CTL.SC2x - Supply Chain Design Key Concept... · Fall 2017・CTL.SC2x – Supply Chain Design Key...
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Fall 2017・CTL.SC2x – Supply Chain Design Key Concepts・MITx MicroMasters in Supply Chain Management MIT Center for Transportation & Logistics・Cambridge, MA 02142 USA ・[email protected] This work is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License.
CTL.SC2x-SupplyChainDesign
KeyConceptsDocument
ThisdocumentcontainstheKeyConceptsfortheSC2xcourse.Thedocumentisbasedonapastrunofthecourseanddoesnotincludeallthematerialthatwillbeincludedinthiscourse;pleasecheckbackfornewerversionsofthedocumentthroughoutthecourse.Thesearemeanttocomplement,notreplace,thelessonvideosandslides.Theyareintendedtobereferencesforyoutousegoingforwardandarebasedontheassumptionthatyouhavelearnedtheconceptsandcompletedthepracticeproblems.TheupdatedbyDr.AlexisBatemaninthefallof2017.Thisisadraftofthematerial,sopleasepostanysuggestions,corrections,orrecommendationstotheDiscussionForumunderthetopicthread“KeyConceptDocumentsImprovements.Thanks,ChrisCaplice,EvaPonceandtheSC2xTeachingCommunity
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Fall 2017・CTL.SC2x – Supply Chain Design Key Concepts・MITx MicroMasters in Supply Chain Management MIT Center for Transportation & Logistics・Cambridge, MA 02142 USA ・[email protected] This work is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License.
TableofContentsSupplyChainDesign 3
Demandforecastingmatrix 4References 7
NetworkModels 8IntroductiontoNetworkModels 8FacilityLocationModels 10SupplyChainNetworkDesign 15AdvancedSupplyChainNetworkDesignTopics 16PracticalConsiderations 20
ProductionPlanning 23FixedPlanningHorizon 23MaterialandDistributionRequirementsPlanning 28
ConnectingSalestoOperations 31AggregatePlanningModel 31MonthlySales&OperationsPlanningProcess 34DistributionandChannelStrategies 35
SupplyChainSourcing 45ProcurementStrategy 45ProcurementOptimization 49
SupplyChainFinance 51AccountingFundamentals 51CostingSystems 54SupplyChainCashFlows 58DiscountedCashFlowAnalysis 60DefiningSupplyChainFinance 64AnalyzingFinancialPerformance 69
Organizational,Process,andPerformanceMetricDesign 77
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SupplyChainDesign
SummarySupplyChainDesignisasmuchanartasitisscience.Sciencebecausewecanquantifytheimpactofdifferentchoices,andfindtheoptimaltrade-offsbetweendifferentchoiceparameters.Butalsoanartbecausetheassumptionswemakearenevergoingtocompletelymatchreality,andbecausethedataweuseforourmodelsisnevergoingtobecompletelyaccurate.Thereisnosinglerightwayofmakingtheseassumptions–doingthisina“good”wayforaparticularproblemismoreartthanscience!Still,welearnedthattherearesomeframeworks,tools,andmethodstoaidthedesignprocess.Thecourseexaminestheflowsinasupplychain,witheachdesignissuediscussedinaseparatemodule:
• DesignofPhysicalFlows.Howshouldmaterialsflowthroughthesupplychain?Wewillmodelphysicalflowstakingintoaccountthecostsoftransportationandfacilities.WewillbalancecostsandserviceusingMixedIntegerPrograms.However,keyisinnotjustsolvingthemodels,butininterpretingtheresults.Remember,thetoolsaredecision-supporttools,theyareintendedtosupportdecisions,notmakethemforus!
• DesignofFinancialFlows.HowtotranslatesupplychainconceptsandactionsintothelanguageoftheCFO(ChiefFinancialOfficer)?Wewillgothroughactivitybasedcosting,cashflowanalysisandcapitalbudgetingtobetterunderstandhowsupplychaindesigndecisionstranslatetochangesintheincomestatementandthebalancesheet.
• DesignofInformationFlows.Forthismodule,wewillfollowtheSCOR-model’sthreephasesofSource,Make,andDeliver.Howshouldyouworkwithsuppliers?Howshouldinformationbecoordinatedbetweendifferentmanufacturers,internalandexternal?Andhowshouldyoucoordinateandcollaboratewithcustomers?Inthismodulestrategiesandproceduresforthisisdiscussed.
• Designingtheorganization.Howshouldasupplychainbeorganized?Wewillinvestigatesupplychainprocessesandhowthemeasuringoftheperformanceoftheprocessescreatedifferentincentives.Wewillalsodiscussorganizationalstructure.
KeyConcepts• SupplyChains-Twoormorepartieslinkedbyaflowofresourcesthatultimatelyfulfilla
customerrequest• SupplyChainFlows–physicalflows,financialflows,andinformationflows.Allare
importanttoconsiderwhendesigningasupplychain.
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Demandforecastingmatrix
Forecastingtruisms:
• Forecastarealwayswrong–userangesandtrackforecasterror• Aggregateforecastaremoreaccurate–riskpoolingreducescoefficientofvariation• Shortertimeforecastsaremoreaccurate–postponecustomizationaslateaspossible
ContinuousreviewandperiodicreviewInventoryisgenerallymanagedusingoneoftwokeytypesofpolicies:policiesusingcontinuousrevieworpoliciesusingperiodicreview.
• Continuousreviewmeansthattheinventorypositioniscontinuouslysupervised(presumablybysoftware).Assoonastheinventorypositionreachesapre-determinedlevelsareplenishmentorderofQunitsisplaced.Consequently,thetimebetweenordersisuncertain.
• Periodicreviewmeansthattheinventorypositionisreviewedatcertainreoccurringpointsintime,suchaseveryeveningafteraretailerclosesthestore.Basedonthecurrentinventoryposition,areplenishmentorderisplacedtobringtheinventorypositionuptoapre-determinedlevelS.Consequently,theorderquantityisuncertain.
Bothpoliciesareusedwhendecisionsaremadeforalonghorizon,wheretheitemscanbestoredbetweenperiodsofreplenishment,butdemandineachreplenishmentperiodisuncertain.
TransportationoptionsThereareseveralwaysoforganizingthetransportationinasupplychain.Amongthem:
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• One-to-one:directpoint-to-pointmovementsfromorigintodestination,e.g.dailyfullvanloadstoeachcustomer
• One-to-many:multi-stopmovesfromasingleorigintomanydestinations• Many-to-many:movingfrommultipleoriginstomultipledestinationsusuallywithahub
orterminal–thisdecoupleslinehaul(frome.g.asuppliertoaterminal)fromlocaldeliveryoperations(frome.g.aterminaltostores)
TotalcostequationThetotalcostequationspecifiesthetotallogisticscostforasystemforanarbitrarytimeperiod:Totalcost=Purchase(UnitValue)Cost+Order(SetUp)Cost+Holding(Carrying)Cost+ShortageCost
• Purchase:Costperitemortotallandedcostforacquiringproduct.• Ordering:Itisafixedcostandcontainscosttoplace,receiveandprocessa
batchofgoodincludingprocessinginvoicing,auditing,labor,etc.Inmanufacturingthisisthesetupcostforarun.
• Holding:Costsrequiredtoholdinventorysuchasstoragecost(warehousespace),servicecosts(insurance,taxes),riskcosts(lost,stolen,damaged,obsolete),andcapitalcosts,bothforunitsin-transit(pipelineinventory)andinwarehouse(cyclestock+safetystock)
• Shortage:Costsofnothavinganiteminstockincludingbackorder,lostsales,lostcustomers,anddisruptioncosts.
NotationD: Demandrate(units/time)Q: Orderquantity(units)L: Leadtime(time)σDL: Standarddeviationofdemandduringtheleadtimek: Safetystockfactorc: Purchasecost($/unit)ct: OrderingCosts($/order)h: Holdingrate–usuallyexpressedasapercentage($/$value/time)ce: ExcessholdingCosts($/unit-time);alsoequaltochcs: Shortagecosts($/unit)TC: TotalCosts–thesumofallfourcostelementsWegetthat
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Fromtheformulaweseethattransportspeedaswellasforecastaccuracyhasanimpactontotalcostthroughtheinventorycosts.
SCOR-modelForthedesignofinformationflows,wefollowtheSource-Make-DeliverprocessoftheSCOR-model.
Fisher’smodel:InnovativeversusfunctionalproductsWhendesigningasupplychain,thedesignneedstobeadaptedtothetypeofproductsitisintendedfor.InFisher’smodel,productscanbeclassifiedasbeingeithermoreFunctionalormoreInnovative.
• Functional:predictabledemand,longlifecycle,lowmargin,lowerrorinproduction,lowstock-outrates
• Innovative:unpredictabledemand,shortlifecycle,highmargin,higherrorinproduction,highstock-outrates
Asaruleofthumb,functionalproductsshouldhaveadesignfocusingmoreonefficiency,whereasinnovativeproductsshouldhaveasupplychaindesignfocusingmoreonmatchingsupplywithdemand.Rememberthatthesearenothardandfastrules.Inpracticethereare,ofcourse,manyproductsthatsharecharacteristicswithbothsegments.Mostfirmsaregoingtohaveaportfolioofsupplychains.Further,innovativeproductsoftenmoveintobecomingmorefunctionalastheirmarketsbecomemoremature.Thisrequiresadaptationofthesupplychaindesign.Forinstance,whenthepatentprotectionforthecholesterolloweringdrugLipitorwentout,Pfizerhadtoreducethepricetoprotectthedrugfromgenericcompetition.Withalowermargin,thesupplychainmustbedesignwithahigherfocusonefficiency.
