objective is to
increase this to $1 billion by the beginning of 2014.
McKesson is considering this new shipment policy for
handling products that it had to previously drop ship
from suppliers (i.e., suppliers directly sent the prod-
ucts to McKesson’s customers), allowing it to service
new markets.
• Some products were not distributed cost effec-
tively. Without end-to-end visibility and an ability to
estimate cost-to-serve for various distribution alter-
natives, McKesson could not determine (1) the prod-
ucts that it was distributing inefficiently (i.e., not
cost effectively), (2) the quantitative value of any
improvements, and (3) the most cost-effective meth-
ods of distribution. The company needed a roadmap
to improve the supply flow at the SKU level. Next, we
list two key findings relative to these inefficiencies.
1. For many products, the hub-and-spoke (i.e.,
vendor-to-RDC-to-FDC) supply chain required more
inventory than alternate supply chain paths.
2. For some customers, the hub (RDC)-to-
customer-to-warehouses supply chain path was more
cost effective.
Our solution enabled us to make these determina-
tions by showing the optimal supply path for each
item. It also estimated the benefits of moving to the
optimal supply flow by comparing its total cost to
that of the current supply flow. Overall, the results
showed that more than one-third of the items shipped
were not using the most cost-effective supply chain
path. Figure 5 shows the number of items that SCSM
recommended for supply flow change. For example, it
recommended moving more than 15,000 items from a
hub-and-spoke supply chain path to a direct-ship sup-
ply chain path. SCSM predicted a 20 percent reduc-
tion in inventory carrying costs if all items used their
optimal supply chain paths. It also predicted that the
total carbon emissions would decrease by 5.8 per-
cent, even though more than 1,700 items would use
air shipment; at optimality, many more items would

(UB
$IRECT
AND
SHIP
SPOKE

Figure 5: The SCSM model recommended shifting 35 percent of the
43,000 items to a different supply chain path.
move to a direct-ship supply chain path, which has
lower carbon emissions than a hub-and-spoke path.
• McKesson had substantial opportunities to lower
inventories and still provide the same service level.
Many items had unnecessary vendor-specified min-
imum inventory requirements. Some direct-shipped
items had reliable supply lead times from the ven-
dor to McKesson sites. Some of the items that were
shipped to the RDC in Memphis for redistribution
also had reliable supply lead times from the ven-
dor and McKesson’s internal RDC-to-FDC lead times
were generally very reliable. Some of these items
had minimum inventory requirements without any
rationale. SCSM provided the scientific reasoning and
the business case to allow McKesson to lower the
minimum inventory requirements for these items.
The results were instrumental in helping negotiate
better terms with vendors.
• McKesson’s suppliers begin billing at the time of
shipment. However, the company tracks the inven-
tory only upon receipt. This in-transit working capital
was not included in any report; therefore, no one at
McKesson had responsibility for managing it. SCSM
calculated the in-transit inventory based on supply
lead times and made it visible in the output reports.
This triggered actions to reduce this part of the total
inventory in the system, because a one-day improve-
ment in in-transit inventory represents $300 million in
working capital. These improvements reduced work-
ing capital, reduced variations in the supply flow, and
improved service.

98
In addition, using SCSM triggered other projects
at McKesson, including: the evaluation of alterna-
tive warehouse locations; identification of best supply
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flow at the vendor level; calculation of break-even ser-
vice fees for vendors to use the RDC as an alternative
to direct shipment to FDCs; evaluation of the impact
of supply lead times on inventory levels and cost of
working capital; profitability analysis of a group of
products; and reporting of the carbon footprint of the
supply chain at various levels of detail. Many of the
projects focused on reducing variations in the supply
chain, which reduces costs and improves service.
