OPER3208-001 Supply Chain Management

Fall 2006 Instructor: Prof. Setzler

Simchi-Levi, Chapters 5

Chapter 5: Supply Chain Integration (Simchi-Levi)

Introduction
The challenge in SC integration is to coordinate activities across the SC so that the enterprise can improve performance
Reduce cost Increase service level Reduce the bullwhip effect Better utilize resources Effectively respond to changes in the marketplace

These challenges are only met by coordination of

Production Transportation Inventory decisions Integrating the front-end of the SC (i.e., customer demand), and the back-end of the SC (i.e., production and manufacturing)

Chapter 5: Supply Chain Integration (Simchi-Levi)

Push-Based Supply Chain
Production and distribution decisions are based on long-term forecasts
Demand forecast for manufacturer is based on orders received from the retailers warehouse
As discussed in Ch 4, the variability of orders received from retailers and warehouses is much larger than the variability of customer demandBullwhip Effect Increases in variability leads to Excessive inventories (safety stock) Larger and more variable production batches Unacceptable service levels Product obsolescence

It takes longer for a push-based SC to react to changes in the marketplace, which can lead to
The inability to meet changing demand patterns The obsolescence of SC inventory

Chapter 5: Supply Chain Integration (Simchi-Levi)

Push-Based Supply Chain

Due to the need for emergency production changeovers, we often find increased transportation costs, high inventory levels, and/or high manufacturing costs

Chapter 5: Supply Chain Integration (Simchi-Levi)

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

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

These systems typically have
A significant reduction in system inventory level Enhanced ability to manage resources A reduction in system costs (when compared to an equivalent push-based system)

Pull systems are difficult to implement when lead times are too long
Unable to react to demand

Pull systems are more difficult to take advantage of economies of scale in manufacturing and transportation since systems are not planned far ahead in time

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

A new SC strategy that takes advantage of the best of the push strategy and the pull strategy Some stages of the SC (usually the initial stages) operate as a push-based system, the remaining stages operate as a pull-based system The interface (boundary) between the push-based stages and the pull-based stages is called the pushpull boundary

Chapter 5: Supply Chain Integration (Simchi-Levi)

Push-Pull Supply Chain

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

Example 1: Dell Computers uses the push-pull strategy
Manufacturer builds to order Component inventory is managed based on forecast (push)
Demand for component is an aggregation of demand for all finished goods that use that component Since aggregate forecasts are more accurate, uncertainty in component demand is much smaller than uncertainty in finished goods This leads to a reduction in safety stock

Final assembly is in response to specific orders (pull) The push-pull boundary is at the beginning of the assembly process

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

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

Chapter 5: Supply Chain Integration (Simchi-Levi)

Identifying the Appropriate Supply Chain Strategy

Figure 5.2 provides a framework for matching SC strategies with products and industries

Chapter 5: Supply Chain Integration (Simchi-Levi)

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

Chapter 5: Supply Chain Integration (Simchi-Levi) Identifying the Appropriate Supply Chain Strategy
Box 1 represents industries (i.e., products) such as computer industry (e.g., Dell uses the pull-based strategy) Box 3 represents product in the grocery industry such as beer, pasta, and soup (a push-based retail strategy is appropriate)
Demand is stable

Boxes 1 & 3 represent situations in which it is relatively easy to identify an efficient SC strategy

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

Chapter 5: Supply Chain Integration (Simchi-Levi)

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

Chapter 5: Supply Chain Integration (Simchi-Levi)

Implementing a Push-Pull Strategy

There are many ways to implement a pushpull strategy, depending on the location of the push-pull boundary
Dell locates the push-pull boundary at the assembly point Furniture manufacturers locate the boundary at the production point

Chapter 5: Supply Chain Integration (Simchi-Levi)

Implementing a Push-Pull Strategy
Push strategy
Demand uncertainty is relatively small and managing this portion based on long-term forecast is appropriate
Service level is not an issue, so the focus can be on cost minimization Low demand uncertainty and economies of scale in production and/or transportation Long lead times and complex SC structures, including product assembly at various levels Cost minimization is achieved by better utilizing resources such as production and distribution capacity while minimizing inventory, transportation, and production costs