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LearningObjectives• Identifyphysical,financial,andinformationflowsinherenttosupplychains• RecapSC1x:demandforecasting,inventorymanagement,transportation• HowtoapproachSupplyChainDesignfordifferentproductsandcompanies• PresentaroadmapforthecourseSummaryofLesson
References• Arntzen,B.(2013)MITCenterforTransportation&Logistics,Hi-VizResearchProject.• Fisher,M.(1997)“WhatIstheRightSupplyChainforYourProduct?”HarvardBusiness
Review.• Olavsun,Lee,&DeNyse (2010)“APortfolioApproachtoSupplyChainDesign,”Supply
ChainManagementReview.AdaptedfromSheffi(2010)ESD.260CourseNotes
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NetworkModels
SummaryNetworkmodelsareausefulclassofmodelsthatcanbeutilizedtoaidmanytypesofsupplychaindecisions.Wereviewthebasicnotationsofthesemodels,andshowhowtosetupasimplespreadsheetmodelinExcelorLibreOfficetosolvethemodel.Wefocusontwotypesofmodelsthatarerelativelysimpleyetpowerfulinderivinginsightstosupportsupplychaindesigndecisions:theTransportationProblemandtheTransshipmentProblem.Boththetransportationproblemandthetransshipmentproblemconsideranunderlyingnetworkofnodes(facilities)andarcs(transportflowsbetweenfacilities).Theobjectiveistominimizecostsforagivenperiod(day,week,year)bychoosingtheamountofunitstobeshipped/transportedondifferentarcsduringtheperiodtofulfilldemand,whilemeetingthecapacityconstraints.Bothproblemscanbeformulatedaslinearprograms(seebelow)andsolvedusingyourspreadsheetsoftwareofchoice(e.g.ExcelorLibreOffice).Fordetailsonhowtorunthesolver,pleaserefertotheseparateguideforhowtosetupandrunthesolver,whichisfoundinthecoursematerial.Wediscusssomeofthelimitationstothesenetworkmodels.First,inthemodelsreview,welimitedourselvestovariablecostsforthearcs(i.e.transportcostsperunit).Clearly,thecoststructureforanetworkis,inpractice,oftenmorecomplex,involvingcoststhatarebothfixedorvaryoverdifferentparameters.Wealsoconsideredasinglecommodity–allplantsproducedperfectlysubstitutablegoods.Thedemandwasdeterministic,thatis,weassumedthatdemandwasperfectlyknownfortheentireperiod.Finallywealsoassumedtherewasnocapacitylimitsonthearcs,sothatanyamountcouldbetransported.Clearly,alloftheseassumptionslimitourresults,sowehavetobecarefulwhatinferenceswemakefromthemodels.Inthecominglessonswewillrelaxsomeoftheseandalsodiscusshowtomakeinferencewhilestillusingarelativelysimplemodel.Also–wenotedthattransportationandtransshipmentproblemsmayhaveseveraloptima(thesamevalueoftheobjectivefunctionisfoundbydifferentvalueonthedecisionvariables).Dependingonthealgorithmandsoftware,differentoptimamaybethe“firstchoice”ofthealgorithm.
IntroductiontoNetworkModels
Networkterminology• Nodeorvertices–apoint(facility,DC,plant,region)• Arcoredge–linkbetweentwonodes(roads,flows,etc.)• Networkorgraph–acollectionofnodesandarcs
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ThetransportationproblemThetransportationproblemconsiderstransportsfromisupplynodestojdemandnodesoverarcsij.Witheacharcisassociatedacostcij.Theamountofunitstransportedoneacharcijisdenotedxij.Thesexij’sareourdecisionvariables–wewanttofindtheamountsforeacharcthatminimizestotalcost.Letzbetheobjectivefunction(i.e.,thefunctionexpressingthetotalcostwewanttominimize).Notation
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Plants iRegions j
xij = Flow on arc from Plant i to Region j (tons) ∀i, j
Indices
Decision Variables
Si =Available supply of sand from Plant i (tons) ∀i ∈ SDj =Demand for sand in Region j (tons) ∀j ∈ D
Input Data
cij =Cost for sending sand from Plant i to Region j ($/ton) ∀i, j
Thesearethesupplyconstraints–thetotalnumberofshippedunitsfromasupplynodeitoalldemandnodesjmustbelessthan(orequalto)thesupplycapacityofnodei.
Thesearethedemandconstraints–thenumberofshippedunitstoademandnodejfromallsupplynodesimustbeatleastthedemandatnodej.
Thesearethenon-negativityconstraints–wedonotallownegativevolumesonanyarc
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ThetransshipmentproblemThetransshipmentproblemissimilartothetransportationproblem.Thedifferenceisthatwenowintroduceasetofnodesthatareneithersupplynodesnordemandnodes,buttransshipmentnodes,meaningthatoveraperiod,anythingthatgoesintothetransshipmentnodeneedstocomeout.Notation
Notethatwehavethesameformulationasforthetransportationproblembutwithonedifference:athirdconstrainthasbeenadded(highlighted).Thisconstraintistheconstraintforcingthetransshipmentnodetobe“empty”–theconservationofflowconstraint.Considertransshipmentnodej.Thefirstsumintheconstraintisthenthetotalnumberofunitsshippedtonodejfromallothernodesi.Thesecondsumisthetotalnumberofunitsshippedfromnodejtoallothernodesi.Theconstraintsaysthatthisdifferencemustbezero.
FacilityLocationModelsInthepreviouslyintroducemodelsweassumedthateveryfacilityinthenetworkwasused.Wenowrelaxthatassumption.First,wereviewwheretolocateafacility,giventhatweneedasinglefacility.Wetheninvestigatehowmany(andwhich)facilitiestouse,givenasetofcandidates.Lastly,wereviewhowtoincorporateexplicitLevelOfService(LOS)constraintsinourmodels,toidentifycertaincostandservicetrade-offsinmoredetail.
Origin iDestination j
xij = Flow on arc from i to j (tons) ∀i, j
Indices
Decision Variables
Si =Available supply of sand from Plant i (tons) ∀i ∈ SDj =Demand for sand in Region j (tons) ∀j ∈ D
Input Data
cij =Cost for sending sand on arc from i to j ($/ton) ∀i, j
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Forthesinglefacilitycasewelookattwofundamentallydifferentwaysofapproachingthedecision.ThefirstwasbyconsideringallpointsintheEuclidianspaceaspotentialcandidates,andsearchforanoptimallocationforafacilityanywhereinthisspace.Forthisweuseboththecenter-of-gravity-methodandtheWebermethod.Whiletheformerhasanintuitiveappeal,theWebermethodismoreappropriateasitminimizestheactualtransportationcosts.Thefundamentalproblemofrelyingoneitherofthesemethods,though,isthattheoptimalsolutionmayendupinplacesthatarenotfeasibleforawidenumberofreasons:lackofinfrastructure(wecouldendupinalake!),highconstructioncosts,difficultyofgettingpermitsetc.Sowhilethesemethodsareusefultogetaballparkfigureofwheretolocatethefacility,theyprovideonlyaregiontotarget.Wereviewanotherapproachwhere,insteadofconsideringthefullEuclidianspace,thereisonlyafinitesetofcandidatelocations.ThisproblemcanbeapproachedusingaMixedIntegerLinearProgram(MILP),forwhichwecanuseaspreadsheetsolvertofindthesolution.MILPusedtosolvethesinglefacilityproblemcouldbeeasilyextendedtoinvestigatethecaseofmultiplefacilities.Themodelcouldthenbeusedtoanswerbothhowmanyfacilitiestouse,andwhichfacilitiestouse.Finally,weincorporateexplicitLOSconstraintsinourmodels.Twotypesofserviceperformancewereconsidered:theaverageweighteddistancetocustomers,andtheamountofdemandwithinacertaindistancefromaDC.WecanspecifyboundsfortheseperformancemeasuresandincludethemintheMILP,toensurethattheoptimalsolutionmettheLOSrequirements.
ContinuoussinglefacilityproblemWithacontinuoussinglefacilitymodel,theaimistofindoneoptimalpointintheEuclidianspace.Centerofgravity.Withacenterofgravitymodel,welettheoptimalpoint’scoordinatesbegivenbyweightedxandycoordinates,wheretheweightgiventoeachnodekisgivenbythedemandinthatnode.Forinstance,ifwewanttofindtheoptimallocationforaDCthatwillsupport3stores,theoptimallocationwillbegivenbytheweightedcoordinatesofthestores,whereeachstore’scoordinatesareweightedbythedemandatthestore.
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Webermethod.WiththeWebermethod,insteadoftakingtheweightedcoordinatesofthenodes,wetrytominimizetheweightedEuclidiandistancesbetweennodeskandlocation(x,y).Theweightsarestillgivenbythedemandatthedifferentnodes.(Wherezisoptimizedbychangingthedecision-variablesxandy.)
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( ) ( )2 2( , )k k k k kk K k KMin z w d x y w x x y y
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NetworkfacilitylocationWhenwehaveanumberofcandidatelocationstochoosebetween,wecancreateanetworkflowmodeltofindwhichofthecandidatelocationsprovidethelowestcost.Todothis,weformulateaMixedIntegerLinearProgram(MILP).OurproblemisMILPbecauseithasalinearobjectivefunctionandlinearconstraints,butwithsomevariablesbeingintegersinsteadofcontinuous.TheintegervaluesaretheYi’sthatdescribewhetherfacilityiisused(Yi=1)ornot(Yi=0).Associatedwitheachfacilityisafixedcostforthetimeperiod,fi.Aswiththetransportationproblem,thenumberofunitsshippedbetweentwonodesaregivenbythexij’s.NotationMij:Anarbitrarylargenumber,specifictoeacharc(butthevaluecouldbethesamebetweenarcs)Pmin:MinimumnumberoffacilitiesPmax:Maximumnumberoffacilities.Withzbeingtheobjectivefunction,theproblemisformulatedasfollows:
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Notethatforasinglefacilitylocationproblem,weletPMIN=PMAX=1.
MultiplelocationselectionmodelForthisweusethesameMILPasforthenetworkfacilitylocationproblemabove.Ifwehaveagivennumberoflocationswewanttochoose,weletPMIN=PMAX=k,wherekisthenumberoflocations.Ifweinsteadwanttofindtheoptimalnumberoflocations,weremovetheconstraintonthesumofY,sothatthissumcanbeinfinitelylarge(orlessthansomelargenumber).Note
Thesearethesupplyanddemandconstraints
Thesearethelinkingconstraints–toensurethatwedonotallocateshipmentstoalocationthatisnotused,theunitsshippedonanarcmustbelessthan(orequalto)alargenumbertimestheYassociatedwiththenodewherethetransportoriginatesTheseareconstraintsonthenumberoffacilitiestouse–thesumoftheY-variableswillbethetotalnumberoffacilitiesinuseThesearethenon-negativityconstraints(forx’s)andthebinaryconstraints(fortheY’s)
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thatwewanttokeepaminimumconstraintonthesumofY,otherwisethemodelwillchooseallYi=0.
EnforcingLOSTocreateenforcingLOS,weusethesamebasicsetupasbefore,withthehighlightedaddition:
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Si =Available supply at DC i (units) ∀i ∈ SDj =Demand by Customer j (units) ∀j ∈ Dcij =Cost to serve Customer j from DC i ($/unit) ∀i, jfi = Fixed cost for opening DC i ($) ∀i ∈ SPMIN = Minimum number of DCs required to openPMAX = Maximum number of DCs allowed to openM = A really big number, but not too big!dij =Distance to Customer j from DC i (miles) ∀i, jaij =1 if Customer j to DC i ≤ 50 miles, =0 otherwise ∀i, jMaxAvgDist = Max allowable average distance DCs to CustomersMinPctIn50 = Min allowable demand within 50 miles of a DC
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Notethattwoconstraintswereadded(highlighted).• Aconstraintontheaverageweighteddistance:Thisconstrainttakesthe(demand)-
weightedaveragedistanceandensuresthatitislessthanorequaltosomecriticallevelMaxAvgDist,themaximumallowedaverageweighteddistance.Consequently,themodelwillmakesurethattheaveragecustomerisnot“toofaraway”.