Data Collection Framework for
Performance Monitoring
To support the solution and its analytical models,
McKesson created a data analytics framework, which
includes extraction of historical data of daily transac-
tions by item and by location. This framework also
includes links from those transactions to their finan-
cial impacts. Virtually all physical and financial trans-
actions for the supply chain are made available as
inputs to the model and for tracking the impact of
resulting projects. In 2010, this framework was at a
prototype level. In 2011, it became more mature, and
the data extraction process was standardized. This
process continues to be refined. Prior to this work,
McKesson could not properly allocate its expenses to
product categories or vendors. Now the framework
is an integral part of McKesson’s P&L reporting for
product categories.
SCSM is helpful in identifying opportunities, and
also provides the detailed analysis reports McKesson
needs to make the improvements or changes and to
track the impacts of these changes. McKesson has
implemented many projects ranging from renegoti-
ated supplier contracts to changes in the day of week
specific orders are made, to improvements in receiv-
ing processes, and to changes in supply management
reports for suppliers.
Finally, because of the holistic nature of SCSM, the
user community at McKesson is diverse. SCSM identi-
fied major benefits and recommended changes; how-
ever to bring about these changes, the team needed
to convince the executive management team that it
needed to make changes to its operations. Convincing
managers who have operational P&L responsibility
Katircioglu et al.: Supply Chain Scenario Modeler
Interfaces 44(1), pp. 85–104, © 2014 INFORMS
to accept the solution and the results of its analy-
sis was a challenge, especially when the model rec-
ommended changing budgets or target performance
levels. For example, air shipment meant that the
transportation budget would have to increase sub-
stantially so that lower inventory levels could become
the new targets. These two metrics were owned by
different McKesson organizations. The management
of both operations had to agree that this would be
a good investment for the company. McKesson also
needed to explain the benefits of air shipments (e.g.,
higher inventory availability) to its customers so that
they would welcome the process change. In partic-
ular, it had to explain the rationale behind reduc-
ing minimum inventory requirements to McKesson’s
procurement management and the vendors. Without
this rationale, proposing substantial changes in inven-
tory policies would have made many people nervous.
SCSM provided this rationale. Nevertheless, it took
many months of intensive work on the part of the
project team to socialize the proposed changes and
convince the stakeholders of the benefits of execut-
ing them. The project team calculated the key metrics
before and after each business action so that it could
verify the projected benefits.
Conclusion
SCSM has been an innovative decision support tool
to allow McKesson to evaluate policy options in its
end-to-end pharmaceutical supply chain. Through its
integrated OR models, SCSM optimizes the distribu-
tion network, supply flow, inventory, and transporta-
tion policies, and quantifies the impacts of actions
on financial, operational, and environmental metrics.
The solution is the first to provide accurate models
of McKesson’s key operations, connect them to cre-
ate an end-to-end view of the business, and directly
link OR modeling results to a detailed P&L statement.
The solution development began in 2009 and was
completed in 2010. McKesson began using it in 2010
to support its analyses and decisions. The insights
from these scenarios led to a number of actions in
procurement, distribution, inventory, and supply flow
management. McKesson made changes in vendor
policies, customer policies, and policies in its internal
 Katircioglu et al.: Supply Chain Scenario Modeler
Interfaces 44(1), pp. 85–104, © 2014 INFORMS
operations. By the end of 2012, McKesson’s Pharma-
ceutical division had reduced its committed capital by
more than $1 billion.
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SCSM received attention from multiple levels of
management in different operations and enhanced the
collaborative decision-making process at McKesson.
It provides the company’s management with a clear
understanding of how various decisions and actions
impact performance metrics, and how it can change
policies and set targets for the overall benefit of the
company. SCSM proves the value of business analyt-
ics and OR models at McKesson and shows that even
if operations are running at their individual near-
optimal levels, integrated planning and decision mak-
ing opens doors to new opportunities.
McKesson executives acknowledged the value of
having the modeling capability and the detailed data
analytics needed to support it. Building models is a
journey; each model needs to be enhanced or modi-
fied over time as new insights create new questions
and reveal new opportunities. The key is to make
the invisible visible, that is, improve visibility to the
KPIs of the supply chain operations through analyti-
cal models and detailed data. Modeling is a powerful
way to discover hidden business opportunities that
cannot be seen by merely reading static business intel-
ligence reports.