Pull strategy
Uncertainty is high, and it is important to manage this portion based on realized demand
High uncertainty, and a short cycle time Focus is on service level High service level is achieved by deploying a flexible and responsive SC A SC that can adapt quickly to changes in customer demand

Chapter 5: Supply Chain Integration (Simchi-Levi)

Implementing a Push-Pull Strategy

Different processes need to be used in different portions of the SC
The focus in the pull part of the SC is on service level, order fulfillment processes are typically applied The focus of the push part of the SC is on cost and resource utilization, SC planning processes are used to develop effective strategies for a given planning horizon (e.g., a few weeks, or months)

Chapter 5: Supply Chain Integration (Simchi-Levi)

Implementing a Push-Pull Strategy

Table 5-1 summarizes the characteristics of the push and pull portions of the SC

Chapter 5: Supply Chain Integration (Simchi-Levi)

Implementing a Push-Pull Strategy
Notice that the push portion and the pull portion of the SC interact only at the push-pull boundary
This is the point along the SC time line where there is a need to coordinate the two SC strategies
Typically through buffer inventory This inventory takes a different role in each portion In the push portion, buffer inventory at the boundary is part of the output generated by the tactical planning process In the pull portion, buffer inventory represents the input to the fulfillment process

The interface between the push portion and the pull portion of the SC is forecast demand
Forecast demand is based on historical data obtained from the pull portion Forecast is used to drive the SC planning process and determines the buffer inventory

Chapter 5: Supply Chain Integration (Simchi-Levi)

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

Chapter 5: Supply Chain Integration (Simchi-Levi)

Demand-Driven Strategies
The forecast is not completely accurate
An important output from the demand-forecast and demand-shaping processes is an estimate of the accuracy of the forecast
Forecast error Measured according to its standard deviation

High demand forecast error has a detrimental impact on SC performance

Resulting in lost sales, obsolete inventory, and inefficient utilization of resources

Chapter 5: Supply Chain Integration (Simchi-Levi)

Demand-Driven Strategies
Can the firm employ SC strategies to increase forecast accuracy and decrease forecast error?
Select the push-pull boundary so that demand is aggregated over one or more of the following dimensions
Demand aggregated across products Demand aggregated across geography Demand aggregated across time

Use market analysis and demographic and economic trends to improve forecast accuracy Determine the optimal assortment of products by store so as to reduce the number of SKUs competing in the same market Incorporate collaborative planning and forecasting processes with your customers so as to achieve a better understanding of market demand, impact of promotions, pricing events, and advertising

Chapter 5: Supply Chain Integration (Simchi-Levi) Demand-Driven Strategies

At the end of the demand planning process, the firm has a demand forecast by SKU by location The next step is to analyze the SC to see if it can support these forecasts
This process is called supply and demand management It involves matching supply and demand by identifying a strategy that minimizes total production, transportation, and inventory costs, or a strategy that maximizes profits The firm also needs to determine the best way to handle volatility and risks in the SC

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

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

Chapter 5: Supply Chain Integration (Simchi-Levi)

The Impact of the Internet on Supply Chain Strategies

Chapter 5: Supply Chain Integration (Simchi-Levi)

The Impact of the Internet on Supply Chain Strategies

Chapter 5: Supply Chain Integration (Simchi-Levi)

The Impact of the Internet on Supply Chain Strategies

Chapter 5: Supply Chain Integration (Simchi-Levi)

The Impact of the Internet on Supply Chain Strategies

Chapter 5: Supply Chain Integration (Simchi-Levi)

What is E-Business
E-business
A collection of business models and processes motivated by Internet technology and focusing on improvement of extended enterprise performance

E-commerce
The ability to perform major commerce transactions electronically

Chapter 5: Supply Chain Integration (Simchi-Levi) What is E-Business

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

Chapter 5: Supply Chain Integration (Simchi-Levi)

The Grocery Industry
A typical supermarket employs a push-based strategy where inventory at the warehouses and stores is based on a forecast Peapod
On-line grocer Founded 11 years ago Idea: establish a pure pull strategy with no inventory and no facilities
Customers ordered groceries, Peapod would pick the products at a nearby supermarket There were significant service problems since stockout rates were very high (about 8 to 10%)

