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Supply Chain Management

By Prof. Prasad Kulkarni

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Module 1

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Introduction to supply Chain Management


Supply chain objectives importance decision phases process view competitive and supply chain strategies achieving strategic fit supply chain drivers obstacles framework facilities inventory transportation information sourcing pricing.

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

definition
A supply chain consists of all parties involved directly or indirectly in fulfilling a customer request. It includes manufacturer supplier, transporters, warehouses, retailers and customers.

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Supply chain management in HUL

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Objectives
Objective 1: enhance the supply chain value Supply chain value is the difference between final worth of product to customer minus costs supply chain incurs in filling the customers request.

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Objective 2: Increase the supply chain profitability. Supply chain profitability is the difference between the revenue generated from the customer and the overall cost across the value chain.

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Objective 3: Maximize the customer satisfaction Objective 4: Have product replenishment at right time.

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Importance of supply chain


Transportation and information infrastructure facilitates effective flow of goods and information. Proper management of product, information and fund flows increases the profitability. Involving customers in supply chain improves the effectiveness. Zero inventory system and JIT reduces the cost of manufacturing.
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[Decision Phases of a Supply Chain ] Supply chain strategy or design Supply chain planning Supply chain operation

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Supply Chain Strategy or Design


Decisions about the structure of the supply chain and what processes each stage will perform Strategic supply chain decisions Locations and capacities of facilities Products to be made or stored at various locations Modes of transportation Information systems Supply chain design must support strategic objectives Supply chain design decisions are long-term and expensive to reverse must take into account market uncertainty
Prof. Prasad Kulkarni, MBA department GIT Belgaum.

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Supply Chain Planning


Definition of a set of policies that govern short-term operations Fixed by the supply configuration from previous phase Starts with a forecast of demand in the coming year

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Supply Chain Planning


Planning decisions:
Which markets will be supplied from which locations Planned buildup of inventories Subcontracting, backup locations Inventory policies Timing and size of market promotions

Must consider in planning decisions demand uncertainty, exchange rates, competition over the time horizon
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Supply Chain Operation


Time horizon is weekly or daily Decisions regarding individual customer orders Supply chain configuration is fixed and operating policies are determined Goal is to implement the operating policies as effectively as possible Allocate orders to inventory or production, set order due dates, generate pick lists at a warehouse, allocate an order to a particular shipment, set delivery schedules, place replenishment orders Much less uncertainty (short time horizon)

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Process View of a Supply Chain


Cycle view: processes in a supply chain are divided into a series of cycles, each performed at the interfaces between two successive supply chain stages Push/pull view: processes in a supply chain are divided into two categories depending on whether they are executed in response to a customer order (pull) or in anticipation of a customer order (push)
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Cycle View of Supply Chains


Customer
Customer Order Cycle

Retailer
Replenishment Cycle

Distributor
Manufacturing Cycle

Manufacturer
Procurement Cycle

Supplier
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Cycle View of a Supply Chain


Each cycle occurs at the interface between two successive stages Customer order cycle (customer-retailer) Replenishment cycle (retailer-distributor) Manufacturing cycle (distributor-manufacturer) Procurement cycle (manufacturer-supplier) Cycle view clearly defines processes involved and the owners of each process. Specifies the roles and responsibilities of each member and the desired outcome of each process.

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Push/Pull View of Supply Chains


Procurement, Manufacturing and Replenishment cycles
Customer Order Cycle

PUSH PROCESSES

PULL PROCESSES

Customer Order Arrives


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Push/Pull View of Supply Chain Processes


Supply chain processes fall into one of two categories depending on the timing of their execution relative to customer demand Pull: execution is initiated in response to a customer order (reactive) Push: execution is initiated in anticipation of customer orders (speculative) Push/pull boundary separates push processes from pull processes
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Push/Pull View of Supply Chain Processes


Useful in considering strategic decisions relating to supply chain design more global view of how supply chain processes relate to customer orders Can combine the push/pull and cycle views

Big Bazaar Hindustan Unilever.


The relative proportion of push and pull processes can have an impact on supply chain performance

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Supply chain processes discussed in the two views can be classified into:

Supply Chain Macro Processes in a Firm


Customer Relationship Management (CRM) Internal Supply Chain Management (ISCM) Supplier Relationship Management (SRM)

Integration among the above three macro processes is critical for effective and successful supply chain management
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Competitive and Supply Chain Strategies Competitive strategy: defines the set of customer needs

a firm seeks to satisfy through its products and services Product development strategy: specifies the portfolio of new products that the company will try to develop

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Marketing and sales strategy: specifies how the market will be segmented and product positioned, priced, and promoted Supply chain strategy:
determines the nature of material procurement, transportation of materials, manufacture of product or creation of service, distribution of product Consistency and support between supply chain strategy, competitive strategy, and other functional strategies is important

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The Value Chain: Linking Supply Chain and Business Strategy


Finance, Accounting, Information Technology, Human Resources New Product Development Marketing and Operations Sales

Distribution

Service

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Achieving Strategic Fit


Strategic fit: Consistency between customer priorities of competitive strategy and supply chain capabilities specified by the supply chain strategy Competitive and supply chain strategies have the same goals A company may fail because of a lack of strategic fit or because its processes and resources do not provide the capabilities to execute the desired strategy

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How is Strategic Fit Achieved?


Step 1: Understanding the customer and supply chain uncertainty Step 2: Understanding the supply chain Step 3: Achieving strategic fit

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Identify the needs of the customer segment being served Quantity of product needed in each lot Response time customers will tolerate Variety of products needed Service level required Price of the product Desired rate of innovation in the product
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Step 1: Understanding the Customer and Supply Chain Uncertainty

Overall attribute of customer demand Demand uncertainty: uncertainty of customer demand for a product Implied demand uncertainty: resulting uncertainty for the supply chain given the portion of the demand the supply chain must handle and attributes the customer desires
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Step 1: Understanding the Customer and Supply Chain Uncertainty

Step 1: Understanding the Customer and Supply Chain Uncertainty

Implied demand uncertainty also related to customer needs and product attributes First step to strategic fit is to understand customers by mapping their demand on the implied uncertainty spectrum

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Achieving Strategic Fit


Understanding the Customer
Lot size Response time Service level Product variety Price Innovation

Implied Demand Uncertainty

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Impact of Customer Needs on Implied Demand Uncertainty


Customer Need Range of quantity increases Lead time decreases Causes implied demand uncertainty to increase because Wider range of quantity implies greater variance in demand Less time to react to orders

Variety of products required increases Demand per product becomes more disaggregated Number of channels increases Rate of innovation increases Required service level increases Total customer demand is now disaggregated over more channels New products tend to have more uncertain demand Firm now has to handle unusual surges in demand
Prof. Prasad Kulkarni, MBA department GIT Belgaum.

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Levels of Implied Demand Uncertainty


Predictable supply and demand Predictable supply and uncertain demand or uncertain supply and predictable demand or somewhat uncertain supply and demand Highly uncertain supply and demand

Salt at a supermarket

An existing automobile model

A new communication device

Figure 2.2: The Implied Uncertainty (Demand and Supply) Spectrum

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Correlation Between Implied Demand Uncertainty and Other


Attribute Product margin Avg. forecast error Avg. stockout rate Low Implied Uncertainty Low 10% 1%-2% High Implied Uncertainty High 40%-100% 10%-40% 10%-25%

Avg. forced season- 0% end markdown

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Step 2: Understanding the Supply Chain


How does the firm best meet demand? Dimension describing the supply chain is supply chain responsiveness Supply chain responsiveness -- ability to respond to wide ranges of quantities demanded meet short lead times handle a large variety of products build highly innovative products meet a very high service level

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Step 2: Understanding the Supply Chain


There is a cost to achieving responsiveness Supply chain efficiency: cost of making and delivering the product to the customer Increasing responsiveness results in higher costs that lower efficiency Second step to achieving strategic fit is to map the supply chain on the responsiveness spectrum

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Understanding the Supply Chain: CostResponsiveness Efficient Frontier


Responsiveness
High

Low

Cost
High
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Low
Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Step 3: Achieving Strategic Fit


Step is to ensure that what the supply chain does well is consistent with target customers needs

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Responsiveness Spectrum

Highly efficient

Somewhat efficient

Somewhat responsive

Highly responsive

Integrated steel mill

Hanes apparel

Most automotive production

Dell

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Achieving Strategic Fit Shown on the Uncertainty/Responsiveness Map


Responsive supply chain

Responsiven ess spectrum

Efficient supply chain Certain demand


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Implied uncertainty spectrum

Uncertain demand

Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Step 3: Achieving Strategic Fit


All functions in the value chain must support the competitive strategy to achieve strategic fit Two key points
there is no right supply chain strategy independent of competitive strategy there is a right supply chain strategy for a given competitive strategy

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Comparison of Efficient and Responsive Supply Chains


Efficient
Primary goal Product design strategy Pricing strategy Mfg strategy Inventory strategy Lead time strategy Supplier selection strategy Transportation strategy Lowest cost Min product cost Lower margins High utilization Minimize inventory Reduce but not at expense of greater cost Cost and low quality Greater reliance on low cost modes

Responsive
Quick response Modularity to allow postponement Higher margins Capacity flexibility Buffer inventory Aggressively reduce even if costs are significant Speed, flexibility, quality Greater reliance on responsive (fast) modes

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Other Issues Affecting Strategic Fit


Multiple products and customer segments Product life cycle Competitive changes over time

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Multiple Products and Customer Segments


Firms sell different products to different customer segments (with different implied demand uncertainty) The supply chain has to be able to balance efficiency and responsiveness given its portfolio of products and customer segments Two approaches: Different supply chains Tailor supply chain to best meet the needs of each products demand

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Product Life Cycle


The demand characteristics of a product and the needs of a customer segment change as a product goes through its life cycle Supply chain strategy must evolve throughout the life cycle Early: uncertain demand, high margins (time is important), product availability is most important, cost is secondary Late: predictable demand, lower margins, price is important

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Product Life Cycle


Examples: pharmaceutical firms, Intel As the product goes through the life cycle, the supply chain changes from one emphasizing responsiveness to one emphasizing efficiency

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Competitive Changes Over Time


Competitive pressures can change over time More competitors may result in an increased emphasis on variety at a reasonable price The Internet makes it easier to offer a wide variety of products The supply chain must change to meet these changing competitive conditions
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Expanding Strategic Scope


Scope of strategic fit
The functions and stages within a supply chain that devise an integrated strategy with a shared objective One extreme: each function at each stage develops its own strategy Other extreme: all functions in all stages devise a strategy jointly

Five categories:
Intracompany intraoperation scope Intracompany intrafunctional scope Intracompany interfunctional scope Intercompany interfunctional scope Flexible interfunctional scope
Prof. Prasad Kulkarni, MBA department GIT Belgaum.