One of the key success factors in this project was
that the core team at IBM and McKesson remained
unchanged throughout this project’s duration. The
stability and continuity were essential in bringing
such a complex solution to completion. Major cor-
porations can have a fair amount of turnover in
key positions. Although this project spanned several
years, the project team was dedicated to achieving
the end goal. The project lead at McKesson, who had
been with McKesson for many years, was very knowl-
edgeable about the company’s supply-chain and OR
techniques. He was well respected and influential in
bringing the project to a successful completion.
Late in 2011, McKesson U.S. Pharmaceutical labeled
the SCSM work as one of its strategic initiatives; its
objective was to make SCSM a part of its mainstream
data analytics and modeling to allow the company
to use it for more business decisions. In June 2012,
IBM and McKesson launched a Phase II effort to
99
expand the use of mathematical modeling and opti-
mization deeper into McKesson’s business processes.
As a result, McKesson identified a number of areas
that can benefit from business analytics and optimiza-
tion support. Meanwhile, IBM is taking the SCSM
solution to market and, through its commercialization
process, making it available to its clients in the distri-
bution sector and potentially other sectors.
Based on the lessons learned in this project, we
believe the future of business analytics and opti-
mization is less about improving existing models by
one notch, but rather about combining models in a
more holistic way. This requires understanding the
touch points of operations and how they affect each
other, designing data models that can connect them
effectively, and developing models and algorithms
that can efficiently solve the optimization problems.
Many aspects of business decision making will always
remain outside of our modeling capabilities. There-
fore, businesses will be more likely to use these
business analytics solutions if the solutions provide
flexible and interactive analysis and decision-making
support rather than a rigid solution recommendation.
Appendix A. Inventory Optimization Model
Our model (a two-echelon system similar to a one-
warehouse-N -retailer model) includes one RDC and mul-
tiple FDCs. Daily demand for each product is random.
Each location can place replenishment orders daily and uses
an (s1 S) inventory policy (i.e., when an inventory position
drops down to s, a supply order is placed at an amount that
increases the inventory position to S). The FDCs place sup-
ply orders to the RDC, which places the order to vendors.
Unfilled customer demand is lost. Unfilled FDC orders are
backlogged at the RDC. We define inventory position as
inventory on hand plus pipeline supply orders minus back-
logged demand. Each replenishment order has a fixed order
cost, and arrives after a random integer lead time.
We use the following notation where a period represents
a day. We omit the product index for ease of communica-
tion because it would otherwise appear in each expression.
Henceforth, index i = 0 refers to the RDC location, and i > 0
for FDC locations.
Oij 4t5: Order quantity placed in period t from customer j
at location i.
Di 4t5: Demand in period t at location i.
Li 4t5: Supply replenishment lead time for an order
placed in period t at location i.
Bi 4t5: Backlog at the end of period t at location i.
Ii 4t5: Inventory on hand at the end of period t at
location i.
 Katircioglu et al.: Supply Chain Scenario Modeler
100 Interfaces 44(1), pp. 85–104, © 2014 INFORMS

IPi 4t5: Inventory position at the end of period t at loca-
tion i before placing an order.
Qi 4t5: Replenishment order size placed in period t by
location i.
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for the rationale behind this is that if at least one pill is
delivered, this can potentially help a single patient in an
emergency situation. We formulate the inventory problem
as follows:

Qi+ 4t5: Sum of pipeline orders that arrive in period t at T

1X
location i. min lim C4t5
Qi− 4t5: Sum of pipeline orders that arrive after period t Si 1 i=110001n T −→ˆ T t=1
at location i. PT
„ 4t5
ˆit+ 4k5: Indicator (= 1 if order placed in period k arrives s.t. lim PTt=1 i ≥ 1 ∀ i = 11 0 0 0 1 n0
t=1 i 4t5
T −→ˆ
in period t at location i).