• Aconstraintontheamountofdemandwithinacertaindistance:Thepreviousconstraintconsidersonlytheaverage,whichmeansthatwedonotknowhowmuchofourdemandthathasanLOSbelowacertainthreshold.Forinstance,evenifweknowthattheaveragedistanceislessthan50miles,wemaybeinterestedinensuringthatatleast75%ofourdemandislessthan50milesfromaDC.Thisconstraintensuresthat.Forthisweneedtospecifyadistance(say50miles).Thebinaryvariableaijthendenoteswhetherornotacertainlinkisshorter(aij=1)than50milesornot(aij=0).Thatis,theconstraintensuresthatnot“toomany”customersarefaraway.
Itisalsoimportanttonotethatwhenweintroduceserviceconstraints,wemayneedtointroducebindingconstraintsonthedemand.Ifnot,themodelmaytrytoenforcetheserviceconstraintbydeliveringmorethandemandedtocertaindemandnodes.Thiswillhoweverbeartificial(andunsold)demand.Toensurethisisnotthecase,letthedemandconstraintbegivenbyequality,insteadofthecomputationallymoreefficientinequality.
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SupplyChainNetworkDesignWenowcombinethedifferenttechniqueslearnedintoonemodel.Wetakenetworkoptimizationandcombineitwiththefacilitylocationmodelstogetherintowhat'sknownasasupplychainnetworkdesignmodel.
Datacollection:TransportationDataThefirststepinbuildingthemodelistocollectdata.Fortransports,wewanttoknowthecostsandcapacitiesassociatedwithbothinboundandoutboundtransportation.WiththeSupplyChainNetworkDesignModel,transportationcostsareassumedlinearintransportvolumes.Clearly,thisisnotalwaysthecase:theremaybeminimumcharges,fixedcosts,ormanyothertypesoffixedandvariablecostcomponents.However,inordertobuildthemodel,alinearapproximationmustbefound.Thiscouldbedoneinseveraldifferentways:
• Takeaveragetransportcostfromhistoricaldata• Uselistprices• Useregressionanalysistofindthecosts• Usebenchmarkratesfromothersources
Whicheverwayyouusetouncoverthesecosts,youneedtobeawareofhowyourlinearapproximationaffectsthereliabilityofthemodel.Forabrush-uponlinearregression,pleaserefertotheKeyConceptsdocumentfromSC1x.
Datacollection:FacilityDataTheSupplyChainNetworkDesignModelallowsfacilitycoststobebothfixedandvariableinvolume.Therewillalwaysbepeoplearguingthat“allcostsarefixed”or“allcostsarevariable”,butwhatyouneedtoconsiderishowfixedandvariablecostcomponentsaffectthesolutionyourmodelsearchesfor.Fixedcostswillmakeitexpensivetohavemanyfacilities,sothemodelwilltrytoreducethenumberoffacilities.Variablecostswillmakeitcostlytohavelongdistances,andthemodelwillthereforetrytoincreasethenumberoffacilities(oratleastreduceaveragedistances).Iffacilitiesareownedand/oroperatedbyathird-party,findingthefixedandvariablecostsisnormallystraight-forward–theyaregiveninthecontract.Ifafacilityisoperatedin-house,othertechniqueshavetobeused.Amongthem:
• Activity-basedcostingtofindvariablecosts• Regressionanalysisovervolume(notethattheinterceptisthefixedcostcomponent)
Forfacilitieswealsoneedtounderstandthecapacity.Thecapacityisthemaximumthroughputoveraspecifiedunitoftime(e.g.aweek).Notethatthiscanbeverydifficulttomeasureinpractice,sinceshiftscanbeadded,whilecapacityalsodependsonplanningandscheduling.
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NetworkDesignBaselinesYoushouldbecarefulinwhichbaselineyouuseforcomparingyourresults.Threebaselinesareimportanttoconsider:
• Baseline1–Actualcosts:whatcostdoesthemodelgiveusifweusetheactual,currentflows?Wewanttoknowhowwellthemodelmatchesreality.Youusethisbaselinetocalibratethemodel.
• Baseline2–Adheretopolicy:theremaybeapolicyinplacethatyouaresimplynotadheringtoinyouroperations.Withthisbaselineyouwanttoknowhowothersolutionscomparetowhatyououghttobedoingaccordingtothepolicyinplace.
• Baseline3–OptimalDCassignment:ifyouweretousetheoptimalassignmentfortheDC–whatwouldthesolutionlooklike?WiththisbaselineyoucanisolatetheeffectofnumberofDCssinceyouoptimizeallocation.
Itisimportanttokeepinmindthatyoucomparedesignchangestotherightbaseline.Forinstance,ifyouusethemodeltofigureouthowmuchyoucouldreducecostsbyreducingthenumberofDCs,youneedtobeawarethemodelwilltellyouthiswhile,atthesametime,optimizingtheallocationgiventhenumberofDCs.Henceyoushouldcompareyoursolution-the“optimalnumberofDCsunderoptimalallocation”-toBaseline3,whereyouhavethe“currentnumberofDCsunderoptimalallocation”.Why?Becauseotherwiseyoucomparesolutionsthathaveoptimalallocationstosolutionsthatdonothaveoptimalallocations–youdonotisolatetheeffectofchangingthenumberofDCs.
RunScenariosOneofthekeybenefitsoftheSupplyChainNetworkDesignModelisthatitiseasyandfasttorundifferentscenarios.Scenarioscaninvestigateuncertainparameters(sensitivityanalysis)orexplorehowdifferentconstraintsaffecttheoptimalsolution.Whilethisisagreatbenefit,itisimportantnottoget“analysisparalysis”–justbecauseitispossibletorunmanyscenariosdoesnotmeanitisthewaytogo.Itisimportanttounderstandwhichscenariosthatarerelevantand,mostimportantly,howtointerprettheresults.Forinstance,whichbaselineshouldbeusedforcomparingtheresultsofthescenario?
AdvancedSupplyChainNetworkDesignTopicsTherearemanyadvancedsupplychainnetworkdesigntopicsandweintroduceseveralhere.Thefirstisrobustoptimizationusingsimulationalongwithoptimization.Thisisarelativelysimpleandquickwaytogetahandleontheimpactofthevariabilityofdemand(orotherfactors)onfacilityselection.Wealsocovermulti-commodityflowproblems,whichsignificantlyincreasesboththecomplexityandsizeofthemodels.Whilemorecomplicated,multi-commodityflowmodelsarestillverysimilartothetransshipmentandfacilitylocationmodelsexploredpreviously.TheconceptofFlexibilitywasintroducedfollowingtheapproach
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developedbyJordanandGraves(1995).Formingchainsbetweenplantsincreasestheoverallflexibilityatamuchlowercostthanifweprovidedfullflexibility.Thefinalexpansionofthemodelcoversmultipletimeperiods.Thisismeantformoretacticalplanningperiods–butagain,themodelswereverysimilartothesimplersinglecommoditytransshipmentmodelswiththeadditionofinventorybalanceequations.Thefinalsectionreviewshowpipelineinventory,safetystock,andcyclestockcanbeincludedinstrategicnetworkdesignmodels.
Robustnessinsupplychainnetworkmodels–demanduncertaintySupplyChainNetworkDesign(SCND)modelsaredeterministic.Theyassumethateachinputvalueisknownwithcertaintyandexhibitsnovariability.Weknowthisisnotthecaseinreality.So,whiletherearemanymoresophisticatedmathematicaltechniquesthataddressthisshortcoming,wecanusesimpleMonte-Carlosimulationtotrytounderstandhowrobustoursolutionsare.Essentially,themethodinvolvesre-solvingthemodelwithnewinputinformationeachtime.Thenewinputdataisrandomlyselectedusingestimatesofthedistributionofthevariables.TheeasiestwaytosimulaterandomvariablesinspreadsheetsistousetheRAND()function.Itreturnsanumberbetween0and1.00followingauniformdistribution.
• TosimulateauniformdistributionwithmeanofX,plusorminusY%,wewouldsetthevalueto: =X*(1+(RAND()-0.50)*(2*Y))
Sothatifwewanted250+/-20%,we’duse=250*(1+(RAND()-0.50)*0.40)returningvaluesfrom~200to300.• TosimulateaNormalDistributionwithameanofXandastandarddeviationofY,we
woulduse: =NORM.INV(RAND(),X,Y)Soformeanof300withstandarddeviationof45we’duse=NORM.INV(RAND(),300,45)returningvalues~N(300,45).
Aftereachnewsimulationofinputvalues,themodelisrunandtheresultsarestored.Theanalysisoftheresultingrunscanhelpdeterminewhichfacilities,forexample,aremorelikelytostayopenunderavarietyofdemandoutcomes.Thisisnotanexhaustivemethod–simplyoneapproachtogaugetherobustnessofthedesign.
Multi-commodityflowsMulti-commodityflowmodelsintroducemultipleproducts.Eachproductwillhaveitsowndemand,supplyandothercharacteristics.Ifeachproductisindependentandtherearenointeractions,thenwecansimplymodeleachcommodityindividually.Wheneverthereisa
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sharedresource(commoncapacityconstraint,forexample),thenamulti-commodityflowmodelisneeded.Theformulationisshownbelow.Theprimaryadditiontotheoriginalformulationistheadditionalsubscriptofkforthedifferentcommoditiesforthecosts,decisionvariables,demand,andsupply.Weadded,inthisformulation,twotypesofsupplycapacityconstraints:onethatislocation-commodityspecificandonethatislocationspecificforallcommoditiesthere.Thesearequitecommoninpractice.
SolvingtheMCFmodelsarethesameasthesinglecommoditymodels–theyaresimplylargerandmoredifficulttointerpret.Themultiplelayersofconstraintsmakethecalculationofindividualcostsdifficult–thisiscoveredinactivitybasedcostingandmanagerialaccounting.
ChainapproachtoflexibilitySCNDmodelsdonotconsidervariabilityofdemand.AMILPsolution,whileoptimal,canoftenbequitefragile.Thismeans,thatifanyoftheinputvalueschange,thetotalcostscouldchangedramatically.WemightwanttofindaSCNDthatismoreflexibleinitsabilitytohandlechangesindemand–inparticularsuddensurgesorpeaksindemandforcertainproductsorcommodities.Fullflexibilitycanbeachievedbyforcingeachplanttomanufactureeveryproduct.Thisprovidescompletedemandflexibilityascapacitycanbedivertedfromanyplanttohandlesurgesofacertainproduct.Thisisveryexpensive,however.Theoppositeextremeistocreatededicatedplantsthatonlymanufactureasingleproduct.Dedicatedplantsareabletoleverageeconomiesofscaleandtendtoincreasethelevelofexpertise,however,theyalsoincreaseriskexposureandlimitflexibilitytorespondtosurges.Acleverdesigncalledchainingallowsmanufacturingnetworkstoachievemostoftheflexibilityallowedinfullyflexibledesigns,butatafractionofthecost.
