1DSC 335, Fall 2009

Supply Chain Dynamics and Coordination

DSC 335

Zhibin Yang, Assistant Professor

Decision Sciences

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Homecustomers

Homecustomers

Commercialcustomers

Commercialcustomers

Flowers-on-Demand floristFlowers-on-Demand florist

PackagingPackaging Flowers: Local/International

Flowers: Local/International

Arrangement materials

Arrangement materials

FedEx delivery service

FedEx delivery service

Local delivery service

Local delivery service

InternetserviceInternetservice

Maintenance services

Maintenance services

Supply Chain for a Florist

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East Coast West Coast East Europe West Europe Retail

USA Ireland Distribution centers

ManufacturerIreland Assembly

Germany Mexico USATier 1 Major subassemblies

Germany Mexico USA ChinaTier 2 Components

A Global Manufacturing Supply Chain

Poland USA Canada Australia MalaysiaTier 3 Raw materials

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Structure of Supply Chain

Multiple tiers of suppliers

Multiple tiers of customers

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Support Processes

Supplier relationship

process

New service/ product

development process

Order fulfillment process

Customer relationship

process

Service/Product Provider

Support Processes

Supplier relationship

process

New service/ product

development process

Order fulfillment process

Customer relationship

process

First-Tier Supplier

A Definition of Supply Chain (text pp 324)

A supply chain is the interrelated series of processes within a firm and across different firms that produces a service or product to the satisfaction of customers.

Ext

erna

l Sup

pli

ers

External C

onsumers

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Outline

Supply chain dynamics – bullwhip effect Causes of bullwhip effect Solutions to bullwhip effect

Supply chain coordination

Supply chain design

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Supply Chain Dynamics – Bullwhip Effect

What is the Bullwhip Effect? The variance of order quantity is greater than that of sales, and

the distortion increases as one moves upstream. Upstream members must react to the demand Slightest change in customer demand can ripple through the

entire chain

Hau L. LeeThoma Professor of Operations, Information, and Technology, Stanford Graduate School of BusinessDirector of the Stanford Global Supply Chain Management ForumDirector of the Strategies and Leadership in Supply Chains Executive Program

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Bullwhip Effect in a Diaper Supply Chain

Babies’ daily demand for diapers

Retailers’ daily orders to

distribution center

DC’s weekly orders to

Manufacturer

Manufacturer’s weekly production

quantity9,000

7,000

5,000

3,000

0

Ord

er q

uan

tity

Day 1 Day 30 Day 1 Day 30 Day 1 Day 30 Day 1 Day 30

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What Causes the Bullwhip Effect?

Demand Forecasting

Order Batching

Price Variations

Rationing Game

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Bullwhip Effect due to Demand Forecast

Stable demand with average 100 units;

Lead time: 4 weeks; At the beginning of each week, the retailer places an order before demand realizes

If demand drops by 10% (to 90 units) the order to the wholesaler drops by 60% (to 40 units)

Wholesaler Retailer

100 units

100 units

100 units

100 units 100

units

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(cont’d) Demand Forecasting

Contributing factors Lag in information flow Lack of information flow

Counter Measures Shorten lead time Better information

Current Practice / State-of-the-Art EDI and Cross docking Sharing sell-thru data

required by contracts (e.g., HP, Apple, IBM)

VMI (P&G and Wal-Mart)

Quick Response

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Bullwhip Effect due to Order Batching

Contributing factors Ordering costs Sales quotas Transportation discounts MRP systems

Counter Measures EDI & Computer

Assisted Ordering (CAO) Discounted on Assorted

Truckload, consolidated by 3rd party logistics

Regular delivery appointment

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Bullwhip Effect due to Price Variations

Contributing factors Promotions or quantity discounts cause retailers to place

larger orders to build up inventory Retailers order less in the following weeks, because

consumer demand is unaffected by promotion/discountCounter Measures

Everyday low price No discount to retailers Direct discounts to consumers through coupons

This is related to our case study #3

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Bullwhip Effect due to Rationing Game

How rationing causes bullwhip effect Limited production capacity during peak season Supplier / Manufacturer will ration the supply to satisfy

retailers’ orders; Retailers receive less than what they order Retailers inflate their orders, in anticipation of discounting in

their quantities Manufacturer observes very large volume and schedule

production to meet this inflated demand signal

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(cont’d) When Is Rationing Game Most Likely?