ˆit− 4k5: Indicator (= 1 if order placed in period k is still in The left side of the constraint is the long-run average service
the pipeline as of period t at location i). level achieved at the FDCs.
hi : Inventory holding cost per period at location i. Solution Approach. Because the replenishment lot-size
ai : Fixed order cost per replenishment order at location i. decision in period t impacts inventory and service in subse-
Next, we show the derivation of some key quantities at quent periods, an analytical solution to this problem is not
the RDC and the FDCs. We have Qi+ 4t5 = t−1 +
P
k=0 ˆit 4k5Qi 4k5 easy to calculate. Because the state space is large in dimen-
t−1
and Qi− 4t5 = k=0 ˆit− 4k5Qi 4k5, where
P
sion, formulating it as a dynamic programming problem
( is not likely to be fruitful. We use a simulation-regression
1 if k + Li 4k5 = t1
+
ˆit 4k5 = approach that involves sampling the universe of products
0 otherwise1 with different problem parameters, obtaining their opti-
mal inventory policies via simulation and optimization, and
and
then using a regression model to characterize the inventory
(
1 if k + Li 4k5 > t1
ˆit− 4k5 = policy for similar products. In our solution approach, we
0 otherwise1 set the economic order quantity as follows:
Pn
D0 4t5 = i=1 Qi 4t5. s
PJi
Di 4t5 = j=1 Oij 4t5, i = 11 0 0 0 1 n, where Ji is the number of 2ai Di 4t5
EOQi = Si − si = 0
customers served by location i. hi
Bi 4t5 = 4Bi 4t − 15 + Di 4t5 − Ii 4t − 15 − Qi+ 4t55+ . To develop a simulation-optimization framework, we
Ii 4t5 = 4Ii 4t − 15 + Qi+ 4t5 − Bi 4t − 15 − Di 4t55+ . first developed a discrete-event simulation model of the
IPi 4t5 = Ii 4t5 + Qi− 4t5 − Bi 4t5, where Bi 4t5 = 0 for all i =
two-echelon supply chain problem. Simulation models to
11 0 0 0 1 n and B0 4t5 ≥ 0.
analyze supply chain performance have been used in the
Qi 4t5 = 4S − IPi 4t55+ , i = 11 0 0 0 1 n.
literature—Bashyam and Fu (1998) provide a review. Our
Let us define
( simulation model has some unique differences because of
1 if Qi 4t5 > 01 McKesson’s unique operational characteristic (e.g., the need
…i 4t5 = for a pseudo-FDC to meet customer demand at the RDC,
0 otherwise.
and service-level definition). We created a simulation-based
Here, …i 4t5 = 1 indicates that at the end of period t, loca- optimization algorithm that has two levels. In the inner
tion i places a replenishment order. The total cost in period t level, for a given (s1 S) policy at the RDC, we use a bisection
is given by search to find the optimal (s1 S) policies at the FDCs. In the
n
X
C4t5 = 4hi Ii 4t5 + ai …i 4t550 outer loop, we find the value of s at the RDC, which mini-
i=0
mizes the total cost using a cost-based bisection-type search.
We are interested in minimizing the long-run average Each time we change the value of s at the RDC, we need
cost subject to a minimum long-run average service level, to run a bisection search for the FDCs to find their optimal
. To calculate the service level, we define the following s values. To provide reasonable solutions quickly for each
indicator variables: item, we use the following regression model to estimate the
( optimal service level R at the RDC as a function of the
1 if Di 4t5 > 0 and Ii 4t − 15 + Qi+ 4t5 > 01 supply chain parameters:
„i 4t5 =
0 otherwise, 
R

log = ‚0 + ‚1 log N + ‚2 log EOQ + ‚3 log ŒD
and ( 1 − R
1 if Di 4t5 > 01
i 4t5 = + ‚4 log ‘D + ‚5 log ŒL + ‚6 log ‘L
0 otherwise0
+ ‚7 log h + ‚8 log 1
Here, i 4t5 = 1 when there is a demand in period t and
„i 4t5 = 1 when at least one unit of demand is satisfied. This where N is the number of FDCs in the network, EOQ is
is the way McKesson wanted to define service. An analogy the economic order quantity at the RDC, ŒD and ‘D are
 Katircioglu et al.: Supply Chain Scenario Modeler
Interfaces 44(1), pp. 85–104, © 2014 INFORMS
the mean and the standard deviation, respectively, of the
daily demand at the RDC, ŒL and ‘L are the mean and
the standard deviation, respectively, of the supply lead time
faced by the RDC, h is the unit holding cost per period in
Downloaded from informs.org by [140.234.255.9] on 17 November 2014, at 20:13 . For personal use only, all rights reserved.