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Time-expandednetworksUptothispoint,eachmodelassumedasinglebucketoftime.Wehaveexpandedthisnowtoconsidermultipletimeperiods.Thisismorecommonwithtacticaltimeframe(weekstomonths)models.Tomodelmultipletimeperiodsweneedtointroducetheideaoftheinventorylevelatalocation,j,attimet,Ijt.Thisisthequantityavailableatlocationjattheendoftimet.Thisallowsustochargeaninventoryholdingcharge(h)foreachtimeperiod.Wealsoneedtoincludeaninventorybalanceconstraint–similartotheconservationofflowconstraintsintransshipmentmodels.Thisisthe3rdconstraintintheformulationbelow,whichstates,thesumofallflowintonodejduringtimet,minusthesumofallflowoutofnodejduringtimet,plustheinventoryavailableatnodejattheendoftimet-1,minustheinventoryavailableatnodejattheendoftimetiszero.
InventoryconsiderationsinsupplychainnetworkmodelsThusfar,inventoryhasnotbeenconsideredinthedesignofthesupplychains!Surprisingly,itisverycommontoignoreinventoryconsiderationswhendesigningasupplychain.Thisisduetoacoupledifferentreasons.First,inventorypoliciesarebasedonprobabilisticmodelsthatdonotcombinewellwithdeterministicMILPoptimizationmodels.Second,mostofthekeydeterminantsofinventorylevels(demandvariability,leadtime,servicelevel,ordersize,etc.)areonlyknowntacticallynotstrategically.Finally,inventorybalanceequations,whichwouldbeneededtomodelinventorycosts,cannotbeusedtotrackandoptimizestrategicinventorydecisionsthataremadeatyearlongincrements.Instead,weofferanapproachthatleveragesthenon-linearempiricalrelationshipbetweeninventoryandthroughput.Ithasbeenfoundthataverageinventoryforaspecifiedtimeperiodisequalto:αTβwhereTisthethroughputinitemsorvalue,andαandβareestimatedcoefficients.Theβparameteristypicallybetween0.5and0.8.Onecansimplyaddthisquantitytodifferentrunsasapost-hocanalysisorincorporateitintothemodelwithbinaryvariables.
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PracticalConsiderationsWhileSCNDproblemsarehighlymathematicalanddependonoptimization,themajorityoftheproblemsthatoccurinpracticehavenothingtodowiththeactualmodels!Itisusuallyaproblemwiththepeopleinvolved:theobjectiveswerenotagreeduponorclearlystated,thescopekeptchanging,thewrongproblemwassolved,etc.ItisimportanttorealizethatSCNDisjustoneprobleminalargersetofsupplychainproblemsthatneedtobesolved.Asshowninthefigurebelow,SCNDisastrategicdecisionthatisconductedwithmultipleyeartimehorizonsandhasaveryhighpotentialimpactonReturnonAssetsorInvestment.Thetransactionalandtactical/operationalproblemsareconductedmorefrequentlybuthavealowerpotentialimpact.Alloftheselowerlevelsolutionsshouldalignwiththeoverallsupplychainstrategyandnetworkdesign.
Source:ChainalyticsKnowThyProject–Itisimportantthatyouhaveasolidunderstandingofnotonlythephysicalsupplychain(sources,facilities,products,flows,etc.),butalsothepeopleinvolved.Youneedtoknowthestakeholdersbutalsotheultimatedecisionmakers.ThereisanexcellentarticleintheHarvardBusinessReviewcalled“WhohastheD?”thatdiscusseshowthedecisionmakingprocessinafirmcanbeimproved.Itisimportantthatyouknow“whohastheD”–thatis,theultimatedecision–foryourproject.Scopingmeetingswithallstakeholdersareverycriticalheretoestablishtheboundaries,objectives,andotherrulesoftheroadforalargeprojectlikeaSCND.FocusontheProblem-ThereisalwaystremendouspressureinaSCNDengagementfromthedifferentstakeholderstoexploreeveryexceptionandessentiallyboiltheoceantoexploreeverypossiblesolution.Thisisimpossibletodoinreality.So,youneedtoknowhowtoseparatetheimportantaspectsfromthetrivialusingsegmentationanddataaggregationasmuchaspossible.Identifyingthefewestpossiblenumberofproductstomodeliscritical–besuretothinkofsupplychaindistinctionsforproducts–notjustmarketingdistinctions.Manymanagers(andyourfuturestakeholders)willnotunderstandthatthemodelisacaricatureofthesupplychain,notahigh-definitionphotograph!Youhaveavarietyofdifferentanalysistoolsandtechniquestoaddressquestionsofvaryingimportance:fromlarge-scaleMILPmodels
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toSideScenarioRunstoQuickHeuristicAnalysis.Usethemappropriately–ifeverythingisequallyimportant,thennothingisimportant!BeExperimental–Therearetwoaspectstothissuggestion:buildingthemodelandusingthemodel.WhenbuildingtheSCNDmodelitself,werecommendusingaspiralmethod(startsmall,testit,evaluate,adaptit,andrepeat)versusthetraditionalwaterfallmethod(collectallinput,developcompleterequirements,buildthefullmodel,testthecompletemodel,releasetousers).Bycreatingthemodeliterativelyyoubuildconfidenceinit,identifypotentialoutliers,keepstakeholdersengaged,andmightendupwithanearlyandunexpectedsolution.Whenrunningthemodelwerecommendyoutryasmanydifferentscenariosandoptionsaspossible.Thisiswhyyougothroughthepainofcreatingthesecomplexmodels!Runningmultiplescenariosallowsyouto:testandcostoutcompetingideasandstrategies,understandinternaltrade-offswithinthenetwork,uncoveropportunitiesforserendipitousdiscovery,andbettercommunicatewithstakeholders.SeparatetheMathfromtheDecision–Thefinalsuggestiondealswithunderstandingthevirtuesofamathematicalmodelversushumans.Mathematicalmodelsareexceptionallygoodatmakingtrade-offsbetweenaccuratelyquantifiedoptions.However,modelswillNEVERconsiderallfactorsandcannotfullyrepresentreality.Humansareneededtodeterminewhataspectsareimportantandtoprovidetheoptionsandinputforthemodeltoconsider.Also,becauseoptimizationmodelswilldoanythingforadollar(penny,euro,ruble,peso,oranyothercurrency)theresultsshouldbescrutinized.Theabsolutelowestcostsolutionisrarelytherightbusinesssolution.ThekeypointisthatmathematicalmodelsshouldbeusedforDecisionSupportnotfortheDecisionitself.Executivesandmanagershaveadditionalexperienceandinsightsintothelargerenvironmentthatneedtobeconsideredwhenmakinglargeandimportantdecisions,likesupplychainnetworkdesign.
LearningObjectives
• Introducenetworkmodels• Reviewhowformulatethetransportationproblemandthetransshipmentproblem• Learnhowtoformulatethecontinuoussinglefacilityproblem• Formulateandsolvenetworkfacilitylocationproblems(discretecandidateselection)• Usenetworkflowmodelstoevaluatethenumberoffacilitiesinanetwork• IncorporateLevel-Of-Service(LOS)constraintsinthenetworkmodels• IdentifyhowtocombinepreviousmodelstoaSupplyChainNetworkDesignModel• Constructrelevantbaselinesfortheanalysis• Performrobustoptimizationusingsupplynetworkmodels• Constructmulti-commodityflowmodels• Reviewhowtoexpandthemodelintoseveraltimeperiods• Understandwhentoincorporateinventorycostsintothenetworkmodels
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• GainanappreciationandunderstandingofpracticalconsiderationswhenconductingSCNDengagements
References
• Watson,Michael,SaraLewis,PeterCacioppi,andJayJayaraman,SupplyChainNetworkDesign,1stEdition,FTPress,2013
• Chopra,SunilandPeterMeindl,SupplyChainManagement,Strategy,Planning,andOperation,5thedition,PearsonPrenticeHall,2012
• Ellet,Steve,ConversationsandPresentations,Chainalytics,2005-2015.• JordanandGraves(1995),“PrinciplesontheBenefitsofManufacturingProcess
Flexibility,”ManagementScience,41,(4),p577-594.• Rogers,PaulandMarciaBlenko,“WhoHastheD?:HowClearDecisionRolesEnhance
OrganizationalPerformance,”HarvardBusinessReview,January2006.• Shapiro,Jeremy.ModelingtheSupplyChain,2ndEdition,DuxburyAppliedSeries,2007.
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ProductionPlanning
SummaryWenowreviewtheinformationflowwithinafirm,andthecoordinationandplanningofproduction.Whatisbeingcoordinated?Well,whatwewanttoachieveistomatchthedemandofourcustomerswiththesupplyfromourfirm,whichrequirescomponentsfromoursuppliers.Forthismatchtobepossible,informationaboutfuturedemandshouldbeusedforthecreatingofthemasterproductionschedule,whichisthenusedtodeterminethematerialsrequirements.
KeyConcepts
FixedPlanningHorizon
MasterProductionSchedule(MPS)TheMPSisthebasiccommunicationbetweenthemarketandmanufacturing.Itisastatementofproduction–notdemand.Itisaplantomeettheforecasteddemand,notaforecastofdemand.ThereareseveralmanufacturingorproductionstrategiesthatdeterminewhattheMPScanlooklike:
• Levelproductionstrategy.Thisisastrategyaimingatevenproductionlevelsovertime.Themajorbenefitisasmoothandstableoperationswhichreducesswitchingcostsandminimizestheneedforoutsourcing,overtime,orotherflexibilitymeasures.Thedownsideisthatisleadstoheavyinventorybuild-upwhendemandislow,andpossibleshortagewhendemandishigh.
• Chasedemandstrategy.Withthisstrategytheaimistoletproductionquantitiesfollow
demandascloselyaspossible,sothatmoreisproducedintimesofhighdemandandviceversa.Thebenefitofthisisthatinventoryiskeptataminimum,andsoisobsolescence.Ontheotherhand,ittendstoleadtolargeswingsinproductionquantitiesandlaborneeds.
• t=Pt=Ft
• Hybridstrategy.Ahybridstrategytriestocombinethebenefitsofthelevelproductionstrategyandthechasedemandstrategy,bybalancingthecostsassociatedwiththestrategies.Thiscanbedoneinseveralways.Belowwereportinmoredetailhowthisishandledwhenthereisafixedplanninghorizon.
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Fixedplanninghorizon(FPH)problemTheFPHproblemconsiderstheproblemoffindingthelowestcostproductionplanoverafixedhorizonwithmultipletimeperiods.Demandisconsidereddeterministicbutcanvarybetweenperiods.
ThereareseveralwaystosolvetheFPHproblem:Simpleheuristics.Thesearesimpledecisionrules,forinstancethatyourunonlyoneproductionrun(Onetimerunheuristic),thatyouproduceineveryperiodexactlywhatisdemanded(lotforlot),orthatyouproduceeitherafixed“optimal”quantityoraccordingtofixed“optimal”intervals.Theseheuristicsaresimplemakingdecision-makingfast,althoughtheresultsarenotnecessarilyparticularlygood.Specializedheuristics.ThereareseveralmoresophisticatedheuristicdevelopedfortheFHP,includingtheSilver-Meal(SM)heuristic,theleastunitcostheuristicandthepart-periodbalancingheuristic.InthiscoursewefocusontheSMheuristic.Thisheuristicsearchesthroughtheperiodstofindthelowestcostperperiod.Iffirsttestsifitislesscostlyperperiodtoproducenextperiod’sdemandinthisperiod.Ifitis,itseesifitalsolesscostlytoincludetheperiodafternextperiodinthisperiod’sproduction.Itcontinuesthisprocessuntilthecostperperiodincreases.Whenitdoes,sayinperiodk,itstartsoverbyconsideringproductioninperiodk,andseesifcostperiodisreducedbyincludingalsothedemandfromk+1intheproductionofperiodk.Itcontinueslikethisuntiltheendofthehorizon.Whilemoresophisticated,itisnotguaranteedtofindaverygoodsolution.