At supplier’s end Tight capacity (real or perceived)

At retailer’s end Anticipate demand peaks Competition with other retailers for same product

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Solutions for Battling Bullwhip Effect

Vendor Managed Inventory (VMI) Vendors take control of inventory management at the retailers

Quick Response (QR) Vendors receive POS data from retailers, and use this

information to synchronize their production and inventory activities.

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Vendor Managed Inventory (VMI)

How does it work? The vendor (supplier) receives inventory and point-of-sales

(POS) data from the retailers and calculates how much to ship to retailers.

The vendor places orders for supply.

VMI projects Dillard Department Stores, JCPenney and Wal-Mart Sales increases of 20 to 25% 30% inventory turnover improvements

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VMI Success at Wal-Mart

P&G collects demand and inventory information on a daily basis, from every Wal-Mart store

P&G automatically makes a shipment to Wal-Mart when inventory falls below the threshold

Because of the speed of this system, Wal-Mart pays P&G after the product passes over the scanners as the customer goes through the checkout lane

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VMI Failure at Spartan Stores

Spartan Stores, a grocery / drug store chain in Grand Rapids, MI (owned by an MSU alum?)

Spartan Stores shut down its VMI effort about one year after its inception.

Why?

Buyers didn’t trust the suppliers enough carefully monitor inventories intervene at slightest hint of trouble

Suppliers

didn’t do much to allay buyers’ fears didn’t do as effective a job as buyers

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Quick Response

The supplier receives POS data from retailers, and use this information to synchronize their production and inventory activities.

The retailer prepares individual orders, but the POS data is used by the supplier to improve forecasting and scheduling.

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Quick Response vs. VMI

Sales information passed back to the supplier.

Bullwhip effect is reduced.

What’s the difference? Who chooses the order quantity?

VMI: Supplier

QR: Retailer Who chooses when to order?

VMI: Supplier

QR: Retailer

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More on Battling the Bullwhip Effect

Lead time reduction Better information system

Better forecasting Better information system

Strategic partnering Information sharing Risk sharing

Product Transshipment Flexible delivery (3rd party logistics, truckload assortment

discounts)

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Outline

Supply chain dynamics – bullwhip effect

Supply chain coordination Coordinating self-interested members to improve the total

supply chain performance

Supply chain design

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Conflicting Objectives in Supply Chain

Decentralized supply chain: each member has his own interest and act independently

Self-interested decision makers: every member of the supply chain optimizes his own objective.

These self-interested members’ decisions may not align with the optimal decisions for the overall performance of the supply chain.

Inefficiencies across supply chain lead to decentralization cost

Solution: to coordinate the members to act as if they are a centralized supply chain (i.e., one decision-maker makes decisions in behalf of the whole supply chain)

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Conflicting Objectives – Prisoner’s Dilemma

A and B committed a crime together, and they were caught and interrogated separately by the police

What’s the best overall outcome for A and B? Both deny

What’s the likely outcome? Both confess

Can A and B coordinate to get away with the best outcome?

Prisoner B denies Prisoner B confesses

Prisoner A denies A & B: 6 months in jail A: 10 years in jailB: set free

Prisoner A confesses A: set freeB: 10 years in jail

A & B: 5 years in jail

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Supply Chain Coordination

Our goal: to attain performance of centralized supply chain with decentralized decision making

How do we do that?

1. A contract is agreed by and announced to all members before they make decisions

2. Each member independently decides and acts

3. The contract is executed

We say a decentralized SC is coordinated by a contract, if The total profit of decentralized SC equals the total profit of

centralized SC, and All members are better off under this contract, compared to

the case without such a contract (uncoordinated case)

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Coordination Issues in Operations

Can SC performance be improved by centralized decision making? – usually, yes!

Do all SC members improve their individual performance under centralized decision making? – may be NOT.

Can centralization be achieved without centralized control? That is, does there exists a coordinating contract that induces

all SC members to act as if they were in a centralized SC? May NOT. We need to design supply contract smartly.

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Example: Coordinating S.C. Inventory

Consider a simple demand driven supply chain: a buyer and a supplier

The buyer produces D = 10,000 units/year of a product at a constant rate. Each time the buyer places an order for a certain component, the ordering cost is Sb = $100. The buyer’s inventory holding cost is H = $10/yr and optimal ordering quantity:

BuyerSupplier Customers

2 2(10,000)(100)447

10b

b

DSEOQ

H= = =

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(cont’d)

The supplier produces an order whenever one is received from the buyer. Each time the seller sets up to produce a batch of components,

the production setup cost is Ss = $300.