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Drivers of Supply Chain Performance


Facilities places where inventory is stored, assembled, or fabricated production sites and storage sites Inventory raw materials, WIP, finished goods within a supply chain inventory policies Transportation moving inventory from point to point in a supply chain combinations of transportation modes and routes

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Information data and analysis regarding inventory, transportation, facilities throughout the supply chain potentially the biggest driver of supply chain performance Sourcing functions a firm performs and functions that are outsourced Pricing Price associated with goods and services provided by a firm to the supply chain

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A Framework for Structuring Drivers


Competitive Strategy Supply Chain Strategy Efficiency Supply chain structure Logistical Drivers Facilities Inventory Transportation Responsiveness

Information

Sourcing Cross Functional Drivers

Pricing

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Facilities
Role in the supply chain
the where of the supply chain manufacturing or storage (warehouses)

Role in the competitive strategy


economies of scale (efficiency priority) larger number of smaller facilities (responsiveness priority)

Components of facilities decisions


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Components of Facilities Decisions


Location centralization (efficiency) vs. decentralization (responsiveness) other factors to consider (e.g., proximity to customers) Capacity (flexibility versus efficiency) Manufacturing methodology (product focused versus process focused) Warehousing methodology (SKU storage, job lot storage, cross-docking) Overall trade-off: Responsiveness versus efficiency

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Inventory
Role in the supply chain Role in the competitive strategy Components of inventory decisions

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Inventory: Role in the Supply Chain


Inventory exists because of a mismatch between supply and demand Source of cost and influence on responsiveness
Inventory and throughput are synonymous in a supply chain

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Inventory: Role in Competitive Strategy


If responsiveness is a strategic competitive priority, a firm can locate larger amounts of inventory closer to customers If cost is more important, inventory can be reduced to make the firm more efficient Trade-off

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Components of Inventory Decisions


Cycle inventory
Average amount of inventory used to satisfy demand between shipments Depends on lot size

Safety inventory
inventory held in case demand exceeds expectations costs of carrying too much inventory versus cost of losing sales

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Seasonal inventory
inventory built up to counter predictable variability in demand cost of carrying additional inventory versus cost of flexible production

Overall trade-off: Responsiveness versus efficiency


more inventory: greater responsiveness but greater cost less inventory: lower cost but lower responsiveness

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Transportation
Role in the supply chain Role in the competitive strategy Components of transportation decisions

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Transportation: Role in the Supply Chain


Moves the product between stages in the supply chain Impact on responsiveness and efficiency Faster transportation allows greater responsiveness but lower efficiency Also affects inventory and facilities

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Transportation: Role in the Competitive Strategy


If responsiveness is a strategic competitive priority, then faster transportation modes can provide greater responsiveness to customers who are willing to pay for it Can also use slower transportation modes for customers whose priority is price (cost) Can also consider both inventory and transportation to find the right balance
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Components of Transportation Decisions


Mode of transportation:
air, truck, rail, ship, pipeline, electronic transportation vary in cost, speed, size of shipment, flexibility

Route and network selection


route: path along which a product is shipped network: collection of locations and routes

In-house or outsource Overall trade-off: Responsiveness versus efficiency


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Information
Role in the supply chain Role in the competitive strategy Components of information decisions

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Information: Role in the Supply Chain


The connection between the various stages in the supply chain allows coordination between stages Crucial to daily operation of each stage in a supply chain e.g., production scheduling, inventory levels

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Information: Role in the Competitive Strategy


Allows supply chain to become more efficient and more responsive at the same time (reduces the need for a trade-off) Information technology What information is most valuable?

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Components of Information Decisions


Push (MRP) versus pull (demand information transmitted quickly throughout the supply chain) Coordination and information sharing Forecasting and aggregate planning Enabling technologies
EDI, Internet, ERP systems Supply Chain Management software

Overall trade-off: Responsiveness versus


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Sourcing
Role in the supply chain Role in the competitive strategy Components of sourcing decisions

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Sourcing: Role in the Supply Chain


Set of business processes required to purchase goods and services in a supply chain Supplier selection, single vs. multiple suppliers, contract negotiation

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Sourcing: Role in the Competitive Strategy


Sourcing decisions are crucial because they affect the level of efficiency and responsiveness in a supply chain In-house vs. outsource decisionsimproving efficiency and responsiveness

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Components of Sourcing Decisions


In-house versus outsource decisions Supplier evaluation and selection Procurement process Overall trade-off: Increase the supply chain profits

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Pricing
Role in the supply chain Role in the competitive strategy Components of pricing decisions

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Pricing: Role in the Supply Chain


Pricing determines the amount to charge customers in a supply chain Pricing strategies can be used to match demand and supply

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Sourcing: Role in the Competitive Strategy


Firms can utilize optimal pricing strategies to improve efficiency and responsiveness Low price and low product availability; vary prices by response times Example 3.7: Amazon

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Components of Pricing Decisions


Pricing and economies of scale Everyday low pricing versus high-low pricing Fixed price versus menu pricing Overall trade-off: Increase the firm profits

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Obstacles to Achieving Strategic Fit


Increasing variety of products Decreasing product life cycles Increasingly demanding customers Fragmentation of supply chain ownership Globalization Difficulty executing new strategies

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MODULE 2 Designing the supply chain network Designing the distribution network role of distribution factors influencing distribution design options e-business and its impact distribution networks in practice network design in the supply chain role of network factors affecting the network design decisions modeling for supply chain.
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The Role of Distribution in the Supply Chain


Distribution: the steps taken to move and store a product from the supplier stage to the customer stage in a supply chain Distribution directly affects cost and the customer experience and therefore drives profitability Choice of distribution network can achieve supply chain objectives from low cost to high responsiveness
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Factors Influencing Distribution Network Design


Distribution network performance evaluated along two dimensions at the highest level:
Customer needs that are met Cost of meeting customer needs

Distribution network design options must therefore be compared according to their impact on customer service and the cost to provide this level of service
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Factors Influencing Distribution Network Design


Elements of customer service influenced by network structure:
Response time Product variety Product availability Customer experience Order visibility Returnability

Supply chain costs affected by network structure:


Inventories and Transportation Facilities and handling Information
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Service and Number of Facilities


Number of Facilities

Response Time
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The Cost-Response Time Frontier


Hi
Local FG
Mix Regional FG

Cost

Local WIP Central FG Central WIP Central Raw Material and Custom production Custom production with raw material at suppliers

Low
Low Response Time Hi

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Inventory Costs and Number of Facilities


Inventory Costs

Number of facilities
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Transportation Costs and Number of Facilities


Transportation Costs

Number of facilities
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Facility Costs and Number of Facilities


Facility Costs

Number of facilities
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Total Costs Related to Number of Facilities


Total Costs

Total Costs

Facilities Inventory

Transportatio n

Number of Facilities
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Variation in Logistics Costs and Response Time with Number of Facilities


Response Time

Total Logistics Costs

Number of Facilities
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Design Options for a Distribution Network


Manufacturer Storage with Direct Shipping Manufacturer Storage with Direct Shipping and In-Transit Merge Distributor Storage with Carrier Delivery Distributor Storage with Last Mile Delivery Manufacturer or Distributor Storage with Consumer Pickup Retail Storage with Consumer Pickup Selecting a Distribution Network Design
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Manufacturer Storage with Direct Shipping


Manufactur er
Retailer

Customers

Product Flow Information Flow


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In-Transit Merge Network


Factories

Retaile r

In-Transit Merge by Carrier

Customer s Product Flow Information Flow


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Distributor Storage with Carrier Delivery


Factories

Warehouse Storage by Distributor/Retailer Customers


Product Information Flow Flow Prof. Prasad Kulkarni, MBA department GIT Belgaum.

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Distributor Storage with Last Mile Delivery


Factories

Distributor/Retailer Warehouse

Customers
Product Flow Information flow
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Manufacturer or Distributor Storage with Customer Pickup (Fig. 4.10)


Factories

Retaile r

Cross Dock DC

Pickup Sites Customer s


Prof. Prasad Kulkarni, MBA department GIT Belgaum.

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E-Business and the Distribution Network


Impact of E-Business on Customer Service Impact of E-Business on Cost Using E-Business: Dell, Amazon, Peapod, Grainger

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Distribution Networks in Practice


The ownership structure of the distribution network can have as big as an impact as the type of distribution network The choice of a distribution network has very long-term consequences Consider whether an exclusive distribution strategy is advantageous Product, price, commoditization, and criticality have an impact on the type of distribution system preferred by customers
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Network Design Decisions


Facility role Facility location Capacity allocation Market and supply allocation

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Factors Influencing Network Design Decisions


Strategic Technological Macroeconomic Political Infrastructure Competitive Logistics and facility costs
Prof. Prasad Kulkarni, MBA department GIT Belgaum.