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Optimalmethods.TheWagner-Whitinalgorithmprovidestheoptimalsolutionbyrelyingondynamicprogramming.Thisisanefficientmethodforlargeproblems.Forsmallerproblems,aspreadsheetMILPmodelisaquickwaytofindtheoptimalsolution.(seefurtherbelow)Insummary-therearemanymethodsavailable.Heuristicsarefastandeasytoimplement,butarenotalwaysgoodinthesensethattheyprovideanear-optimalsolution.Specialtyheuristicsaremoresophisticated,abithardertosetup,buttendtoprovidebetter“real-world’results.Optimalmethodsrequiremoretimeanddata,allowforseveralconstraintsandgivetheoptimalsolutions.However,keepinmindthattheinformationfedintothemodelisoftennotexact.
ApproachesforSolvingtheFPHProblemSimpleHeuristicsOneTimeRun–ManufactureallinonerunforthatmonthExample:
LotforLot(Chase)–EachmonthmanufactureproductforecastedforthatmonthExample:
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FixedEOQ(FOQ)–OrderQ*ifFt>IOH(QisStable,Tvaries)Example:
ReviewofEOQTheEconomicOrderQuantityorEOQisthemost influentialandwidelyused(andsometimesmisused!)inventorymodelinexistence.Whileverysimple,itprovidesdeepandusefulinsights.Essentially, theEOQ isa trade-offbetween fixed (ordering)andvariable (holding)costs. It isoftencalledLot-Sizingaswell.TheminimumoftheTotalCostequationistheEOQorQ*.TheInventoryReplenishmentPolicybecomes “OrderQ*everyT* timeperiods”whichunderourassumptionsisthesameas“OrderQ*whenInventoryPosition(IP)=0”.
EOQModel• Assumptions
o Demandisuniformanddeterministic.o Leadtimeisinstantaneous(0)–althoughthisisnotrestrictiveatallsince
theleadtime,L,doesnotinfluencetheOrderSize,Q.o Totalamountorderedisreceived.
• InventoryReplenishmentPolicyo OrderQ*unitseveryT*timeperiods.o OrderQ*unitswheninventoryonhand(IOH)iszero.
• Essentially, the Q* is the Cycle Stock for each replenishment cycle. It is theexpecteddemandforthatamountoftimebetweenorderdeliveries.
Notationct: OrderingCosts($/order)ce: ExcessholdingCosts($/unit/time)D: Demand(units/time)Q*: OptimalOrderQuantityunderEOQ(units/order)T: OrderCycleTime(time/order)T*: OptimalTimebetweenReplenishments(time/order)
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OptimalOrderQuantity(Q*)RecallthatthisistheFirstOrderconditionoftheTRCequation–whereitisaglobalminimum.
𝑄∗ =2𝑐&𝐷𝑐(
OptimalTimebetweenReplenishmentsRecallthatT*=Q*/D.Thatis,thetimebetweenordersistheoptimalordersizedividedbytheannualdemand.Similarly,thenumberofreplenishmentsperyearissimplyN*=1/T*=D/Q*.PluggingintheactualQ*givesyoutheformulabelow.
𝑇∗ =2𝑐&𝐷𝑐(
PeriodicOrderQuantity(POQ)–ordersumofforecastsevery~T*periods(Tisstable,Qvaries)
Example:
ProductionplanningMILPTheFPHcanbesetupasaMILPproblem,similartotheproblemsdiscussedinthefirstthreeweeksaswellaslastweek.WithaMILPformulation,theobjectiveistominimizethetotalcosts,whichconsistofsetupcostsforeveryproductionrun/batch,andholdingcostsfromfinishedgoodsinventory.Indexdenotestimeperiod.WeletZtbeabinarydecisionvariableindicatingproductioninperiodt,andQtbethedecisionvariabledeterminingproductionquantityinperiodt.Wethushavethat
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wherecsetupisthesetupcost,histheholdingcostperunitandtimeperiod,Itisinventorylevelattheendofperiodt,Dtisthe(forecasted)demandinperiodt,Misalargenumber,andCAPtistheproductioncapacityinperiodt.Intheaboveformulation,theinitialinventoryiszero.Asbefore,wehaveaconservationofflowconstraintaswellasalinkingconstraint.Theconservationofflowstatesthatthedifferenceininventorybetweentheendandthestartoftheperiodmustbeequaltothedifferencebetweendemandandproductionquantityinthatperiod.ThelinkingconstraintforcesQtobezeroifZiszerointhesameperiod.
MaterialandDistributionRequirementsPlanning
AvailabletoPromise(ATP)Theportionofexistinginventoryand/orplannedproductionthatisnotcommittedorconsumedisconsideredtobeAvailabletoPromise.Thismeansthattheseunitscanstillbesoldtocustomers.Therearetwoslightlydifferentwaystocalculatethis:
• Discrete–meaningthateachproductioncycleisplanningindependently.Inventoryfromoneproductionrunisnotcarriedovertothenextrun.
• Cumulative–meaningthatinventoryiscarriedoverbetweenperiods.Thatis,inventoryfromthefirstproductionrunwhichisunsoldatthestartofthesecondproductionruncanstillbesoldduringandafterthesecondproductionrun.
TimeFencingisoftenusedtostabilizeproductionplanning(demandandplanning)
• ift<Demand_FencethenuseonlycommittedordersforMPS • ifDemand_Fence<t<Planning_FencethenlimitedMPSoverrides • ift>Planning_FencethenallMPSchangesallowed(withinlimits)
MaterialsRequirementsPlanning(MRP)
Min z = csetupZtt∑ + hItt∑s.t.
I0 = 0Qt −Dt + It−1 − It = 0 ∀t ∈ TMZt −Qt ≥ 0 ∀t ∈ TQt ≤CAPt ∀t ∈ TIt ,Qt ≥ 0 ∀t ∈ TZt ={0,1} ∀t ∈ T
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MaterialRequirementsPlanning(MRP)systemsensurethatallcomponentsandpartsrequiredforanenditemareonhandwhenneeded.Thesesystemsareintendedtoanswerquestionsaboutwhatshouldbeorderedormanufactured,howmuch,andwhen.ThesequestionsareansweredbyfeedingtheMRPwiththeMPS,inventoryrecords,andtheBillofMaterials(seebelow).
• BenefitsofMRPo Leadstolowerinventorylevelso Fewerstockoutso Lessexpeditingo Fewerproductiondisruptions
• LimitationsofMRPo Scheduling,notastockage,algorithmo Doesnotaddresshowtodeterminelotsizeo Doesnotinherentlydealwithuncertaintyo Assumesconstant,knownleadtimeso Doesnotprovideincentivesforimprovement
BillofMaterials(BOM)TheBillofmaterials(BOM)showswhichparts,subassemblies,andcomponentsthatmakeupagivenproducttobeproduced.Forillustrativepurposes,theBOMcanbeshownasatree-diagram,withthecompletedproductatthetop,andallpartsandcomponentsbeingtheroots.Oneexampleforabicycleisshownbelow.
MRPcoordinationTherearedifferentwaytocoordinatetheMRPbetweenafirmandits(independent)suppliers.Inthislessonwewentthroughthreedifferentapproaches:
• SimpleMRPrules.Thismeansusingsimplerulesalsoforcoordinationwiththesupplier.Forinstance,ifthereisaleadtimeofxweekstogetacomponentfromthesupplier,orderreleaseisscheduledxweeksbeforetheunitsareneededfortheassemblyatthefirm.Thesupplierusesthisasthedemandinputforitsownproductionplanning.
• Sequentialoptimization.Withthisapproach,thefirmoptimizeshisproductionfirst,and
ForkFront fenderRear FenderSprocketCrankPedalChain guard
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thenfeedstherequirementstothesupplierwhooptimizeshisproduction.• Simultaneousoptimization.Withthisapproach,thefirmandthesupplier’sproduction
isoptimizedsimultaneously.Thismeansthatfirm’sorthesuppliers’costsmayincrease,whiletotalcostswilldecrease.
DistributionRequirementsPlanning(DRP)DRPcanbethoughtofastheapplicationoftheMRPprinciplestodistributioninventories.Itisusedforinventorycontrolinadistributionenvironmentwithmanyproducts,manystockagelocations,andmultipleechelons.Inpractice,itisanalgorithmforschedulingandstocking,however,itdoesnotdeterminelotsizeorsafetystock.
LearningObjectives• Identifyhowcoordinatetheinternalinformationflowofafirm• Learnhowtousedemandinformationtocreatethemasterproductionschedule(MPS)• Howtosolvethefixedplanninghorizonproblem(FPH)usingseveraldifferent
algorithms• Determineavailabletopromise(ATP)• Understandhowmaterialrequirementsplanning(MRP)anddistributionrequirements
planning(DRP)work• Understandthebillofmaterials(BOM)• UnderstandbenefitsandlimitationsofMRPandDRP
ReferencesJacobs,F.R.,Berry,W.L.,Whybark,D.C.,Vollman,T.E.(2011).Manufacturingplanningandcontrolforsupplychainmanagement.McGraw-Hill.
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ConnectingSalestoOperations
SummaryWereviewhowtheSales&OperationsPlanning(S&OP)processwithinafirmcanbeusedfindtherightbalancebetweenoperationalcapacityanddemand.Theaggregateplanningmodelallowsafirmtosetvariousoperationalandsalesleversinordertodeterminethebesttrade-offstomaketomaximizeprofitability.Theprimaryleversontheoperationalsideare:workforce,outsourcedproduction,inventory,internalproductionlevels,backlogs,andovertimehours.Theremightbemoreleversforspecificsituations,ofcourse.Onthedemandside,wediscussedhowsaleschangesandpromotionscanbeusedtoshapedemandandhowtheaggregateplanningmodelcanhelpdeterminetheoperationalimpact.Theoptimizationmodelcanalsobeusedtotestoutdifferentstrategiesandpotentialpolicies.