the RDC, and  is the common target service level at the
FDCs. The regression can explain two-thirds of the variation
in the optimal service target at the RDC.
We also tried heuristic methods as alternatives. For more
details on the methods we tried and their performance, see
Li et al. (2010). The simulation-regression method was much
quicker than the heuristics and provided comparable solu-
tions with the system cost being within five percent of that
of the optimal (s1 S) policy. Once the optimal RDC service
level is estimated, we adjust the supply lead times from the
RDC to FDCs by using Lai 4t5 = Li 4t5 + 41 − R 5L0 4t5. Then, we
approximate the optimal reorder points for both the RDC
and the FDCs by using si = ŒLD LD
i + z4i 5‘i , where Œi
LD
and
‘iLD are the mean and the standard deviation, respectively,
of the demand during the lead time at location i, and z4i 5 is
the inverse of the standard normal distribution evaluated at
i , the service target at location i.
We also need to solve the single-echelon problem because
the supply flow optimization also uses a single-echelon
model. In this case, we use the same approximations to esti-
mate the optimal reorder points for the FDCs. However, no
adjustment is needed for the lead times.
These approximations perform well when the service tar-
gets are high (see Li et al. 2010), which is McKesson’s case.
Appendix B. Supply Flow Optimization Model
The objective of the supply flow optimization model is to
find the best distribution path for the items. Three major
flow alternatives, which McKesson calls supply chains or
supply-chain paths, are possible. We will use this terminol-
ogy and define three major supply-chain paths.
SC1. Vendor-RDC-FDC-customer flow. This is the two-
echelon model that we formulated previously. The vendors
ship supplies to the RDC (i.e., hub in Memphis), which dis-
tributes supplies to all FDCs making shipments to customer
locations.
SC2. Vendor-FDC-customer flow. This is the direct-
shipment (single-echelon) model in which the vendor ships
supply to the FDCs directly.
SC3. Vendor-RDC-customer. This is a direct-shipment
model from the RDC to customers via air (because all cus-
tomers can only be reached by air only with an overnight
service target).
Next, we formulate the objective function for these
flows:
sj : supply chain path for item j (s = 11 21 3).
rij : redistribution fee McKesson charges vendors (per
unit) at location i for item j.
hij : annual inventory carrying cost (per unit) at location i
for item j.
101
wij : annual warehousing cost (per unit) at location i for
item j.
tijs : outbound transportation cost (per unit) at location i
for item j in supply chain path s.
Iijs : expected average inventory at location i for item j in
supply chain path s when inventory policies are optimized.
Dijs : expected total annual demand at location i for item j
in supply chain path s.
Here, because the redistribution fee only applies at the
RDC and for supply chain paths 1 and 3, we have
(
0 if sj = 2 or i > 01
rij =
≥ 0 otherwise0
Note that i = 0 refers to the RDC and i > 0 is used for
FDCs. The total annual cost for item j as a function of
supply-chain path s is
n
X
TCj 4s5 = 4hij Iijs + wij Dijs + tijs Dijs − rij Dijs 50
i=0
If the user creates a scenario in which supply-chain
path sj is selected for item j, then SCSM reports TC =
P m
j=1 T Cj 4sj 5. If the user requests an optimal supply-chain
Pm for item
path j in a scenario, then SCSM reports TC =
∗ ∗
j=1 T Cj 4sj 51 where sj is the optimal supply chain path for
item j, which minimizes T Cj 4s5. Note that to do the mini-
mization, the inventory optimization engine has to be used,
because Iijs is the inventory level of the optimal inventory
policy for supply chain path s.