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A Framework for Global Site Location


Competitive STRATEGY GLOBAL COMPETITION INTERNAL CONSTRAINTS Capital, growth strategy, existing network PRODUCTION TECHNOLOGIES Cost, Scale/Scope impact, support required, flexibility

PHASE I Supply Chain Strategy

TARIFFS AND TAX INCENTIVES

COMPETITIVE ENVIRONMENT

PHASE II Regional Facility Configuration

REGIONAL DEMAND Size, growth, homogeneity, local specifications POLITICAL, EXCHANGE RATE AND DEMAND RISK

PHASE III Desirable Sites


PRODUCTION METHODS Skill needs, response time FACTOR COSTS Labor, materials, site specific

AVAILABLE INFRASTRUCTURE

PHASE IV Location Choices

LOGISTICS COSTS Transport, inventory, coordination

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Conventional Network
Vendor DC Materials DC

Finished Goods DC

Customer DC

Customer Store

Vendor DC

Component Manufacturin g Components DC

Customer Store
Plant Warehouse Customer DC

Customer Store
Customer Store

Vendor DC Final Assembly


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Finished Goods DC

Customer DC

Customer Store

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Tailored Network: Multi-Echelon Finished Goods Network


Regional Finished Goods DC Local DC Cross-Dock Customer 1 DC Local DC Cross-Dock Customer 2 DC Local DC Cross-Dock Store 1 Store 1 Store 2 Store 2 Store 3 Store 3

National Finished Goods DC


Regional Finished Goods DC

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Gravity Methods for Location


Ton Mile-Center Solution
x,y: Warehouse Coordinates xn, yn : Coordinates of
delivery location n
d ( x x n) ( y y n) x Dn F d x F Dn d y Dn F d y F Dn d
n
2 k n n n 1 n k n n 1 n k n n n 1 n k n n 1 n 2

dn : Distance to delivery
location n

Fn : Annual tonnage to
delivery location n

Min

d n Dn F n
Prof. Prasad Kulkarni, MBA department GIT Belgaum.

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Network Optimization Models


Allocating demand to production facilities Locating facilities and Key Costs : allocating capacity
Fixed facility cost Transportation cost Production cost Inventory cost Coordination cost

Which plants to establish? How to configure the network?


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Demand Allocation Model


Which market is served by which plant? Which supply sources are used by a plant? xij = Quantity shipped from plant site i to customer j
Min cij xij
i 1 j 1 n m

s.t.

x D , j 1,...,m
i 1 m ij j

x K , i 1,...,n
j 1 ij i

ij

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Plant Location with Multiple Sourcing


yi = 1 if plant is located at site i, 0 otherwise xij = Quantity shipped from plant site i to customer j

Min
i 1

f y c x
i i i 1 j 1 ij

ij

s.t.

x D , j 1,...,m
i 1 n ij j

x K y , i 1,...,n
j 1 m ij i i

y k ; y {0,1}
i 1 i i

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Plant Location with Single Sourcing


yi = 1 if plant is located at site i, 0 otherwise xij = 1 if market j is supplied by factory i, 0 otherwise
Min
i 1 n

f y D j c x
i i i 1 j 1 ij

ij

s.t.

x
i 1 n j 1

ij

1, j 1,...,m

D j x K y , i 1,...,n
ij i i

xij, y {0,1}
i

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MODULE 3 (5 Hours) Designing and Planning Transportation Networks. Role of transportation - modes and their performance - transportation infrastructure and policies - design options and their trade-offs - Tailored transportation
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Factors Affecting Transportation Decisions


Carrier (party that moves or transports the product) Vehicle-related cost Fixed operating cost Trip-related cost Shipper (party that requires the movement of the product between two points in the supply chain) Transportation cost Inventory cost Facility cost

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Transportation Modes
Trucks
TL LTL

Rail Air Package Carriers Water Pipeline


Prof. Prasad Kulkarni, MBA department GIT Belgaum.

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Truckload (TL)
Average revenue per ton mile (1996) = 9.13 cents Average haul = 274 miles Average Capacity = 42,000 - 50,000 lb. Low fixed and variable costs Major Issues
Utilization Consistent service Backhauls
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Less Than Truckload (LTL)


Average revenue per ton-mile (1996) = 25.08 cents Average haul = 646 miles Higher fixed costs (terminals) and low variable costs Major issues: Location of consolidation facilities Utilization Vehicle routing Customer service

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Rail
Average revenue / ton-mile (1996) = 2.5 cents Average haul = 720 miles Average load = 80 tons Key issues: Scheduling to minimize delays / improve service Off-track delays (at pickup and delivery end) Yard operations Variability of delivery times

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Air
Key issues:
Location/number of hubs Location of fleet bases/crew bases Schedule optimization Fleet assignment Crew scheduling Yield management

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Package Carriers
Companies like FedEx, UPS,, that carry small packages ranging from letters to shipments of about 150 pounds Expensive Rapid and reliable delivery Small and time-sensitive shipments Preferred mode for e-businesses Consolidation of shipments (especially important for package carriers that use air as a primary method of transport)
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Water
Limited to certain geographic areas Ocean, inland waterway system, coastal waters Very large loads at very low cost Slowest Dominant in global

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Pipeline
High fixed cost Primarily for crude petroleum, refined petroleum products, natural gas Best for large and predictable demand Would be used for getting crude oil to a port or refinery, but not for getting refined gasoline to a gasoline station (why?)
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Intermodal
Use of more than one mode of transportation to move a shipment to its destination Most common example: rail/truck Also water/rail/truck or water/truck Grown considerably with increased use of containers Increased global trade has also increased use of intermodal transportation More convenient for shippers (one entity provides the complete service) Key issue involves the exchange of information to facilitate transfer between different transport modes

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Design Options for a Transportation Network


What are the transportation options? Which one to select? On what basis? Direct shipping network Direct shipping with milk runs All shipments via central DC Shipping via DC using milk runs Tailored network
Prof. Prasad Kulkarni, MBA department GIT Belgaum.

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Trade-offs in Transportation Design


Transportation and inventory cost tradeoff
Choice of transportation mode Inventory aggregation

Transportation cost and responsiveness trade-off

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Choice of Transportation Mode


A manager must account for inventory costs when selecting a mode of transportation A mode with higher transportation costs can be justified if it results in significantly lower inventories

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Inventory Aggregation: Inventory vs. Transportation Cost As a result of physical aggregation


Inventory costs decrease Inbound transportation cost decreases Outbound transportation cost increases

Inventory aggregation decreases supply chain costs if the product has a high value to weight ratio, high demand uncertainty, or customer orders are large Inventory aggregation may increase supply chain costs if the product has a low value to weight ratio, low demand uncertainty, or customer orders are small
Prof. Prasad Kulkarni, MBA department GIT Belgaum.

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Trade-offs Between Transportation Cost and Customer Responsiveness


Temporal aggregation is the process of combining orders across time Temporal aggregation reduces transportation cost because it results in larger shipments and reduces variation in shipment sizes However, temporal aggregation reduces customer responsiveness
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Tailored Transportation
The use of different transportation networks and modes based on customer and product characteristics Factors affecting tailoring:
Customer distance and density Customer size Product demand and value

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Role of IT in Transportation
The complexity of transportation decisions demands to use of IT systems IT software can assist in:
Identification of optimal routes by minimizing costs subject to delivery constraints Optimal fleet utilization GPS applications

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Risk Management in Transportation


Three main risks to be considered in transportation are:
Risk that the shipment is delayed Risk of disruptions Risk of hazardous material

Risk mitigation strategies:


Decrease the probability of disruptions Alternative routings In case of hazardous materials the use of modified containers, low-risk transportation models, modification of physical and chemical Prof. Prasad Kulkarni, MBA department GIT Belgaum. Change to change otherwise change will change you

MODULE 4 (6 Hours) Sourcing and Pricing. Sourcing In-house or Outsource 3rd and 4th PLs supplier scoring and assessment, selection design collaboration procurement process sourcing planning and analysis. Pricing and revenue management for multiple customers, perishable products, seasonal demand, bulk and spot contracts.

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The Role of Sourcing in a Supply Chain


Sourcing is the set of business processes required to purchase goods and services Sourcing processes include:
Supplier scoring and assessment Supplier selection and contract negotiation Design collaboration Procurement Sourcing planning and analysis
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Benefits of Effective Sourcing Decisions


Better economies of scale can be achieved if orders are aggregated More efficient procurement transactions can significantly reduce the overall cost of purchasing Design collaboration can result in products that are easier to manufacture and distribute, resulting in lower overall costs Good procurement processes can facilitate coordination with suppliers Appropriate supplier contracts can allow for the sharing of risk Firms can achieve a lower purchase price by increasing competition through the use of Prof. Prasad Kulkarni, MBA department GIT Belgaum. Change auctions to change otherwise change will change you

Supplier Scoring and Assessment


Supplier performance should be compared on the basis of the suppliers impact on total cost There are several other factors besides purchase price that influence total cost

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Supplier Assessment Factors


Replenishment Lead Time On-Time Performance Supply Flexibility Delivery Frequency / Minimum Lot Size Supply Quality Inbound Transportation Cost Pricing Terms Information Coordination Capability Design Collaboration Capability Exchange Rates, Taxes, Duties Supplier Viability

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Supplier Selection- Auctions and Negotiations


Supplier selection can be performed through competitive bids, reverse auctions, and direct negotiations Supplier evaluation is based on total cost of using a supplier Auctions:
Sealed-bid first-price auctions English auctions Dutch auctions Second-price (Vickery) auctions

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Contracts and Supply Chain Performance


Contracts for Product Availability and Supply Chain Profits
Buyback Contracts Revenue-Sharing Contracts Quantity Flexibility Contracts

Contracts to Coordinate Supply Chain Costs Contracts to Increase Agent Effort Contracts to Induce Performance
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Contracts for Product Availability and Supply Chain Profits Many shortcomings in supply chain performance
occur because the buyer and supplier are separate organizations and each tries to optimize its own profit Total supply chain profits might therefore be lower than if the supply chain coordinated actions to have a common objective of maximizing total supply chain profits Recall Chapter 10: double marginalization results in suboptimal order quantity An approach to dealing with this problem is to design a contract that encourages a buyer to purchase more and increase the level of product availability The supplier must share in some of the buyers demand uncertainty, however
Prof. Prasad Kulkarni, MBA department GIT Belgaum.