KeyConcepts
AggregatePlanningModelTheaggregateplanningmodelisusedtoplanforthemid-term3-18monthtimeframe.Ittakesasinputtheproposeddemandaswellasstartinginventory,workforce,andcostsfordifferentoptions.Thelongerhorizonplanninginvolvesmorestrategicdecisions–suchasnetworkdesignetc.–whiletheclosertimeframeisplannedusingtheMasterProductionSchedule.TheplanningunitfortheaggregateplanningmodelistypicallynottheindividualSKU,butratherafamilyorrelatedSKUsorgeneralflowunit–suchastons,orcompositeunits.ThemodelisusedtofindthebestmixofProduction,Inventory,Workforce,Outsourcing,andCapacityLevelsinordertomaximizethefirm’sprofitoverthe3-18monthplanninghorizongiventheforecasteddemandovertheplanninghorizonbychanging:
• ProductionRate–howmuchproduceeachmonth• Workforce–howmanyemployeestohireorlayoffeachmonth• Overtime–howmanyovertimehourstoplanforeachmonth• Machinecapacity–howmuchcapacityshouldbeallocatedtoproductionlineseach
month• Outsourcing–howmanyitemstoproduceusingcontractoroutsourcedmanufacturing
eachmonth• Backlog–howmanyunitseachmonthshouldweallowtobebacklogged• Inventoryonhand–howmuchinventoryshouldweplanonholdingeachmonth• Pricing–howshouldtheproductpricingbechanged(promotions,discountsetc)each
month
Theoutputfromtheaggregateplanningmodelisessentiallytheproduction(andpricing)plan.Twobasicstrategiesthatcanbeimplementedare:ChaseandLevel.Thechasestrategyimplies
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thatproductionismadeasclosetothepointofdemandaspossible.Thisleadstolowinventorycostsbutgenerallyhigherproduction(overtime,workforce,outsourcing)costsneededtoadjusttheproductiontomeetdemandpeaks.Thelevelstrategyattemptstokeeptheproductionlevelfortheentiretimeperiodandlettheinventorybuilduptocoveranydemandpeaks.Thehybridstrategythatcombinesthesetwoextremesolutionsisgenerallyused.
ModelFormulation
Decisionvariables
Min z = cWWt + cHHt + cFFt + cOOt + cI It + cBBt + cM Pt + cCCt( )t∑s.t.
Pt −HWt +OtL
#
$%
&
'( ≤ 0 ∀t ∈ T
Wt −Wt−1 −Ht + Ft = 0 ∀t ∈ TIt − It−1 − Pt −Ct +Dt + Bt−1 − Bt = 0 ∀t ∈ TOt −MWt ≤ 0 ∀t ∈ TWt ,Ht ,Ft ,Ot , It ,Bt ,Pt ,Ct ≥ 0 ∀t
Ht =Number of employees to hire at start of month t ∀tFt =Number of employees to fire at start of month t ∀tWt =Number of employees in month t ∀tIt =Number of units of inventory on hand in month t ∀tOt =Number of overtime hours to work in month t ∀tBt =Number of units to put on backorder in month t ∀tPt =Number of units to manufacture internally in month t ∀tCt =Number of units to outsource to contract mafg in month t ∀t
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InputData:
AggregatePlanningModelLeversTheaggregateplanningmodelismainlyusedtodeterminethebestmixorbothoperationalandsalesbasedstrategies.Theoperationalleverscontrolthesupplywhilethesalesleversinfluencethedemand.Ontheoperationalside,wecanmanageSupplybycontrollinginventory(CommonComponentsandPre-buildInventory)and/orcapacity(WorkforceFlexibility,SeasonalWorkforce,Outsourcingproduction,orProductFlexibility).ManagingDemandisalittlelessdirect.Theobjectivesonthedemandsideareto(1)GrowMarket,(2)StealMarketSharefromcompetitors,or(3)ShiftBuyingPatternsofthecustomers.Theleversavailableare:
• Pricing–incentives(discounts,MOQ’s,etc.),• Advertising–increasingbrandawareness,and• Promotions–pricereductionovershortperiodoftime.
DemandElasticityTheconceptofDemandelasticitywithrespecttopriceisusefulindetermininghowachangeinpricewillimpactthedemand.
son)(hours/permonth per employeeper allowed overtime of hours Maximumson)(hours/permonth per can work employeeeach hours ofNumber
t)(hours/uni itemeach make torequired hours ofNumber ($/unit)er manufacturcontract a togoutsourcin ofCost
($/hour) overtime ofCost month)($/person/ employee ofCost
($/person) employee one hiring ofCost ($/person) employee one firing ofCost
nth)($/unit/mobackorder a ofCost nth)($/unit/mo inventory holding ofCost
($/unit)per material raw ofCost (units)month t in Demand
T)(month period planning of endat backlog ofAmount 0)(month period planning ofstart at backlog ofAmount T)(month period planning of endat inventory ofAmount 0)(month period planning ofstart at inventory ofAmount
T)(month period planning of endat workforceof Size0)(month period planning ofstart at workforceof Size
0
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Recallthattheelasticitywillalmostalwaysbenegative.Thatis,anegativechangeinprice(adiscount)willleadtohigherdemand.Theelasticityofdemandformanygoodscanrangefrom-0.01toashighas-10ormore.Thewaytointerpretanelasticityof,say,-2.5isthatforevery1%changeinprice,thedemandwillincreaseby2.5%.
MonthlySales&OperationsPlanningProcessTherearemanyflavorsofS&OPoutthere.Mostfeatureasetofstructuredmeetingswherespecifictasksareperformedbydifferentfunctionswithinthefirmandeventuallyarepresentedwithrecommendationstoseniorleadershiptomakeafinaldecision.Wedescribedafive-stepprocessasfollows:Step1:DataGathering–thecoredataonthemostrecentmonth’sdemand,inventory,productionlevels,sales,etc.isgathered,cleaned,andmadereadytodistribute.Thisshouldbeaccomplishedinthefirstfewdaysofanewmonth.Step2:DemandPlanning–Thedemandplanningteamfromthesales/marketingorganizationdevelopstheinitialsetofforecasts.Theseincludetheirexpertopinionsonmodificationstoanynumericforecaststhatweremade.Step3:SupplyPlanning–Thesupplyplanning/operationsteamreceivestheinitialforecastandthemostrecentsetofdataanddeveloparesourceplantomeettheproposeddemandforecast.Anyconflictsorrestrictionsarenoted.Step4:Pre-Meeting–Thesupplyanddemandplansarebroughttogetherandcompared.Thislargergroupmakessuggestionsandrecommendations.Anyconflictsthatcannotbesolvedatthislevelareidentified.Step5:ExecutiveMeeting–Theseniorteammakesdecisionsonanyoutstandingconflicts–theyhaveagonogodecisionauthority.
e = Percent Change In DemandPercent Change In Price
=
DNew −DOld
DOldPNew −POld
POld
=POldDOld
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&'DNew −DOld( )PNew −POld( )
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DistributionandChannelStrategiesInthislessonwecoverdistributionandchannelstrategies.ADistributionChannelisthepathbywhichallgoodsandservicestravelfromtheoriginalvendortotheendconsumerandthepathwaythatpaymentsmakefromtheendconsumertotheoriginalvendor.Wedivdedeeperintothistopicbyexploringe-commerceandomni-channelstrategiesandomni-channelnetworkdesign.Weconcludewithadiscussionofreverselogisticsandreverselogisticsnetworkdesign.Therearefourtypesofplayersindistributionchannelsthatincludemanufacturer,wholesaler/distributor,retailer,andconsumer:
• Manufacturer:MakesProducts• Wholesaler/Distributor:Traditionalmiddleman.Purchasesproductsinlargequantities,
consolidates,assembles,andresellstoretailers&others.• Retailer:Sellsgooddirectlytotheconsumer• Consumer:Personwhobuystheproduct
Thedifferenttypesofdistributionchannelsincludewholesalerchannel,directtoretailer,anddirecttoconsumer(seefigurebelow).ChannelTypes
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DistributionChannelStrategiesToaddressthedifferentdistributionchanneltypes,therearevariousstrategiesthataddressneedsofthebusinessandtheactorspresentinthechanneltoensureanefficientflow.Typesofstrategiesincludethetraditionalretailmulti-echelon,mix/consolidationcenter,distributor/wholesaler,directtostoredelivery,anddropshipfrommanufacturer(seefigurebelow).Wefurtherarticulatethesestrategiesbelowbydescribingtheproductflowandthepros/consofeach.
TraditionalMulti-TieredDistributionProductFlow
• Retailerplacesorderstoeachmanufacturer,• ProductflowsfrommanufacturertoretailDCs,• RetailDCsreceiveproductfrommultiplevendors,• DCssendfullTLsofmixedgoodstostores,and• Consumers/Customersview,select,receive,andpayforgoodsatstore.
Pros/Cons• Flowleveragesretailereconomiesofscalebutwithlotsofhandling• Ontheinbound,DCsneedtobeabletojustifyfullloadsfromvendors• Ontheoutbound,DCsareabletomixproductfrommultiplesources• Highlevelofinventorystoredatretaillocations• Lowertransportationcostsduetoscaleeconomies• Goodforfastmovingitems• Shortertransittimesfromvendorstostores
MixingCenters/HubsProductFlowRetailerplacesorderstoeachmanufacturer,
• ProductflowsfrommanufacturertoMixingCenter,• No(orverylittle)inventoryisheldattheMixingCenters–In-transitMerge,• RetailDCsreceivefullTLofgoodsfrommultiplemanufacturersfromtheMixingCenter,
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• DCssendfullTLsofmixedgoodstostores,and• Consumers/Customersview,select,receive,andpayforgoodsatstore.
Pros/Cons
• Flowleveragesretailereconomiesofscalewithlotsofhandling• OnbothIBandOB,DCsareabletomixproductfrommultiplesources• Highlevelofinventorystoredatretaillocations• Lowertransportationcostsduetoscaleeconomies• Goodforslowermovingitems• Longertransittimesfromvendorstostores
DistributorsProductFlow
• Retailerplacesorderstodistributor,• Productflowsfrommanufacturertodistributor,• Inventoryisheldbythedistributor,• RetailDCsreceivefullTLofgoodsfrommultiplemanufacturersfromthedistributor,• DCssendfullTLsofmixedgoodstostores,and• Consumers/Customersview,select,receive,andpayforgoodsatstore.
Pros/Cons• Flowleveragesthedistributor’seconomicswithlotsofhandling• OnbothIBandOB,DCsareabletomixproductfrommultiplevendors• Highlevelofinventorystoredatretaillocations• Lowertransportationcostsduetoscaleeconomies• Goodformuchslowermovingitems• Muchlongertransittimesfromvendorstostores• Highercostdueto3rdpartyinvolvement
DirecttoStoreDeliveryProductFlow
• Retailerplacesorderstoeachmanufacturer,• ProductflowsfrommanufacturerdirectlytotheretailstoresbypassingtheDCs,• Vendoroftenmerchandises,orders,andmanagestheretailer’sshelf,• Consumers/Customersview,select,receive,andpayforgoodsatstore.
Pros/Cons• Flowleveragesthevendor’seconomics• BypassingtheretailDCreducescongestion• Vendorcantakeoverordering,merchandising,etc.• Canleadtocongestionandaddedcostsattheretailstores• Lossofcontrolofproductflowandavailabilitybytheretailer• Usedforselectitems(beverages,newspapers,snackfoods)
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DropShiptoCustomerProductFlow
• ConsumerordersfromRetailer,• RetailerpassesordertoManufacturer,• Manufacturersendsproductdirectlytoconsumer.• ManufacturerandRetailercouldbesamefirm.