Peapod changed its business model to a push-pull strategy by setting up a number of warehouses; stockout rates are now less than 2%
The push part is the portion of the Peapod SC prior to satisfying customer demand and the pull part starts from a customer order Since Peapod warehouse covers a large geographical area, clearly larger than the one covered by an individual supermarket, demand is aggregated over may customers and locations, resulting in better forecasts and inventory reduction

Chapter 5: Supply Chain Integration (Simchi-Levi)

The Grocery Industry

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

Chapter 5: Supply Chain Integration (Simchi-Levi)

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

Chapter 5: Supply Chain Integration (Simchi-Levi)

The Book Industry

Barnes and Noble had a typical push supply chain
Amazon.com changed its Barnes and Nobles philosophy Has several warehouses around the country where most of the titles are stocked Inventory at the warehouses is managed based on a push strategy Demand is satisfied based on individual requests, a pull strategy

Chapter 5: Supply Chain Integration (Simchi-Levi) The Retail Industry

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

Chapter 5: Supply Chain Integration (Simchi-Levi) The Retail Industry

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

Chapter 5: Supply Chain Integration (Simchi-Levi)

The Retail Industry

The move from brick-and-mortar to click-andmortar is not an easy one, and may require skills that the brick-and-mortar companies dont have

Chapter 5: Supply Chain Integration (Simchi-Levi)

Impact on Transportation and Fulfillment

The Internet and the associated new SC paradigms introduce a shift in fulfillment strategies: from cases and bulk shipments to single items and smaller-size shipments, and from shipping to a small number of stores to serving highly geographically dispersed customers This shift has also increased the importance and the complexity of reverse logistics

Chapter 5: Supply Chain Integration (Simchi-Levi)

Impact on Transportation and Fulfillment

Table 5-2 summarizes the impact of the Internet on fulfillment strategies

Chapter 5: Supply Chain Integration (Simchi-Levi) Impact on Transportation and Fulfillment

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

Chapter 5: Supply Chain Integration (Simchi-Levi) Impact on Transportation and Fulfillment

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

Chapter 5: Supply Chain Integration (Simchi-Levi) Distribution Strategies

Typically, three distinct outbound distribution strategies are utilized:
1. Direct shipment
Items are shipped directly from the supplier to the retail stores without going through distribution centers Classic strategy in which warehouses keep stock and provide customers with items as required

2. Warehousing

3. Cross-docking

Items are distributed continuously from suppliers through warehouses to customers Warehouses rarely keep the items more than 10 to 15 hours

Chapter 5: Supply Chain Integration (Simchi-Levi)

Direct shipment
Bypass warehouses and distribution centers Employing direct shipment, the manufacturer or supplier delivers goods directly to retail stores The advantages
The retailer avoids the expenses of operating a distribution center Lead times are reduced

Chapter 5: Supply Chain Integration (Simchi-Levi)

Direct shipment
Disadvantages:
Risk-pooling effects are negated because there is no central warehouse The manufacturer and distributor transportation costs increase because it must send smaller trucks to more locations

Direct shipment is common when the retail store requires fully loaded trucks, which implies that the warehouse does not help in reducing transportation cost
Sometimes, the manufacturer is reluctant to be involved with direct shipping but may have no choice in order to keep the business Also prevalent in the grocery industry, where lead times are critical because of perishable goods

Chapter 5: Supply Chain Integration (Simchi-Levi) Cross-Docking

A strategy that Wal-Mart made famous Warehouses function as inventory coordination points rather than as inventory storage points Goods arrive at warehouses from the manufacturer, are transferred to vehicles serving the retailers, and are delivered to the retailers as rapidly as possible This system limits inventory cost and decreases lead time by decreasing storage time

Chapter 5: Supply Chain Integration (Simchi-Levi)

Distribution Strategies
Few major retailers utilize one of these strategies exclusively
Different approaches are used for different products, making it necessary to analyze the SC and determine the appropriate approach to use for a particular product or product family

Chapter 5: Supply Chain Integration (Simchi-Levi) Distribution Strategies

What are the factors that influence distribution strategies?
Customer demand and location Service level Transportation costs inventory costs

Both transportation and inventory costs depend on shipment size, but in opposite ways
Increasing lot sizes reduces delivery frequency and enables the shipper to take advantage of price breaks in shipping volume, which reduces transportation costs Large lost sizes increase inventory cost per item because items remain in inventory for a longer period of time