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Contracts for Product Availability and Supply Chain Profits: Buyback Contracts
Allows a retailer to return unsold inventory up to a specified amount at an agreed upon price Increases the optimal order quantity for the retailer, resulting in higher product availability and higher profits for both the retailer and the supplier Most effective for products with low variable cost, such as music, software, books, magazines, and newspapers Downside is that buyback contract results in surplus inventory that must be disposed of, which increases supply chain costs Can also increase information distortion through the supply chain because the supply chain reacts to retail orders, not actual customer demand
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Contracts for Product Availability and Supply Chain Profits: Revenue Sharing Contracts

The buyer pays a minimal amount for each unit purchased from the supplier but shares a fraction of the revenue for each unit sold Decreases the cost per unit charged to the retailer, which effectively decreases the cost of overstocking Can result in supply chain information distortion, however, just as in the case of buyback contracts
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Contracts for Product Availability and Supply Chain Profits: Quantity Flexibility Contracts

Allows the buyer to modify the order (within limits) as demand visibility increases closer to the point of sale Better matching of supply and demand Increased overall supply chain profits if the supplier has flexible capacity Lower levels of information distortion than either buyback contracts or revenue sharing contracts
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Contracts to Coordinate Supply Chain Costs


Differences in costs at the buyer and supplier can lead to decisions that increase total supply chain costs Example: Replenishment order size placed by the buyer. The buyers EOQ does not take into account the suppliers costs. A quantity discount contract may encourage the buyer to purchase a larger quantity (which would be lower costs for the supplier), which would result in lower total supply chain costs Quantity discounts lead to information distortion because of order batching

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Contracts to Increase Agent Effort


There are many instances in a supply chain where an agent acts on the behalf of a principal and the agents actions affect the reward for the principal Example: A car dealer who sells the cars of a manufacturer, as well as those of other manufacturers Examples of contracts to increase agent effort include two-part tariffs and threshold contracts Threshold contracts increase information distortion, however

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Contracts to Induce Performance Improvement


A buyer may want performance improvement from a supplier who otherwise would have little incentive to do so A shared savings contract provides the supplier with a fraction of the savings that result from the performance improvement Particularly effective where the benefit from improvement accrues primarily to the buyer, but where the effort for the improvement comes primarily from the supplier

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Design Collaboration
50-70 percent of spending at a manufacturer is through procurement 80 percent of the cost of a purchased part is fixed in the design phase Design collaboration with suppliers can result in reduced cost, improved quality, and decreased time to market Important to employ design for logistics, design for manufacturability Manufacturers must become effective design coordinators throughout the supply chain

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The Procurement Process


The process in which the supplier sends product in response to orders placed by the buyer Goal is to enable orders to be placed and delivered on schedule at the lowest possible overall cost Two main categories of purchased goods: Direct materials: components used to make finished goods Indirect materials: goods used to support the operations of a firm Focus for direct materials should be on improving coordination and visibility with supplier Focus for indirect materials should be on decreasing the transaction cost for each order Procurement for both should consolidate orders where possible to take advantage of economies of scale and quantity discounts

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Product Categorization by Value and Criticality


High Critical Items Strategic Items

Criticality

General Items

Bulk Purchase Items

Low Low High

Value/Cost
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Sourcing Planning and Analysis


A firm should periodically analyze its procurement spending and supplier performance and use this analysis as an input for future sourcing decisions Procurement spending should be analyzed by part and supplier to ensure appropriate economies of scale Supplier performance analysis should be used to build a portfolio of suppliers with complementary strengths

Cheaper but lower performing suppliers should be used to supply base demand Higher performing but more expensive suppliers should be used to buffer against variation in demand and supply from the other source
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Making Sourcing Decisions in Practice


Use multifunction teams Ensure appropriate coordination across regions and business units Always evaluate the total cost of ownership Build long-term relationships with key suppliers

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The Role of Revenue Management in the Supply Chain Revenue management is the use of pricing to increase the profit

generated from a limited supply of supply chain assets Supply assets exist in two forms: capacity and inventory Revenue management may also be defined as the use of differential pricing based on customer segment, time of use, and product or capacity availability to increase supply chain profits Most common example is probably in airline pricing

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Conditions Under Which Revenue Management Has the Greatest Effect


The value of the product varies in different market segments (Example: airline seats) The product is highly perishable or product waste occurs (Example: fashion and seasonal apparel) Demand has seasonal and other peaks (Example: products ordered at Amazon.com) The product is sold both in bulk and on the spot market (Example: owner of warehouse who can decide whether to lease the entire warehouse through long-term contracts or save a portion of the warehouse for use in the spot market)

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Revenue Management for Multiple Customer Segments


If a supplier serves multiple customer segments with a fixed asset, the supplier can improve revenues by setting different prices for each segment Prices must be set with barriers such that the segment willing to pay more is not able to pay the lower price The amount of the asset reserved for the higher price segment is such that the expected marginal revenue from the higher priced segment equals the price of the lower price segment

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Revenue Management for Multiple Customer Segments


pL = the price charged to the lower price segment pH = the price charged to the higher price segment DH = mean demand for the higher price segment sH = standard deviation of demand for the higher price segment CH = capacity reserved for the higher price segment RH(CH) = expected marginal revenue from reserving more capacity = Probability(demand from higher price segment > CH) x pH RH(CH) = pL Probability(demand from higher price segment > CH) = pL / pH CH = F-1(1- pL/pH, DH,sH) = NORMINV(1- pL/pH, DH,sH)

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Example : ToFrom Trucking


Revenue from segment A = pA = $3.50 per cubic ft Revenue from segment B = pB = $3.50 per cubic ft Mean demand for segment A = DA = 3,000 cubic ft Std dev of segment A demand = sA = 1,000 cubic ft CA = NORMINV(1- pB/pA, DA,sA) = NORMINV(1- (2.00/3.50), 3000, 1000) = 2,820 cubic ft If pA increases to $5.00 per cubic foot, then CA = NORMINV(1- pB/pA, DA,sA) = NORMINV(1- (2.00/5.00), 3000, 1000) = 3,253 cubic ft
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Revenue Management for Perishable Assets


Any asset that loses value over time is perishable Examples: high-tech products such as computers and cell phones, high fashion apparel, underutilized capacity, fruits and vegetables Two basic approaches: Vary price over time to maximize expected revenue Overbook sales of the asset to account for cancellations

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Revenue Management for Perishable Assets


Overbooking or overselling of a supply chain asset is valuable if order cancellations occur and the asset is perishable The level of overbooking is based on the trade-off between the cost of wasting the asset if too many cancellations lead to unused assets and the cost of arranging a backup if too few cancellations lead to committed orders being larger than the available capacity
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Revenue Management for Perishable Assets


p = price at which each unit of the asset is sold c = cost of using or producing each unit of the asset b = cost per unit at which a backup can be used in the case of asset shortage Cw = p c = marginal cost of wasted capacity Cs = b c = marginal cost of a capacity shortage O* = optimal overbooking level s* = Probability(cancellations < O*) = Cw / (Cw + Cs)

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Revenue Management for Perishable Assets


If the distribution of cancellations is known to be normal with mean mc and standard deviation sc then O* = F-1(s*, mc, sc) = NORMINV(s*, mc, sc) If the distribution of cancellations is known only as a function of the booking level (capacity L + overbooking O) to have a mean of m(L+O) and std deviation of s(L+O), the optimal overbooking level is the solution to the following equation: O = F-1(s*,m(L+O),s(L+O)) = NORMINV(s*,m(L+O),s(L+O))

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Example
Cost of wasted capacity = Cw = $10 per dress Cost of capacity shortage = Cs = $5 per dress s* = Cw / (Cw + Cs) = 10/(10+5) = 0.667 mc = 800; sc = 400 O* = NORMINV(s*, mc,sc) = NORMINV(0.667,800,400) = 973 If the mean is 15% of the booking level and the coefficient of variation is 0.5, then the optimal overbooking level is the solution of the following equation: O = NORMINV(0.667,0.15(5000+O),0.075(5000+O)) Using Excel Solver, O* = 1,115
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Revenue Management for Seasonal Demand


Seasonal peaks of demand are common in many supply chains Examples: Most retailers achieve a large portion of total annual demand in December (Amazon.com) Off-peak discounting can shift demand from peak to non-peak periods Charge higher price during peak periods and a lower price during off-peak periods
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Revenue Management for Bulk and Spot Customers


Most consumers of production, warehousing, and transportation assets in a supply chain face the problem of constructing a portfolio of long-term bulk contracts and short-term spot market contracts The basic decision is the size of the bulk contract The fundamental trade-off is between wasting a portion of the low-cost bulk contract and paying more for the asset on the spot market Given that both the spot market price and the purchasers need for the asset are uncertain, a decision tree approach as discussed in Chapter 6 should be used to evaluate the amount of long-term Prof. Prasad Kulkarni, MBA department GIT Belgaum. Change to change otherwise change change you bulk contract towill sign

Revenue Management for Bulk and Spot Customers


For the simple case where the spot market price is known but demand is uncertain, a formula can be used cB = bulk rate cS = spot market price Q* = optimal amount of the asset to be purchased in bulk p* = probability that the demand for the asset does not exceed Q* Marginal cost of purchasing another unit in bulk is cB. The expected marginal cost of not purchasing another unit in bulk and then purchasing it in the spot market is (1-p*)cS.