Pros/Cons• Veryslowresponsetimetoconsumer• Verystrongproductavailabilitywhilekeepinginventorylevelslow• BypassingretailDCandstorereducescongestion• Transportationcostcanbehigh–smallshipmentsizetoconsumer• Allowsforhighlevelofcustomization• Consumerplacesorder–triggerspulloperation
Distributionchannelstrategiesarenotmutuallyexclusive.Mostfirmsusemultiplechannelsforproducts.Selectionofthestrategyisbasedonseveralneedsincluding:velocity(demand)oftheproduct;desiredresponsetimetoconsumers;physicalandothercharacteristicsofproducts,supplier,andcustomers;andvalueofproducts.
Omni-ChannelDistributionFromaround1995to2000atitsearlieststage,e-commercewaslargelymadeupof“pureplayers”.Thesemadeupoffirmsthatallowedcustomerstobuygoodsandservicesovertheinternetusingawebsite(ebayorAmazon).Thesefirmsalsodidnothaveaphysicalpresence.Thisbeganearlydiscussionsthatmaybetraditionalstoresmightbeunnecessaryinthefuture.Around2000–2010,multi-channelbecamethenextwave.Inthiscase,firmsusemultipleonlineandtraditionaldistributionchannels.Inmostcases,traditionalandonlinechanneloperationswerekeptseparateanddistinct;referredtoas“BricksandClicks”.Thiscausedinefficienciesintraditionaldistributionchannelstrategies.Withthereleaseofthesmartphonearound2007andconsumerabilityusetheinternetonthephone,e-commercegrewatafasterraterthaneverbefore,andwiththatadesireforeaseofaccessacrossonlineandbrickandmortarpurchaseandreturns.Asof2010on,thenewpathforwardformanyfirmshasbeenOmni-Channel.Thisismulti-channelretailingstrategywherefirmsprovideaseamlessretailingexperiencethroughallavailableshoppingchannels(online&offline).Operationsaremixedbetweenchallengesandconsumershavemultipleoptionsforresearching,ordering,receiving,paying,and/orreturningproducts.RetailPerspective:Wheretopreparetheorders?
• DistributionCentervs.FulfillmentCentervs.Store• Tradingoffdistancevsefficiencyvs.effectiveness• Changesinpackagingrequirementsandusability• Adaptingworkforce,facilities,andsystemstonewtasks
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• Maintaininginventoryvisibilityacrossthechannels&facilitiesWhereandhowdoestheordermeetthecustomer?
• Storesvs.Homevs.3rdPartylocations(work,lockers,gasstation)• Attendedvs.UnattendedDelivery• Ownfleetvs.Parcelvs.Crowdsourcingvs.Mobilelockers
Howtohandlereturns?• Productreturns~30%foronlinevs.8%fortraditional• Atlocationofpurchasevs.Droppointsvs.Everywhere• Allowablereasons:Damaged,Wrongsize/color/style,etc.
Omni-ChannelNetworkDesignAnomni-channelretailingexperiencerequiresflexibledeliverynetworks.Omni,meansin“allplaces”,“allways”,“withoutlimits”.Omni-channelstrategiesaffectordering,fulfillmentandreturns.AnOmniChannelNetworkDesignmodelformulationisillustratedinthefigurebelow.
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ReverseSupplyChains(ReverseLogistics)Reversesupplychainisalloperationsrelatedtothereuseofproductsandmaterials.Itinvolvescollectingitemsattheir“endoflife”forcapturingvalueorproperdisposal.Reversesupplychainsaremosteffectiveforreusableitems.Reusableitems:DurableproductsintendedtobeusedmultipletimesbydifferentusersindifferentlocationsofasupplychainnetworkReversesupplychainsarebecominganincreasingfocusforconsumersandcompaniesalikebecause:Increasingamountofwastegenerated:
• Over300,000cellphonesdisposeddailyinUnitedStates• EachEUcitizenproduces17-20kgoftechnologicalwasteperyear
Manymodernproductscontaininghazardousmaterials:• Electronicdevicescontainlead,cadmium,mercury…
Manyproductshaveshrinkingproductlifecycles:• Lifecycleofcellphonesis18months;laptops24months,etc.
Thereareareemergingregulations:• Insomeregions,producersareresponsiblefortheenvironmentallysafedisposalof
products.ExtendedProducerResponsibility(EPR)• EndoflifewasteframeworkdirectivesintheEUforbatteries,vehicles,tires,etc.
ProductRecoveryOptionsTherearedifferenttypesofproductrecoveroptions.Seefigurebelowthatbuildsoutthetraditionalsupplychainwithrecoveryoptionsateachphaseofthesupplychain.
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Therearedifferentformsofreversesupplychainsbasedonconditionofthematerial:DirectReuseorResale:ThisincludesbothReusableArticles(containers,totes,pallets,books,etc.)andnormal(non-reusable)products.ReusableArticlesareinspectedand,ifneeded,sterilized/cleaned/preparedforredeploymentwithinfirmoracrossnetwork.Non-reusableProductsareinspectedanddeemedreadyforre-useorresaletoothercustomerswithoutanyrepairorrefurbishing.e.g.,Wrongsize/color/styleapparelRepair:Usedproductsreturnedtoworkingorder.Typicallyinvolvesfixingand/orreplacingbrokenparts.e.g.,computers,phones,electronicdevices.Refurbish:Usedproductsbroughtuptospecifiedqualitylevel.Criticalmodulesareinspectedandfixedorreplaced.Sometimesincludestechnologyupgrading.e.g.,aircraftRemanufacture:Usedproductsbroughtuptoqualitystandardsasrigorousasnewproducts.Completedisassembly,inspection,andpart/modulereplacementasneeded.e.g.,automotiveenginesCannibalization:Thereturnedproductisusedtorecoveralimitedsetofreusablepartsandcomponentsforuseinotherproducts.Onlyasmallproportionoftheusedproductistypicallyreused.Theremainingpartsarerecycledordisposedof.e.g.,integratedcircuitsfromcomputers.Recycling:Materialsfromusedproductsandcomponentsareprocessedandcanbereusedinproductionoforiginalorotherparts.e.g.,metals,paperandcardboards,plastics,etc.
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DifferencesBetweenForwardandReverseLogisticsThefollowingfigureillustratesthedifferencesbetweenforwardandreverselogistics.Itillustratesthatreverselogisticscanbeconsiderablychangedduetoinconsistency,non-uniformity,anduncertaintyembeddedinreversesupplychains.
NetworkDesignThefollowingnetworkdesignexampleillustratesaMILPforreverselogistics.
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LearningObjectives• UnderstandthefundamentalconceptsofSales&OperationsPlanninginbalancing
supplyanddemand• Formulateandsolveanaggregateplanningmodel• Understandtrade-offsandleversavailableformakingaggregateplanningdecisions• Appreciationforthetrade-offsthatcanbemadebetweensalesandoperationsinterms
ofsupplyversusdemandandvolumeversusproductmix• Understandwhatdistributionschannelsareandwhotheplayersare.• Reviewflowpathsforproductsthatareafunctionofsuppliers,customerandproduct• IntroductiontoOmni-Channelandhowitisimpactingthesupplychain.• Understandtheimportantofreverselogisticslogistics.• Recognizethevarietyofrecoveryoptions.• Reviewnetworkdesignforreverselogistics.
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References• "Sales&operationsplanning:thehow-tohandbook"ThomasF.WallaceandRobertA.
Stahl.,2008,T.F.Wallace&Co.,Cincinnati,Ohio• "Salesandoperationsplanning-bestpractices:lessonslearnedfromworldwide
companies"JohnR.DoughertyandChristopherD.Gray.,2006,PartnersforExcellence,Belmont,N.H.
• "Manufacturingplanningandcontrolforsupplychainmanagement"F.RobertJacobs,WilliamBerry,D.ClayWhybark,ThomasVollmann2011,McGraw-Hill,NewYork
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SupplyChainSourcing
SummarySourcingisanimportantpartofasuccessfulsupplychain;itoftenhelpsabusinessmaintainacompetitiveedge.Effectivesourcingkeepsthecostsdown,whileprovidingqualitygoodsandservicesontimeandefficiently.Sourcingisdrivenlargelybytherelationshipbetweenthebuyerandsupplier.Wereviewsomeofthemaincomponentsofsupplychainsourcing.
ProcurementStrategyTofurtherourdiscussiononSupplyChainSourcing,wereviewthebasicsofprocurementandsourcing-whicharetheprocessesforbuyingthematerialsandservicesneededforthecompanytoconductitsbusiness.
ThePriceIcebergWhilemanypurchasersfocusonthepriceofacomponentorrawmaterial,thisisonlypartofthetotalcostofthepurchase.Thisisillustratedbythe“priceIceberg”–whilewetendtoonlyseethepricepaidupfront,therearemanyaspectsthatdeterminethetotalcosttoourbusinessofmakingthepurchase.
ValueandRiskMapping(risk-spendframework)Onewaytodifferentiatethepurchasingportfolioisbyconsideringwhereanitemfallsalongtwodimensions:1)thesupplyriskand,2)theannualspend(orprofitimpactonbusiness).Basedonthis,atwo-by-twomatrixcanbecreatedtodescribeallitems:
Price
Delivery Delays
Handling Defects
Inspection
Consumables Training Service
Handling
CSR risks
Financial stability
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Foreachquadrant,differenttypesofprocurementstrategiesaresuitable.
TheSourcingProcessOnagenerallevel,thesourcingprocessconsistofthefollowingsteps:
• Internalassessment.Thisistoconfirmcategorydefinition,validatebaselineinformationandunderstandthekeyconstituents.Thatis,focusisontheownbusiness.
• Marketassessment.Thisistoanalyzemarketdynamicsandidentifywhichpotentialsuppliersthatmaybeofinterest.Italsoincludesunderstandingwhatcompetitorsdo.
• Collectsupplierinformation.Inthisstepinformationiscollectedtounderstandwhichcriteriatouseintheprocessaswellastounderstandcurrentspend.
• Sourcingstrategy.Aftertheinitialassessments,thesourcingstrategyisdeveloped.Thisspecifiestheapproach,thespecifications,andhowtoapproachthesubsequentsteps.
• Biddingprocess.Inthebiddingprocess,RFPsaredevelopedandsentout.Thebuyingfirmdecidesonabiddingformatandshort-listsuppliers.
$$$
Risk/Impact
High
Low
High Low
Tactical
Critical
Leverage
Strategic
Common items Generics
Potential problems
Competitive advantage
$$$
Risk/Impact
High
Low
High
Low
Tactical
Critical
Leverage
• Streamline acquisition process
• Reduce activity• Minimize # of
transactions• VMI
• Reduce risk• Eliminate• Substitute• Simplify
• Strategic alliances• Shared cost
reductions• Partnerships• Limited active
sourcing• Supplier development• Maximize leverage• Standardization• Consolidated volumes• Reduce transaction costs• Global sourcing• Active sourcing
Strategic
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• Negotiate,select.Afterthebiddingprocessisover,thebuyingfirmnegotiateswithselectedshort-listedsuppliers.Thisstependswithaselection.