The supplier’s total (setup) cost = Ss(D/EOQb).

Optimal ordering quantity for the centralized supply chain:

2 ( ) 2(10,000)(100 300)894

10b s

SC

D S SEOQ

H

+ += = =

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(cont’d)

If buyer orders Q=894, supply chain’s total cost is reduced

But, buyer incurs a higher cost, and will not order Q=894

The SC is NOT coordinated without a compensation for buyer

Buyer's optimal quantity

Centralized supply chain's optimal quantity Cost saving

Q=447 Q=894Supplier cost $6,711 $3,356 $3,356Buyer cost $4,472 $5,589 -$1,116Supply chain cost $11,184 $8,944 $2,239

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(cont’d) A Cost-sharing Contract

For any order quantity Q, the buyer always bears a fraction of of the total cost of the supply chain Supplier promises to pay buyer = (1–)(buy’s total holding

and setup cost) The buyer promises to pay the supplier = ()(supplier’s total

setup cost)

Buy’s optimal quantity = SC’s optimal quantity = centralized SC’s optimal quantity = 894

There exist a such that buyer and suppliers are both better off than ordering Q=447

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Factors that Affect Coordination of SC

Cooperation among self-interested agents require: extensive information sharing capabilities, trust among players, permission and coordination efforts by the controller, revealing truth about cost parameters.

Mechanisms such as pricing, auctions, contracts, or incentive rules are worth investigating.

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Outline

Supply chain dynamics – bullwhip effect

Supply chain coordination

Supply chain design Matching the type of product with the type of supply chain

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Outsourcing?VMI?

Quick Response?

Make to order?

…….

What Is the Right Supply Chain for Your Product ?

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Rule of Supply Chain Design

To match product characteristics with supply chain characteristics

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Campbell's Soup Fashion Apparel

Life cycle

Contribution margin

Variety

Forecast error

Stock-out rate

Forced markdowns

Make-to-order LT

Product Characteristics

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Product Life-Cycle: Soup

1969

1999

1989

1979

2009

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Product Life-Cycle: Fashion

Fall Winter

Spring

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Margins?

Retail Price: $139.50Retail Price: $1.39

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Variety? New Design?

Differed in color, size, style, etc., 95% new

Unchanged over years, only 5%

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Forecasting Error?

High forecast error, 40-100% errorHighly predictable, service level of 98%

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Stockout Rate?

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Markdowns?

Deep discount in the end of the seasonRare

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Functional Products

(Soup)

Innovative Products

(Fashion clothing)

Demand Uncertainty Low (forecast error) High (forecast error)

Life Cycle Long Short

Risk of Obsolescence Low High

Profit Margin Low High

Variety Low High

Demand volume High Low

Two Types of Products

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Tow Main Functions of Supply Chains

Physical function Transformation process – converting raw materials to finished

goods and moving them along SC

Market mediation Ensuring that the right variety of products are available at the

right place, at the right time, in the right quantities

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Two Types of Supply Chains

Factor Efficient Supply Chains Responsive Supply Chains

Operation strategy Make-to-stock or standardized services or products; emphasize high volumes

Make-to-order, or customized service or products; emphasize variety

Capacity cushion Low High

Inventory investment

Low; enable high inventory turns

If needed to enable fast delivery time

Lead time Shorten, but do not increase costs

Shorten aggressively

Supplier selection Emphasize low prices, consistent quality, on-time delivery

Emphasize fast delivery time, customization, variety, volume flexibility, top quality

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mismatchmatch

mismatch match

Source: “What is the Right Supply Chain for Your Product?”,by Marshall Fisher, HBR March-April 1997

Functional products Innovative products

Responsive SC

Efficient SC

Choose Supply Chain for Your Product

Common Mistake: Physically Efficient Supply Chain for an Innovative product

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Some Lessons of SC Design

Functional products: Don’t add complexity to a functional product, i.e. avoid trade

promotions SC players should cooperate to cut costs

Innovative products: Accept uncertainty Reduce uncertainty: new data, component commonality Avoid uncertainty: cut lead times, switch to make-to-order Hedge against uncertainty: inventory buffers, excess capacity