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Revenue Management for Bulk and Spot Customers


If the optimal amount of the asset is purchased in bulk, the marginal cost of the bulk purchase should equal the expected marginal cost of the spot market purchase, or cB = (1-p*)cS Solving for p* yields p* = (cS cB) / cS If demand is normal with mean m and std deviation s, the optimal amount Q* to be purchased in bulk is Q* = F-1(p*,m,s) = NORMINV(p*,m,s)

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Example 15.6
Bulk contract cost = cB = $10,000 per million units Spot market cost = cS = $12,500 per million units m = 10 million units s = 4 million units p* = (cS cB) / cS = (12,500 10,000) / 12,500 = 0.2 Q* = NORMINV(p*,m,s) = NORMINV(0.2,10,4) = 6.63 The manufacturer should sign a long-term bulk contract for 6.63 million units per month and purchase any transportation capacity beyond that on the spot market

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Using Revenue Management in Practice


Evaluate your market carefully Quantify the benefits of revenue management Implement a forecasting process Apply optimization to obtain the revenue management decision Involve both sales and operations Understand and inform the customer Integrate supply planning with revenue management

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Role of Information Technology in a Supply Chain


Information is the driver that serves as the glue to create a coordinated supply chain Information must have the following characteristics to be useful: Accurate Accessible in a timely manner Information must be of the right kind Information provides the basis for supply chain management decisions Inventory Transportation Facility
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Characteristics of Useful Supply Chain Information


Accurate Accessible in a timely manner The right kind Provides supply chain visibility

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Use of Information in a Supply Chain


Information used at all phases of decision making: strategic, planning, operational Examples:
Strategic: location decisions Operational: what products will be produced during todays production run

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Use of Information in a Supply Chain


Inventory: demand patterns, carrying costs, stockout costs, ordering costs Transportation: costs, customer locations, shipment sizes Facility: location, capacity, schedules of a facility; need information about tradeoffs between flexibility and efficiency, demand, exchange rates, taxes, etc.
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Role of Information Technology in a Supply Chain


Information technology (IT)
Hardware and software used throughout the supply chain to gather and analyze information Captures and delivers information needed to make good decisions

Effective use of IT in the supply chain can have a significant impact on supply chain performance
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The Importance of Information in a Supply Chain


Relevant information available throughout the supply chain allows managers to make decisions that take into account all stages of the supply chain Allows performance to be optimized for the entire supply chain, not just for one stage leads to higher performance for each individual firm in the supply chain
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The Supply Chain IT Framework


The Supply Chain Macro Processes
Customer Relationship Management (CRM) Internal Supply Chain Management (ISCM) Supplier Relationship Management (SRM) Plus: Transaction Management Foundation

Why Focus on the Macro Processes? Macro Processes Applied to the Evolution of Software
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Macro Processes in a Supply Chain (Figure 16.1)


Supplier Relationshi p Managemen t (SRM) Internal Supply Chain Managemen t (ISCM) Customer Relationshi p Managemen t (CRM)

Transaction Management Foundation (TFM)

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Customer Relationship Management


The processes that take place between an enterprise and its customers downstream in the supply chain Key processes:
Marketing Selling Order management Call/Service center
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Internal Supply Chain Management


Includes all processes involved in planning for and fulfilling a customer order ISCM processes: Strategic Planning Demand Planning Supply Planning Fulfillment Field Service There must be strong integration between the ISCM and CRM macro processes
Prof. Prasad Kulkarni, MBA department GIT Belgaum.

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Supplier Relationship Management


Those processes focused on the interaction between the enterprise and suppliers that are upstream in the supply chain Key processes:
Design Collaboration Source Negotiate Buy Supply Collaboration

There is a natural fit between ISCM and SRM processes


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The Transaction Management Foundation


Enterprise software systems (ERP) Earlier systems focused on automation of simple transactions and the creation of an integrated method of storing and viewing data across the enterprise Real value of the TMF exists only if decision making is improved The extent to which the TMF enables integration across the three macro processes determines its value
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The Future of IT in the Supply Chain


At the highest level, the three SCM macro processes will continue to drive the evolution of enterprise software Software focused on the macro processes will become a larger share of the total enterprise software market and the firms producing this software will become more successful Functionality, the ability to integrate across macro processes, and the strength of their ecosystems, will be keys to success
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Supply Chain Information Technology in Practice


Select an IT system that addresses the companys key success factors Take incremental steps and measure value Align the level of sophistication with the need for sophistication Use IT systems to support decision making, not to make decisions Think about the future
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Lack of SC Coordination and the Bullwhip Effect


Supply chain coordination all stages in the supply chain take actions together (usually results in greater total supply chain profits) SC coordination requires that each stage take into account the effects of its actions on the other stages Lack of coordination results when:
Objectives of different stages conflict or Information moving between stages is distorted
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Bullwhip Effect
Fluctuations in orders increase as they move up the supply chain from retailers to wholesalers to manufacturers to suppliers Distorts demand information within the supply chain, where different stages have very different estimates of what demand looks like Results in a loss of supply chain coordination Examples: Proctor & Gamble

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The Effect of Lack of Coordination on Performance


Manufacturing cost (increases) Inventory cost (increases) Replenishment lead time (increases) Transportation cost (increases) Labor cost for shipping and receiving (increases) Level of product availability (decreases) Relationships across the supply chain (worsens) Profitability (decreases) The bullwhip effect reduces supply chain profitability by making it more expensive to provide a given level of product availability

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Obstacles to Coordination in a Supply Chain


Incentive Obstacles Information Processing Obstacles Operational Obstacles Pricing Obstacles Behavioral Obstacles

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Incentive Obstacles
When incentives offered to different stages or participants in a supply chain lead to actions that increase variability and reduce total supply chain profits misalignment of total supply chain objectives and individual objectives Local optimization within functions or stages of a supply chain Sales force incentives
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Information Processing Obstacles


When demand information is distorted as it moves between different stages of the supply chain, leading to increased variability in orders within the supply chain Forecasting based on orders, not customer demand Forecasting demand based on orders magnifies demand fluctuations moving up the supply chain from retailer to manufacturer Lack of information sharing

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Operational Obstacles
Actions taken in the course of placing and filling orders that lead to an increase in variability Ordering in large lots (much larger than dictated by demand) Large replenishment lead times Rationing and shortage gaming (common in the computer industry because of periodic cycles of component shortages and surpluses)

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Pricing Obstacles
When pricing policies for a product lead to an increase in variability of orders placed Lot-size based quantity decisions Price fluctuations (resulting in forward buying) Figure 17.3

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Behavioral Obstacles
Problems in learning, often related to communication in the supply chain and how the supply chain is structured Each stage of the supply chain views its actions locally and is unable to see the impact of its actions on other stages Different stages react to the current local situation rather than trying to identify the root causes Based on local analysis, different stages blame each other for the fluctuations, with successive stages becoming enemies rather than partners No stage learns from its actions over time because the most significant consequences of the actions of any one stage occur elsewhere, resulting in a vicious cycle of actions and blame Change Lack of otherwise trust change results in you opportunism, duplication of effort, Prof. Prasad Kulkarni, MBA department GIT Belgaum. to change will change

Managerial Levers to Achieve Coordination


Aligning Goals and Incentives Improving Information Accuracy Improving Operational Performance Designing Pricing Strategies to Stabilize Orders Building Strategic Partnerships and Trust

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Aligning Goals and Incentives


Align incentives so that each participant has an incentive to do the things that will maximize total supply chain profits Align incentives across functions Pricing for coordination Alter sales force incentives from sell-in (to the retailer) to sell-through (by the retailer)
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Improving Information Accuracy


Sharing point of sale data Collaborative forecasting and planning Single stage control of replenishment
Continuous replenishment programs (CRP) Vendor managed inventory (VMI)

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Reducing replenishment lead time Reduces uncertainty in demand EDI is useful Reducing lot sizes Computer-assisted ordering, B2B exchanges Shipping in LTL sizes by combining shipments Technology and other methods to simplify receiving Changing customer ordering behavior Rationing based on past sales and sharing information to limit gaming Turn-and-earn Information sharing
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Improving Operational Performance

Designing Pricing Strategies to Stabilize Orders


Encouraging retailers to order in smaller lots and reduce forward buying Moving from lot size-based to volume-based quantity discounts (consider total purchases over a specified time period) Stabilizing pricing Eliminate promotions (everyday low pricing, EDLP) Limit quantity purchased during a promotion Tie promotion payments to sell-through rather than amount purchased Building strategic partnerships and trust easier to implement these approaches if there is trust
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Building Strategic Partnerships and Trust in a Supply Chain


Background Designing a Relationship with Cooperation and Trust Managing Supply Chain Relationships for Cooperation and Trust

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Building Strategic Partnerships and Trust in a Supply Chain


Trust-based relationship
Dependability Leap of faith

Cooperation and trust work because:


Alignment of incentives and goals Actions to achieve coordination are easier to implement Supply chain productivity improves by reducing duplication or allocation of effort to appropriate stage Greater information sharing results Prof. Prasad Kulkarni, MBA department GIT Belgaum.