Chapter 5: Supply Chain Integration (Simchi-Levi)

Distribution Strategies
Demand variability also has an impact on the distribution strategy
Demand variability has a huge impact on cost
The larger the variability, the more safety stock needed Stock held at the warehouses provides protection against demand variability and uncertainty, and due to risk pooling, the more warehouses a distributor has, the more safety stock is needed If warehouses are not used for inventory storage, as in the crossdocking strategy, or if there are no warehouses at all, as in direct shipping, more safety stock is required in the distribution system This is true because in both cases each store needs to keep enough safety stock This effect is mitigated by distribution strategies that enable better demand forecasts and smaller safety stocks, and transshipment strategies Any assessment of different strategies must also consider lead time and volume requirements

Chapter 5: Supply Chain Integration (Simchi-Levi)

Distribution Strategies
Table 5-3 summarizes and compares the three distribution strategies

Chapter 5: Supply Chain Integration (Simchi-Levi) Transshipment

An important option to consider when selecting SC strategies
Transshipment: The shipment of items between different facilities at the same level in the SC to meet some immediate need Transshipment is considered at the retail level Transshipment capability allows the retailer to meet customer demand from the inventory of other retailers
The retailer must know what other retailers have in inventory and must have a rapid way to ship the items either to the store where the customer originally tried to make the purchase or to the customers home Requirements can only be met with advanced information systems, which allow a retailer to see what other retailers have in stock and facilitate rapid shipping between retailers

Chapter 5: Supply Chain Integration (Simchi-Levi) Centralized versus Decentralized Control

Centralized Control
Decisions are made at a central location for the entire supply network Objective: to minimize the total cost of the system while maintaining some stated service-level requirement True when the network is owned by one entity True when the network includes many different organizations
Savings, or profits, need to be allocated across the network using some contractual mechanism

Leads to global optimization

Chapter 5: Supply Chain Integration (Simchi-Levi)

Centralized versus Decentralized Control

Decentralized Control
Each facility identifies its most effective strategy without considering the impact on the other facilities in the SC Leads to local optimization

Chapter 5: Supply Chain Integration (Simchi-Levi) Centralized versus Decentralized Control

Centralized distribution network will be at least as effective as a decentralized one With advances in IT, all facilities in a centralized system can have access to the same data
Single point of contract
Information can be accessed from anywhere in the SC and is the same no matter what mode of inquiry is used or who is seeking the information Allows for sharing of information Utilization of this information in ways that reduce the bullwhip effect and improve forecasts Allow for the use of coordinated strategies across the entire SC Strategies that reduce systemwide costs and improve service levels

Chapter 5: Supply Chain Integration (Simchi-Levi)

Centralized versus Local Facilities

Important considerations
Safety stock
Consolidating warehouses allows the vendor to take advantage of risk pooling The more centralized an operation is, the lower the safety stock levels

Overhead
Economies of scale suggest that operating a few large central warehouses leads to lower total overhead cost relative to operating many smaller warehouses

Chapter 5: Supply Chain Integration (Simchi-Levi)

Centralized versus Local Facilities

Important considerations
Economies of scale
Economies of scale can be realized if manufacturing is consolidated Often much more expensive to operate many small manufacturing facilities than to operate a few large facilities with the same total capacity

Lead time
Lead time to market can often be reduced if a large number of warehouses are located closer to the market areas

Chapter 5: Supply Chain Integration (Simchi-Levi)

Centralized versus Local Facilities
Important considerations
Service
Depends on how service is defined Centralized warehousing enables the utilization of risk pooling, which means that more orders can be met with a lower total inventory level Shipping time from the warehouse to the retailer will be longer

Transportation costs
Directly related to the number of warehouses used As the number of warehouses increases, transportation costs between the production facilities and the warehouses also increases because total distance traveled is greater, and quantity discounts are less likely to apply Transportation costs from the warehouses to the retailers are likely to fall because the warehouses tend to be much closer to the market area

Chapter 5: Supply Chain Integration (Simchi-Levi)

Centralized versus Local Facilities

It is possible
That in an effective distribution strategy, some products will be stored in a central facility while others will be kept in various local warehouses
e.g., very expensive products with low customer demand may be stocked at a central warehouse while low-cost products facing high customer demand may be stocked at many local warehouses