Appendix C. Network Assignment Model
When we look at the big picture, the network starts with
vendor locations, includes the RDC, the FDCs, the cross-
docks (we use XDC), and the customer locations. The part
of the network that starts at the XDC and ends at the cus-
tomer locations is a VRP and is handled by the VRP engine.
The part that starts at the vendors and ends when sup-
ply reaches the RDC and FDCs is the supply flow prob-
lem and is handled by the supply-flow model we describe
previously. Therefore, the network model handles the flow
from the RDC and the FDCs to the XDCs. This is mainly an
assignment problem (i.e., assigning the XDCs to the FDCs
and the RDC), where the objective is to minimize the sum
of the inventory carrying, the warehousing, and the trans-
portation costs. When an XDC is assigned to an FDC, all
customer locations served from that XDC on a daily basis
are automatically associated with the assigned FDC; there-
fore, their demand must be handled by that FDC. In a way,
an XDC represents a cluster of demand nodes, which must
be satisfied by the FDC linked to that XDC. Next, we give
the formulation of the problem:
hij : annual inventory carrying cost (for a single unit) in
FDC i for item j.
wij : annual warehousing cost (for a single unit) in FDC i
for item j.
tikj : outbound transportation cost (for a single unit) in
FDC i to serve XDC k for item j.
 Katircioglu et al.: Supply Chain Scenario Modeler
102 Interfaces 44(1), pp. 85–104, © 2014 INFORMS

Sij : average days of supply (inventory) maintained in where

FDC i for item j.
Dkj : annual demand at XDC k for item j. OperationHours4i1j1k1’5
Dk = nj=1 Dkj : total demand at XDC k.
P
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TPS 4i1j1k1’5
Ci : Capacity at location i expressed in number of item = OPHB 4i1j1k1’5 1+TPF4i1’5 −1 1
units. TPB 4i1j1k1’5
ˆik : indicator variable (= 1 if XDC k can be reached from OPH B 4i1j1k1’5 ≡ Total operation hours in the base case1
FDC i, and 0 otherwise).
aik : indicator variable (= 1 if XDC k is assigned to FDC i, TPF4i1’5 ≡ Total throughput at location i in period ’1
and 0 otherwise). measured in number of items processed1
The total annual cost of serving XDC k from FDC i is
n n n
TPS 4i1j1k1’5 ≡ Throughput in the scenario case1
1 X X X
cik = hij Dkj Sij + wij Dkj + tikj Dkj 0 TPB 4i1j1k1’5 ≡ Throughput in the base case0
365 j=1 j=1 j=1

Heuristic Algorithm: Here, the EmissionFactor4—5 is the amount of carbon

1. Assume {Dk , k = 11 0 0 0 1 K} are sorted in decreasing emitted if energy source — is used for one hour for one
order without loss of generality. unit of power (e.g., kilowatt-hours for electricity). Power4j5
2. Set a4k1 i5 = 0 for all k = 11 0 0 0 1 K, i = 01 0 0 0 1 I, where indicates the power level of equipment j. When the energy
K is the total number of XDCs, and I is the total number of source — is not electricity (e.g., natural gas, propane, diesel):
FDCs. Note that i = 0 refers to RDC.