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Trust in the Supply Chain


Table 17.2 shows benefits Historically, supply chain relationships are based on power or trust Disadvantages of power-based relationship: Results in one stage maximizing profits, often at the expense of other stages Can hurt a company when balance of power changes Less powerful stages have sought ways to resist

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Building Trust into a Supply Chain Relationship


Deterrence-based view Use formal contracts Parties behave in trusting manner out of selfinterest Process-based view Trust and cooperation are built up over time as a result of a series of interactions Positive interactions strengthen the belief in cooperation of other party Neither view holds exclusively in all situations

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Building Trust into a Supply Chain Relationship


Initially more reliance on deterrencebased view, then evolves to a processbased view Co-identification: ideal goal Two phases to a supply chain relationship
Design phase Management phase
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Designing a Relationship with Cooperation and Trust


Assessing the value of the relationship and its contributions Identifying operational roles and decision rights for each party Creating effective contracts Designing effective conflict resolution mechanisms

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Identify the mutual benefit provided Identify the criteria used to evaluate the relationship (equity is important) Important to share benefits equitably Clarify contribution of each party and the benefits each party will receive

Assessing the Value of the Relationship and its Contributions

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Identifying Operational Roles and Decision Rights for Each Party Recognize interdependence between parties
Sequential interdependence: activities of one partner precede the other Reciprocal interdependence: the parties come together, exchange information and inputs in both directions Sequential interdependence is the traditional supply chain form Reciprocal interdependence is more difficult but can result in more benefits

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Effects of Interdependence on Supply Chain Relationships


High

Partner Relatively Powerful

High Level of Interdependence


Effective Relationship

Organizations Dependence

Low

Low Level of Interdependenc e


Low

Organization Relatively Powerful

High

Partners Dependence
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Creating Effective Contracts


Create contracts that encourage negotiation when unplanned contingencies arise It is impossible to define and plan for every possible occurrence Informal relationships and agreements can fill in the gaps in contracts Informal arrangements may eventually be formalized in later contracts
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Designing Effective Conflict Resolution Mechanisms


Initial formal specification of rules and guidelines for procedures and transactions Regular, frequent meetings to promote communication Courts or other intermediaries

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Managing Supply Chain Relationships for Cooperation and Trust


Effective management of a relationship is important for its success Top management is often involved in the design but not management of a relationship -- process of alliance evolution Perceptions of reduced benefits or opportunistic actions can significantly impair a supply chain partnership

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Achieving Coordination in Practice


Quantify the bullwhip effect Get top management commitment for coordination Devote resources to coordination Focus on communication with other stages Try to achieve coordination in the entire supply chain network Use technology to improve connectivity in the supply chain Share the benefits of coordination equitably

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Role of Forecasting in a Supply Chain


The basis for all strategic and planning decisions in a supply chain Used for both push and pull processes Examples: Production: scheduling, inventory, aggregate planning Marketing: sales force allocation, promotions, new production introduction Finance: plant/equipment investment, budgetary planning Personnel: workforce planning, hiring, layoffs All of these decisions are interrelated
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Characteristics of Forecasts
Forecasts are always wrong. Should include expected value and measure of error. Long-term forecasts are less accurate than short-term forecasts (forecast horizon is important) Aggregate forecasts are more accurate than disaggregate forecasts
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Forecasting Methods
Qualitative: primarily subjective; rely on judgment and opinion Time Series: use historical demand only Static Adaptive Causal: use the relationship between demand and some other factor to develop forecast Simulation Imitate consumer choices that give rise to demand Can combine time series and causal methods
Prof. Prasad Kulkarni, MBA department GIT Belgaum.

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Components of an Observation
Observed demand (O) = Systematic component (S) + Random component (R)
Level (current deseasonalized demand) Trend (growth or decline in demand) Seasonality (predictable seasonal fluctuation) Systematic component: Expected value of demand Random component: The part of the forecast that deviates from the systematic component Forecast error: difference between forecast and actual demand

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Time Series Forecasting


Quarter II, 1998 III, 1998 IV, 1998 I, 1999 II, 1999 III, 1999 IV, 1999 I, 2000 II, 2000 III, 2000 IV, 2000 I, 2001 Demand Dt 8000 13000 23000 34000 10000 18000 23000 38000 12000 13000 32000 41000

Forecast demand for the next four quarters.

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Time Series Forecasting


50,000 40,000 30,000 20,000 10,000 0

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97 ,2 97 ,3 97 ,4 98 ,1 98 ,2 98 ,3 98 ,4 99 ,1 99 ,2 99 ,3 99 ,4 00 ,1
Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Forecasting Methods
Static Adaptive
Moving average Simple exponential smoothing Holts model (with trend) Winters model (with trend and seasonality)

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Basic Approach to Demand Forecasting


Understand the objectives of forecasting Integrate demand planning and forecasting Identify major factors that influence the demand forecast Understand and identify customer segments Determine the appropriate forecasting technique Establish performance and error measures for the forecast

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Time Series Forecasting Methods


Goal is to predict systematic component of demand
Multiplicative: (level)(trend)(seasonal factor) Additive: level + trend + seasonal factor Mixed: (level + trend)(seasonal factor)

Static methods Adaptive forecasting

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Static Methods
Assume a mixed model: Systematic component = (level + trend)(seasonal factor) Ft+l = [L + (t + l)T]St+l = forecast in period t for demand in period t + l L = estimate of level for period 0 T = estimate of trend St = estimate of seasonal factor for period t Dt = actual demand in period t Ft = forecast of demand in period t

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Static Methods
Estimating level and trend Estimating seasonal factors

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Estimating Level and Trend


Before estimating level and trend, demand data must be deseasonalized Deseasonalized demand = demand that would have been observed in the absence of seasonal fluctuations Periodicity (p)
the number of periods after which the seasonal cycle repeats itself for demand at Tahoe Salt (Table 7.1, Figure 7.1) p = 4 Prof. Prasad Kulkarni, MBA department GIT Belgaum. Change to change otherwise change will change you

Time Series Forecasting (Table 7.1)


Quarter II, 1998 III, 1998 IV, 1998 I, 1999 II, 1999 III, 1999 IV, 1999 I, 2000 II, 2000 III, 2000 IV, 2000 I, 2001 Demand Dt 8000 13000 23000 34000 10000 18000 23000 38000 12000 13000 32000 41000

Forecast demand for the next four quarters.

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Time Series Forecasting (Figure 7.1)


50,000 40,000 30,000 20,000 10,000 0

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97 ,2 97 ,3 97 ,4 98 ,1 98 ,2 98 ,3 98 ,4 99 ,1 99 ,2 99 ,3 99 ,4 00 ,1
Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Estimating Level and Trend


Before estimating level and trend, demand data must be deseasonalized Deseasonalized demand = demand that would have been observed in the absence of seasonal fluctuations Periodicity (p)
the number of periods after which the seasonal cycle repeats itself for demand at Tahoe Salt (Table 7.1, Figure 7.1) p = 4 Prof. Prasad Kulkarni, MBA department GIT Belgaum. Change to change otherwise change will change you

Deseasonalizing Demand

[Dt-(p/2) + Dt+(p/2) + S 2Di] / 2p for p even

Dt =

(sum is from i = t+1-(p/2) to t+1+(p/2))

S Di / p for p odd
(sum is from i = t-(p/2) to t+(p/2)), p/2 truncated to lower integer

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Deseasonalizing Demand
For the example, p = 4 is even For t = 3: D3 = {D1 + D5 + Sum(i=2 to 4) [2Di]}/8 = {8000+10000+[(2)(13000)+(2)(23000)+(2)(34000)]}/8 = 19750 D4 = {D2 + D6 + Sum(i=3 to 5) [2Di]}/8 = {13000+18000+[(2)(23000)+(2)(34000)+(2)(10000)]/8 = 20625

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Deseasonalizing Demand
Then include trend Dt = L + tT where Dt = deseasonalized demand in period t L = level (deseasonalized demand at period 0) T = trend (rate of growth of deseasonalized demand) Trend is determined by linear regression using deseasonalized demand as the dependent variable and period as the independent variable (can be done in Excel) In the example, L = 18,439 and T = 524

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Time Series of Demand (Figure 7.3)


50000 40000

Demand

30000 20000 10000 0 1 2 3 4 5 6 7 8 9 10 11 12 Period

Dt Dt-bar

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Estimating Seasonal Factors


Use the previous equation to calculate deseasonalized demand for each period St = Dt / Dt = seasonal factor for period t In the example, D2 = 18439 + (524)(2) = 19487 D2 = 13000 S2 = 13000/19487 = 0.67 The seasonal factors for the other periods are calculated in the same manner
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Estimating Seasonal Factors (Fig. 7.4)


t 1 2 3 4 5 6 7 8 9 10 11 12 Dt Dt-bar S-bar 8000 18963 0.42 = 8000/18963 13000 19487 0.67 = 13000/19487 23000 20011 1.15 = 23000/20011 34000 20535 1.66 = 34000/20535 10000 21059 0.47 = 10000/21059 18000 21583 0.83 = 18000/21583 23000 22107 1.04 = 23000/22107 38000 22631 1.68 = 38000/22631 12000 23155 0.52 = 12000/23155 13000 23679 0.55 = 13000/23679 32000 24203 1.32 = 32000/24203 41000 24727 1.66 = 41000/24727

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Estimating Seasonal Factors


The overall seasonal factor for a season is then obtained by averaging all of the factors for a season If there are r seasonal cycles, for all periods of the form pt+i, 1<i<p, the seasonal factor for season i is Si = [Sum(j=0 to r-1) Sjp+i]/r In the example, there are 3 seasonal cycles in the data and p=4, so S1 = (0.42+0.47+0.52)/3 = 0.47 S2 = (0.67+0.83+0.55)/3 = 0.68 S3 = (1.15+1.04+1.32)/3 = 1.17 Prof. Prasad Kulkarni, MBA department GIT Belgaum. Change to change otherwise change will change you S4 = (1.66+1.68+1.66)/3 = 1.67

Estimating the Forecast


Using the original equation, we can forecast the next four periods of demand: F13 = (L+13T)S1 = [18439+(13)(524)](0.47) = 11868 F14 = (L+14T)S2 = [18439+(14)(524)](0.68) = 17527 F15 = (L+15T)S3 = [18439+(15)(524)](1.17) = 30770 F16 = (L+16T)S4 = [18439+(16)(524)](1.67) = 44794

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Adaptive Forecasting
The estimates of level, trend, and seasonality are adjusted after each demand observation General steps in adaptive forecasting Moving average Simple exponential smoothing Trend-corrected exponential smoothing (Holts model) Trend- and seasonality-corrected exponential smoothing (Winters model)

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Basic Formula for Adaptive Forecasting


Ft+1 = (Lt + lT)St+1 = forecast for period t+l in period t Lt = Estimate of level at the end of period t Tt = Estimate of trend at the end of period t St = Estimate of seasonal factor for period t Ft = Forecast of demand for period t (made period t-1 or earlier) Dt = Actual demand observed in period t Et = Forecast error in period t At = Absolute deviation for period t = |Et| MAD = Mean Absolute Deviation = average value of At
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General Steps in Adaptive Forecasting


Initialize: Compute initial estimates of level (L0), trend (T0), and seasonal factors (S1,,Sp). This is done as in static forecasting. Forecast: Forecast demand for period t+1 using the general equation Estimate error: Compute error Et+1 = Ft+1- Dt+1 Modify estimates: Modify the estimates of level (Lt+1), trend (Tt+1), and seasonal factor (St+p+1), given the error Et+1 in the forecast Repeat steps 2, 3, and 4 for each subsequent period

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Moving Average
Used when demand has no observable trend or seasonality Systematic component of demand = level The level in period t is the average demand over the last N periods (the N-period moving average) Current forecast for all future periods is the same and is based on the current estimate of the level Lt = (Dt + Dt-1 + + Dt-N+1) / N Ft+1 = Lt and Ft+n = Lt After observing the demand for period t+1, revise the estimates as follows: Lt+1 = (Dt+1 + Dt + + Dt-N+2) / N Prof. Prasad Kulkarni, MBA department GIT Belgaum. Ft+2 = Lotherwise Change to change change will change you t+1

Moving Average Example


From Tahoe Salt example (Table 7.1) At the end of period 4, what is the forecast demand for periods 5 through 8 using a 4-period moving average? L4 = (D4+D3+D2+D1)/4 = (34000+23000+13000+8000)/4 = 19500 F5 = 19500 = F6 = F7 = F8 Observe demand in period 5 to be D5 = 10000 Forecast error in period 5, E5 = F5 - D5 = 19500 - 10000 = 9500 Revise estimate of level in period 5: L5 = (D5+D4+D3+D2)/4 = (10000+34000+23000+13000)/4 = 20000
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Simple Exponential Smoothing


Used when demand has no observable trend or seasonality Systematic component of demand = level Initial estimate of level, L0, assumed to be the average of all historical data L0 = [Sum(i=1 to n)Di]/n Current forecast for all future periods is equal to the current estimate of the level and is given as follows: Ft+1 = Lt and Ft+n = Lt After observing demand Dt+1, revise the estimate of the level: Lt+1 = aDt+1 + (1-a)Lt Lt+1 = Sum(n=0 to t+1)[a(1-a)nDt+1-n ]

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From Tahoe Salt data, forecast demand for period 1 using exponential smoothing L0 = average of all 12 periods of data = Sum(i=1 to 12)[Di]/12 = 22083 F1 = L0 = 22083 Observed demand for period 1 = D1 = 8000 Forecast error for period 1, E1, is as follows: E1 = F1 - D1 = 22083 - 8000 = 14083 Assuming a = 0.1, revised estimate of level for period 1: L1 = aD1 + (1-a)L0 = (0.1)(8000) + (0.9)(22083) = 20675 F2 = L1 = 20675 Note that the estimate of level for period 1 is lower than in Prof. Prasad Kulkarni, MBA department GIT Belgaum. Change to change period 0 otherwise change will change you

Simple Exponential Smoothing Example

Trend-Corrected Exponential Smoothing (Holts Model)


Appropriate when the demand is assumed to have a level and trend in the systematic component of demand but no seasonality Obtain initial estimate of level and trend by running a linear regression of the following form: Dt = at + b T0 = a L0 = b In period t, the forecast for future periods is expressed as follows: Ft+1 = Lt + Tt Ft+n = Lt + nTt
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Trend-Corrected Exponential Smoothing (Holts Model)


After observing demand for period t, revise the estimates for level and trend as follows: Lt+1 = aDt+1 + (1-a)(Lt + Tt) Tt+1 = b(Lt+1 - Lt) + (1-b)Tt a = smoothing constant for level b = smoothing constant for trend Example: Tahoe Salt demand data. Forecast demand for period 1 using Holts model (trend corrected exponential smoothing) Using linear regression, L0 = 12015 (linear intercept) T0 = 1549 (linear slope)
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Holts Model Example (continued)


Forecast for period 1: F1 = L0 + T0 = 12015 + 1549 = 13564 Observed demand for period 1 = D1 = 8000 E1 = F1 - D1 = 13564 - 8000 = 5564 Assume a = 0.1, b = 0.2 L1 = aD1 + (1-a)(L0+T0) = (0.1)(8000) + (0.9)(13564) = 13008 T1 = b(L1 - L0) + (1-b)T0 = (0.2)(13008 - 12015) + (0.8)(1549) = 1438 F2 = L1 + T1 = 13008 + 1438 = 14446 F5 = L1 + 4T1 = 13008 + (4)(1438) = 18760
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Trend- and Seasonality-Corrected Exponential Smoothing Appropriate when the systematic component of demand is assumed to have a level, trend, and seasonal factor Systematic component = (level+trend)(seasonal factor) Assume periodicity p Obtain initial estimates of level (L0), trend (T0), seasonal factors (S1,,Sp) using procedure for static forecasting In period t, the forecast for future periods is given by: Ft+1 = (Lt+Tt)(St+1) and Ft+n = (Lt + nTt)St+n

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Trend- and Seasonality-Corrected Exponential Smoothing (continued) After observing demand for period t+1, revise estimates for level, trend, and seasonal factors as follows: Lt+1 = a(Dt+1/St+1) + (1-a)(Lt+Tt) Tt+1 = b(Lt+1 - Lt) + (1-b)Tt St+p+1 = g(Dt+1/Lt+1) + (1-g)St+1 a = smoothing constant for level b = smoothing constant for trend g = smoothing constant for seasonal factor Example: Tahoe Salt data. Forecast demand for period 1 using Winters model. Initial estimates of level, trend, and seasonal factors are obtained as in the static forecasting case
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Trend- and Seasonality-Corrected Exponential Smoothing Example (continued)


L0 = 18439 T0 = 524 S1=0.47, S2=0.68, S3=1.17, S4=1.67 F1 = (L0 + T0)S1 = (18439+524)(0.47) = 8913 The observed demand for period 1 = D1 = 8000 Forecast error for period 1 = E1 = F1-D1 = 8913 - 8000 = 913 Assume a = 0.1, b=0.2, g=0.1; revise estimates for level and trend for period 1 and for seasonal factor for period 5 L1 = a(D1/S1)+(1-a)(L0+T0) = (0.1)(8000/0.47)+(0.9)(18439+524)=18769 T1 = b(L1-L0)+(1-b)T0 = (0.2)(18769-18439)+(0.8)(524) = 485 S5 = g(D1/L1)+(1-g)S1 = (0.1)(8000/18769)+(0.9)(0.47) = 0.47 F2 = (L1+T1)S2 = (18769 + 485)(0.68) = 13093

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Measures of Forecast Error


Forecast error = Et = Ft - Dt Mean squared error (MSE) MSEn = (Sum(t=1 to n)[Et2])/n Absolute deviation = At = |Et| Mean absolute deviation (MAD) MADn = (Sum(t=1 to n)[At])/n s = 1.25MAD
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Measures of Forecast Error


Mean absolute percentage error (MAPE) MAPEn = (Sum(t=1 to n)[|Et/ Dt|100])/n Bias Shows whether the forecast consistently under- or overestimates demand; should fluctuate around 0 biasn = Sum(t=1 to n)[Et] Tracking signal Should be within the range of +6 Otherwise, possibly use a new forecasting method TSt = bias / MADt
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Forecasting Demand at Tahoe Salt


Moving average Simple exponential smoothing Trend-corrected exponential smoothing Trend- and seasonality-corrected exponential smoothing

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Forecasting in Practice
Collaborate in building forecasts The value of data depends on where you are in the supply chain Be sure to distinguish between demand and sales

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Collaborative Planning, Forecasting And Replenishment (CPFR)


Initiatives that have attempted to create efficiency and effectiveness through integration of supply chain activities and processes have been identified as quick response, electronic data interchange (EDI), short cycle manufacturing, vendor managed inventory (VMI), continuous replenishment planning (CRP) and efficient consumer response (ECR). CPFR has become recognized as a breakthrough business model for planning, forecasting and replenishment. Using this approach, retailers, transport providers, distributors and manufacturers can utilize available internet-based technologies to collaborate from operational planning through execution. CPFR simplifies and streamlines overall demand planning.

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CPFR Business Model

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Development of CPFR came from an effort by Wal Mart and one of its suppliers, WarnerLambert Company, particularly with regard to its Listerine brand product. In addition to rationalizing inventories of specific line items and addressing out-of-stock occurrences, these two companies collaborated to increase their forecasting accuracy, so as to have just the right amount of inventory where it was needed, when it was needed. CPFR emphasizes a sharing of consumer purchasing data among and between trading partners for the purpose of helping to govern supply chain activities. In this manner, CPFR creates a significant, direct link between the consumer and the supply chain.
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The CPFR initiative begins with the sharing of marketing plans between trading partners. Once an agreement is reached on the timing and planned sales of specific products, and a commitment is made to follow that plan closely, the plan is then used to create a forecast, by stock-keeping unit, by week, and by quantity. The planning can be for thirteen, twenty-six, or fifty two weeks.