3. k ←− 1. CO2 Emissions4i1j1k1—1’5
4. Find the cheapest FDC that has the capacity to serve
XDC k. Let imin indicate that FDC. If there is no FDC that = FuelConsumed4i1j1k1’5×EmissionFactor4—51 (D3)
can meet the demand of XDC k, then determine imin by
rationalizing overcapacity (see explanation next). where:
5. a4k1 imin 5 ←− 1 (assign XDC k to FDC imin ). FuelConsumed4i1 j1 k1 ’5
6. Ci = Ci − Dk (update capacity of FDC i).
7. k ←− k + 1. OperationHours4i1 j1 k1 ’5
= 1 and
8. If k ≤ K, go to step 4. EFF4j5 (D4)
9. Stop; 8a4k1 i51 k = 11 0 0 0 1 K1 i = 01 0 0 0 1 I9 represents the
recommended XDC-FDC assignments. EFF4j5
If all FDCs that can serve the XDC at hand are out of ≡ Efficiency factor (e.g., hours per gallon)0
capacity, we rationalize the overcapacity. This is done sim-
ply by assigning the current XDC to the FDC that would Transportation Emissions
have the smallest percentage of utilization among others Let l and ‹ be the indices for transportation type and equip-
after the assignment is done. This rule ensures that all ment, respectively. Let — be the index for the energy source,
demand is met and allocation of demand in excess of capac- and let ’ be the duration of a planning period. The total CO2
ity is balanced across available FDCs. emissions for all transportation over a planning interval of
duration ’ is:
Appendix D. Sustainability Model
Transportation CO2 Emissions4l1 ‹1 —1 ’5
Warehouse Emissions
Let i, j, and k be the indices for location, equipment, and
XXX
= CO2 Emissions4l1 ‹1 —1 ’51 (D5)
operation type, respectively. Let — be the index for the l ‹ —
energy source, and let ’ be the duration of a planning
period. The total CO2 emissions for a warehouse (i.e., loca- where
tion i) over a planning interval of duration ’ is:
CO2 Emissions4l1 ‹1 —1 ’5
Warehouse CO2 Emissions4i1 ’5
XXX = FuelConsumed4l1 ‹1 ’5 × EmissionFactor4—50 (D6)
= CO2 Emissions4i1 j1 k1 —1 ’50 (D1)
j k — When the transportation type l is ground, then:
When the energy source, —, is electricity, then:
TotalGroundMiles4l1 ‹1 ’5
CO2 Emissions4i1 j1 k1 —1 ’5 FuelConsumed4l1 ‹1 ’5 = 1 (D7)
FuelEfficiency4l1 ‹1 —5
= Power4j5 × OperationHours4i1 j1 k1 ’5
where fuel efficiency, in miles per gallon, is calculated as
× EmissionFactors4—51 (D2) a function of equipment type and energy, and based on
 Katircioglu et al.: Supply Chain Scenario Modeler
Interfaces 44(1), pp. 85–104, © 2014 INFORMS
an average load factor. When the transportation type l is
air, then:
TotalAirMilesCuFT4l1 ‹1 ’5
FuelConsumed4l1 ‹1 ’5 = 0 (D8)
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FuelEfficiency4l1 ‹1 —5
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Kaan Katircioglu is a senior research scientist and man-
ager at IBM T.J. Watson Research Center. He has 17 years
of industry experience in OR/MS. He received his BSc in
industrial engineering, MSc in statistics, and PhD in OR/MS.
At IBM Research, he has conducted close to 40 projects
for various divisions of IBM and its clients. He performed
as IBM representative at SEMATECH Logistics Forum in
1997–2000, and as the IBM Research Relationship Manager
for Travel and Transportation Industry in 2007–2009. He
has several granted and pending patent applications for his
work. His research areas include business analytics, opti-
mization, supply chain, sustainability, and IT service man-
agement. His industry experience spans travel and trans-
portation, distribution, financial and industrial sectors. He
is a member of IBM Academy of Technology and currently
manages a group of researchers in Watson’s Services Inno-
vation Lab.
Robert Gooby is the VP of process redesign for the
McKesson Corporation, a Fortune top 16 company and
the largest healthcare services company in North America.