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Order Fulfillment and Order Management


Three critical elements of collaborative planning are collaborative demand planning, joint capacity planning, and synchronized order fulfillment. This type of planning improves quality of the demand signal for the entire supply chain through a constant exchange of information from one end to the other that goes well beyond traditional practices. The Order-Management system represents the principal means by which buyers and sellers communicate information relating to individual orders of product. Effective order management is a key to operational efficiency and customer satisfaction.
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Collaborative Planning
Collaborative demand planning

Synchronized Order fulfillment Joint Capacity planning

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Order Management Functions


Receive order Enter order manual/electronic Verify and check order for accuracy Check credit Check inventory availability Process back order Acknowledge order Modify order Suspend order Check pricing and promotion Identify shipping point Generate picking documents Originate shipment Inquire order status Deliver order Measure service level Measure quality of service
Prof. Prasad Kulkarni, MBA department GIT Belgaum.

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Order and Replenishment Cycles


When referring to outbound-to-customer shipments, we typically use the term order cycle. The term replenishment cycle is used more frequently when referring to the acquisition of additional inventory, as in materials management. Basically one firms order cycle is anothers replenishment cycle. Major components of Order Cycle
Order placement

Order processing

Order preparation

Order shipment

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Order Placement Order-placement time can vary significantly, from taking days or weeks to being instantaneous. Company experiences indicate that improvements in order-placement systems and processes offer some of the greatest opportunities for significantly reducing the length and variability of the overall order. Significant increases were projected for Internet facilitated resources such as E-marketplace, Extranets and E-mail. Order Processing The order-processing function usually involves checking customer credit, transferring information to sales records, sending the order to the inventory and shipping areas, and preparing shipping documents. Order Preparation Depending on the commodity being handled and other factors, the order-preparation process sometimes may be very simple and performed manually or, perhaps, may be relatively complex and highly automated. Order Shipment Shipment time extends from the moment an order is placed upon the transport vehicle for movement, until the moment it is received and unloaded at the buyers location.

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Customer Service
Having the right product, at the right time, in the right quantity, without damage or loss, to the right customer is an underlying principle of logistics systems that recognizes the importance of customer service. Another aspect of customer service that deserves mention is the growing consumer awareness of the price/quality ratio and the special needs of todays consumers, who are time conscious and who demand flexibility.
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The Traditional Logistics/Marketing Interface


Product Price Promotion Place/Customer service levels

Inventory carrying costs

Transportatio n costs

Lot quantity costs Order processing and information costs


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Warehousing costs

Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Defining Customer Service


Customer service is a process for providing competitive advantage and adding benefits to the supply chain in order to maximize the total value to the ultimate customer. According to marketers, there are three levels of product: 1. The core benefit or service, which constitutes what the buyer is really buying. 2. The tangible product, or the physical product or service itself; 3. The augmented product, which includes benefits that are secondary to, but an integral enhancement to, the tangible product the customer is purchasing. Logistical customer service, installation warranties and after-sale service are examples of augmented product features.

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Examples of the various forms that customer service may take include the following: 1. Revamping a billing procedure to accommodate a customers request. 2. Providing financial and credit terms. 3. Guaranteeing delivery within specified time periods. 4. Providing prompt and congenial sales representatives. 5. Extending the option to sell on consignment. 6. Providing material to aid in a customers sales presentation. 7. Installing the product. 8. Maintaining satisfactory repair parts inventories.

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Customer service as an activity This level treats customer service as a particular task that a firm must accomplish to satisfy the customers needs. Order processing, billing and invoicing, product returns and claims handling are all typical examples of this level of customer service. Customer service as performance measures This level emphasizes customer service in terms of specific performance measures, such as the percentage of orders delivered on time and complete and the number of orders processed within acceptable time limits. Customer service as a philosophy This level elevates customer service to a firm-wide commitment to providing customer satisfaction through superior customer service by laying emphasis on quality and quality management. Prof. Prasad Kulkarni, MBA department GIT Belgaum.
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Levels of Customer Service

Elements of Customer Service


Customer service has multifunctional interest for a company; but, from the point of view of the logistics function, we can view customer service as having four traditional dimensions: Time The time factor is usually order cycle time, particularly from the perspective of the seller looking at customer service. On the other hand, the buyer usually refers to the time dimension as the lead time, or replenishment time. Dependability Dependability can be more important than lead time. The customer can minimize its inventory level if lead time is fixed.
Change to change otherwise change will change you Prof. Prasad Kulkarni, MBA department GIT Belgaum.

1. Cycle time A seller who can assure the customer of a given level of lead time, plus some tolerance, distinctly differentiates its product from that of its competitor. The seller that provides a dependable lead time permits the buyer to minimize the total cost of inventory, stockouts, order processing and production scheduling. 2. Safe delivery If goods arrive damaged or are lost, the customer cannot use the goods as intended. A shipment containing damaged goods aggravates several customer cost centers inventory, production and marketing. 3. Correct orders An improperly filled order forces the customer to reorder, if the customer is not angry enough to buy from another supplier. If a customer who is an intermediary in the marketing channel experiences a stockout, the stockout cost also directly affects the seller.
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Communications The two logistics activities vital to order-filling are the communication of customer order information to the order-filling area and the actual process of picking out of inventory the items ordered. In the order information stage, the use of EDI or Internetenabled communications can reduce errors in transferring order information from the order to the warehouse receipt. Convenience Convenience is another way of saying that the logistics service level must be flexible. Basically, logistics requirements differ with regard to packaging, the mode and carrier the customer requires, routing and delivery times.
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Performance Measures for Customer Service


Element Product availability Brief Description Usually defined as percent in stock (target performance level) in some base unit (i.e. order, product, dollars) Typical Measurement Unit % availability in base units

Order cycle time

Distribution system flexibility

Elapsed time from order placement to order receipt. Usually measured in time units and variation from standard or target order cycle Ability of system to respond to special and/or unexpected needs of customer.

Speed and consistency

Response time to special requests

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Distribution system information

Ability of firms information system to respond in timely and accurate manner to customers requests for information Efficiency of procedures and time required to recover from distribution system malfunction (i.e. errors in billing, shipping, damage , claims).

Speed, accuracy and message detail of response

Distribution system malfunction

Response and recovery time requirements

Postsale product support

Efficiency in providing product support after delivery, including technical, information, spare parts, or equipment modification, as appropriate.

Response time, quality of response

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Expected cost of stockouts


A principal benefit of inventory availability and, hence of customer service is to reduce the incidence of stockouts. Once we develop a convenient way to calculate the costs of a stockout, we can use stockout probability information to determine the expected stockout cost. Last, we can analyse alternative customer service levels directly by comparing the expected cost of stockouts with the revenue enhancing benefits of customer service.
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Effects of stockouts
A stockout occurs when desired quantities of finished goods are not available when and where a customer needs them. When a seller is unable to satisfy demand with available inventory, one of four possible events may occur: 1. The customer waits until the product is available 2. The customer back orders the product 3. The seller loses a sale 4. The seller loses a customer
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Back Order
A company having to back order an item that is out of stock will incur expenses for special order processing and transportation. The extra order processing traces the back orders movement , in addition to the normal processing for regular replenishments. The customer usually incurs extra transportation charges because a back order is typically a smaller shipment and often incurs higher rates.
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Lost sales
Most firms find that although some customers may prefer a back order, others will turn to alternative supply sources. Most companies have competitors who produce substitute products; and when one source does not have an item available, the customer will order that item from another source. In such cases, the stockout has caused a lost sale. The sellers direct loss is the loss of profit on the item that was unavailable when the customer wanted it. Thus, a seller can determine direct loss by calculating profit on one item and multiplying it by the number the customer ordered. For eg. If the order was for 100 units and the profit is Rs. 10 per unit, the loss is Rs 1000.

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Lost Customer
The customer permanently switches to another supplier. A supplier who loses a customer loses a future stream of income.

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

The first step is to identify a stockouts potential consequences. These include a back order, a lost sale, and a lost customer. The second step is to calculate each results expense or loss of profit and then to estimate the cost of a single stockout. Assume : 70% of all stockouts result in a back order, and a back order requires extra handling costs of Rs. 6; 20% results in a lost sale for the item, and this loss equals Rs. 20 in lost profit margin; and 10% result in a lost customer, or a loss of Rs. 200. Overall impact : 70% of Rs 6 = Rs. 4.20 20% of Rs. 20 = Rs 4 10% of Rs. 200 = Rs 20 Total estimated cost per stockout = Rs 28.20 A firm should carry additional inventory to protect against stockouts only as long as carrying the additional inventory costs less than Rs. 28.20.
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Determining the Expected Cost of Stockouts

Channels of Distribution
A channel of distribution consists of one or more companies or individuals who participate in the flow of goods, services, information and finances from the producer to the final user or consumer. This encompasses a variety of intermediary firms, including those that we classify as wholesalers or retailers.

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Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Types of Channels
Managing distribution channels requires firms to coordinate and integrate logistics and marketing activities in a manner consistent with overall corporate strategy. Logistical channel refers to the means by which products flow physically from where they are available to where they are needed. Marketing channels refers to the means by which necessary transactional elements are managed. (e.g. customer orders, billing, accounts receivable etc.)
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Logistical and Marketing Channels


Logistical channel Channel
Supplier Transportatio n Manufacturer

Marketing
E-Procurement

National account sales

Transportatio n Distribution center Transportatio n Retail store


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Wholesaler/ Distributor

Retail customer

Consumer Prof. Prasad Kulkarni, MBA department GIT Belgaum.

Example of channels of distribution for the food products manufacturing industry Food Manufacturing firms
Food Service distributors Grocery wholesalers Food brokers Internet (direct)

Restaurant s

Specialty (airlines etc.) Retail chains (local and regional)

Retail groce rs

Institutio nal buyers

Retail chains

Interne t retailer

Consumers of manufactured food products


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