Bob has been with McKesson for 18 years where he has
been dedicated to re-engineering critical processes, primar-
ily in transaction processing including purchasing, inven-
tory management, and other administrative processes. Prior
to his current role, Bob was the Six Sigma Deployment
Champion for McKesson’s Shared Financial Service Organi-
zation. Previously, Bob held a variety of executive positions
with NCR and IBM in inventory management, customer ful-
fillment, business planning, strategy and market research,
in the U.S. and Europe. Bob has a BA in mathematics and
statistics, an MS and PhC in operations research, from the
University of California, Berkeley.
Mary Helander is a math scientist and master inven-
tor in the Mathematical Sciences Department at IBM’s T.J.
Watson Research Center. Mary has more than 20 years
of combined industry and academic experience in opera-
tions research, optimal network and transportation plan-
ning, software engineering, and supply chain management.
Prior to IBM, Mary was the director of the Applied Soft-
ware Engineering Lab at Linköping University in Sweden,
where she was a faculty member of the Computer and
Information Science Department and a research fellow with
the Department of Mechanical Engineering/Quality Tech-
nology Group. Mary earned a BA in CIS and mathematics
from the State University of New York at Potsdam, an MS in
IE/OR from Syracuse University, a PhD in IE/OR from the

104
University at Buffalo, and a Docent in quality technology
and software engineering from Linköping University.
Youssef Drissi is an IBM master inventor, a Franz Edel-
man laureate, and a senior member of the Business Analyt-
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ics and Mathematical Sciences Department at IBM Research.
He is involved in the research and technical leadership of
innovative projects and technologies in the areas of business
analytics, strategic enterprise planning, risk management,
decision analytics under uncertainty, supply chain, sustain-
ability, and resilient business services. Youssef is a recog-
nized prolific inventor, with over 50 inventions, including
a number of unstructured information management patents
co-invented with David Ferrucci. Youssef is the author of
several publications in refereed and peer-reviewed journals
and conferences. Previously, he was involved in research
projects in the areas of knowledge management and text
analytics, as a member of the Semantic Analysis and Inte-
gration Department at IBM Research. Youssef received his
master’s degree in computer science from Ecole Centrale de
Paris, France.
Pawan Chowdhary is a senior technical staff member in
the Business Analytics and Mathematical Science Depart-
ment at T.J. Watson Research Center at IBM. He leads several
projects in the area of bid pricing and procurement-spend
analysis. In the past, he co-led and was chief technical archi-
tect for the next generation supply chain solution (SCSM)
that earned him the laureate status in INFORMS’ Edel-
man Prize Competition. His areas of interests are integrated
Katircioglu et al.: Supply Chain Scenario Modeler
Interfaces 44(1), pp. 85–104, © 2014 INFORMS
analytics, data warehousing, and big data. He has received
several outstanding research awards for his contributions,
holds several patents, and published several papers in pro-
fessional journals and conferences.
Matt Johnson is senior director of financial planning and
analysis for McKesson Corporation, one of the world’s lead-
ing providers of healthcare services and technology. Matt
has been with McKesson Corporation since 2008 focusing
on supply chain profitability, M&A valuations, competitive
analysis, and financial analysis of the generic drug supply
chain. Prior to joining McKesson, Matt worked at Amgen
Corporation, VWR International, and various healthcare
diagnostic firms. Matt has an MBA from Vanderbilt Univer-
sity specializing in healthcare policy and corporate financial
management, and a BS in biochemistry from the University
of Tennessee.
Takashi Yonezawa is a consultant and data scientist in
the Business Analytics and Optimization Department at
IBM Global Business Services Japan. In the last decade,
Takashi has been in business analytics consulting prac-
tice, particularly for supply chain optimization and sys-
tem integration. Before that, Takashi was a software engi-
neer developing logistics and supply chain optimization
software including solutions to vehicle routing problem.
Takashi was an adjunct and part-time teacher of opera-
tions research and mathematical programming in Shonan
Institute of Technology. Takashi holds a Bachelor of Science
degree in physics from the Kyoto University in Japan.
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