• ContractImplement.Thisinvolvesdevelopingcategoryimplementationplan,communicationsplanaswellasmeasurementsandauditplans.
Thereisalsoafeedbackloop,consistingof• Measureandreport• Capturelessons• Ensurecompliance
Value-BasedSourcingValuebasedsourcingisthenamegiventothepracticeofgoingbeyondthepurchasepriceinaprocurementevent.Forinstance,insteadoffocusingonprice,focusisonvalue;insteadoffocusingontotalcostofownership,focusisontotalcontribution.
FinancialHedgingThereareprimarilythreewaystohedgefinanciallywhenbuyingmaterialswithhighpricevolatility:
• Simplehedge:Negotiatelongterm,fixedpricecontractinthecompany’spreferredcurrency
• Forwardcontract:buy/sellthecommodityorarelatedoneforfuturedeliveryonagivendateatagivenprice
• Option:acall/putoptionistherighttobuy/sellatacertainpriceatacertainfuturedate
PhysicalHedgingApartfromfinancialhedging,afirmcanusephysicalhedgingtohandlevolatility.Createconditionsinwhichthefluctuationsaremitigated“naturally.”(usedmainlyforcurrencyhedging)Examples:
• Buildaplantincountrieswherelaborratesandcurrencyarenotexpectedtoappreciate• Manufactureandsellinthesamecountry• Actuallybuyacommoditywhenthepriceislow
CapitalGoodsPurchasingSourcingofcapitalgoodsgobeyondstandardpurchasinginseveralways.First,onemustfocusmuchmoreonthetotallifecycleofthegood.Onemustalsomoreexplicitlyconsidertheexpectedvalueofthegoodattheendofitsusefullife.Further,aspectssuchastraining,trials,andsubsidiesmayhavealargeimpactonthetotalcostofthegood.Thelifetimecostofcapitalitemsaresummarizedinthefigurebelow(source:ATKearney).
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OutsourcingThereareseveralreasonswhyfirmsoutsource.Theseinclude:
• Externalsupplierhasbettercapability• Externalsupplierhasgreaterormoreappropriatecapacity• Freeingresourcesforotherpurposes• Reductioninoperatingcosts• Infusionofcashbysellingassettoprovider• Reducingorspreadingrisk• Lackofinternalresource• Desiretofocusmoretightlyoncorebusiness• Economiesofscaleofsupplier
Whenoutsourcing,thecontractisextremelyimportant.Awellwrittencontractmakessuretonotjusthavecleardecisionsabouthowtohandledisputesandhowtomeasureandreward,butalsohowtohandleIP,howtodefinetheservicetobeperformed,andhowtohandletheevolutionoftherelationship.Outsourcingissubjecttoconsiderablerisk.Someofthekeyrisksare:
• Creatingacompetitor• Losingcontrolofthechanneltoasupplier• Losingcontrolofthechanneltoacustomer
PurchasingSocialResponsibilityCorporatesocialresponsibilityhasawiderangeofunderlyingobjectives.Theseincludephilanthropy,brandimage,HRattraction,missionsupport,socialbusinessandprofitable
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business.Basedonthese,companiesworkindifferentways,includingusingextensivecodesofconduct,auditsuppliers,trainsupplierorworkhardtoensuresupplychaintransparency.Independentlyofactivity,thereisahierarchyforthedifferentresponsibilitieswithinCSR.Thetopresponsibilityforallfirmsistheeconomicresponsibility–afirmcannotsurviveinthelongrunifitdoesnotmeetthisresponsibility.Aftertheeconomicresponsibilityfollows,inthefollowingorder:Legalresponsibilities,ethicalresponsibilities,anddiscretionaryresponsibilities.
ProcurementOptimizationInaway,eachprocurementisanoptimizationprocessinthesensethattheprocurementdepartmentorthecompanytriestogetthebestsetofsupplierstoserveyou.
Item-supplier(lane-carrier)specificconstraintsItem-supplierspecificconstraintsareconstraintsthatapplytooneoftheproductsatoneofthesuppliers.Forinstance,whenprocuringtransportservicesforanumberoflanesinanetwork,eachcarriermayhavecapacityrestrictionsforagivenlane.IntheMILP-formulationoftheproblem,theseconstraintsareeasilyimplementedasaseparatematrix.
OptimizingwithserviceattributesServiceattributesareoftenassociatedwithanindividualitematagivensupplier.Forinstance,“ontimedeliveryperformance”mayvarybetweendifferentsuppliersforagivenitemaswellasbetweendifferentitemsfromthesamesupplier.Therearemanytypesofserviceattributesthatmaybeimportantevaluationcriteriaintheprocurementprocess.ThesecanbeincorporatedintotheMILP-problem,eitherasconstraintsorbyattachingadollarvaluetotheservicelevel.Forinstance,ifacertainservicemeasureisbelievedtorepresent$10per%-unitofservice,anLOS-adjustedcostcanbeminimized.
Systemattributes/constraintsSystemattributesarenottiedtoaspecificitem.Suchconstraintsareusuallyconcernedwithconstraintsonthesuppliersasagroup.Thesearenotasstraight-forwardtoimplementintheMILP-formulationastheitem-supplierspecificconstraints.Onehastoinvestigateeachcaseindividually,andmayneedtointroducebinaryvariablesfordifferentsuppliersand/oritems.Implementingcertainsystemconstraintsinthemodelisalsousefulformakingsensitivityanalyses.Forinstance,itenablesananalysisofhowreducingthesupplierbasewouldaffecttotalcost.
EconomiesofscopeInmanycasesthebidonereceivesforanitemdependsonwhetherornotthesupplierbelievesitwillbesupplyinganotheritem.Forinstance,whenbuyingtransportservices,asuppliermaybewillingtoofferalowerpriceforalaneifhealsogetsthereturntransportonthelane.Similareconomiesofscopemayappearinallprocurementsituations.
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CombinatorialauctionsCombinatorialauctionsisawaytocapturethepotentialeconomiesofscope.Inessence,theideaistoletallsuppliersbidforallpossiblecombinationsofrelatedproducts.
LearningObjectives• Reviewhowtomapitemsbasedonriskandspend• Differentiateprocurementstrategybasedonthemapping• Understandthestructuredsourcingprocess• Reviewcapitalgoodspurchasing• HighlightimportanceofCSRinprocurement• Introduceprocurementoptimizationwhenoneevaluatesbidsformanyitemsfrom
severalpotentialsuppliers• Identifyhowtotakeservicecriteriaandsystemsattributesintoaccount• Introductiontocombinatorialauctionsinpresenceofeconomiesofscope
ReferencesCachon,G.P.(2003).Supplychaincoordinationwithcontracts.Handbooksinoperationsresearchandmanagementscience,11,227-339.
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SupplyChainFinance
SummaryThisreviewcoverssomeofthemostimportantconceptsofaccountingandfinancefromasupplychainmanager’sperspectiveincludingashortdiscussionoftheroleofaccounting,thechoicesandaccountantcanmake,theroleanddifficultiesofdepreciation,andanoverviewofbasicaccountingconcepts.
KeyConcepts
AccountingFundamentals
TheIncomeStatementTheIncomeStatementprovidesasummaryoftheflowsin(revenue)andout(expenses)ofthefirmoveraperiodoftime;thenetdifferencebetweentherevenueandexpensebeingtheprofitorlossofthefirm.Putinanotherway,theincomestatementdescribeshowtheassetsandliabilitiesareusedduringaparticularperiod.Youcouldalsothinkofitasthesumofincome-generatingtransactions,financialtransactionsoverastatedperiodoftime.Thethreemaincomponentsare:
• Revenues(turnover,sales,proceeds,‘topline’)–theincomingflow• Expenses(costs)–theoutgoingflow• Profit(income,earnings,‘bottomline’)–thedifferencebetweenincomingandoutgoing
flow
Forasupplychainmanager,thereareseveralcomponentstoExpensestobeawareof:• COGS(CostOfGoodsSold,Costofproductssold)–thesearethedirectcostsof
producingthegoods/servicesthataresoldtogeneraterevenues.• CostofRevenue(costofsales)–SimilartoCOGS,butincludesalsocostsoutsideof
production,e.g.marketingexpenses• Depreciation–thesearenon-cashexpensesassociatedwiththeuseofcapital
equipment(formoreaboutthis,seebelow).Relatedisamortization–thisareductioningoodwill(goodwillisanintangibleassetthatariseswhenthefirmacquiresanotherfirmatapricehigherthanthebookvalueoftheacquiredfirm)
• SG&A(Sales,General,andAdministration)–overheadcostsassociatedwithgeneratingrevenue,includingthesalesforce,
• OperatingExpenses–thesumofCOGS,Depreciation,andSG&A.
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TheBalanceSheetTheBalanceSheetpresentsthefinancialconditionofthefirmatonepointintime.Itliststheassets,whichissomethingthatisownedbythefirmandhasmeasuredvalue.Italsoliststheliabilities,whichareclaimsagainsttheassetsbyotherparties.Youcouldalsothinkoftheseasdebtsorobligationsthatthefirmhastopayotherpeople.TheBalanceSheetgivesasnapshotoftheassetsandobligationsofthefirmatasinglemomentintime.Assetsalwaysequalliabilities.Remember,thebalancesheetreportBookvalue,notMarketvalue.Thesecouldbeequal,butaswewillseeinthenextlessontheymaynotbe.
• Assets.YouwanttoseparateCurrentAssetsfromLongTermAssets.Currentassetscanbeusedonshort-termtopayforobligations(e.g.cash,accountreceivables,inventories),whereaslong-termassetsare,asthenameimplies,longterm(e.g.facilities,equipment–sometimesabbreviatedPPEforProperty,PlantandEquipment)
• Liabilities.NormallyliabilitiesaredividedintoCurrentLiabilities,Long-termLiabilities(Dept),andEquity.Currentliabilitiesgenerallyhavetobepaidinthenextaccountingperiodandinclude,e.g.,accountspayables.Long-termliabilitiesincludee.g.loans,bonds,ormortgages.Equityisthecapitalthatownershaveputintothefirm.
TheRoleofAccountingTheroleofaccountingistorecordthetransactionsofabusiness.Theaccountantclassifiesthesourcesanduseoffunds.Thereareprimarilythreetypesofreportsprepared:
• Financialreports.Theseareintendedforthefirm’sinvestors,includestheincomestatementandthebalancesheet.
• Taxaccountingreports.Theseareprovidedforthegovernment,intheUSfortheIRS.• Productcostingreports.Theseareusedformanagementdecisionmaking.
Therearecertainchoicesthatcanbemade,aslongastheaccountfollowgenerallyacceptedaccountingpractice.Notethatthefinancialreportsprovidedtoinvestorscandifferfromthetaxreports.Theyservedifferentpurposes.Financialaccounting’sobjectiveisto“presentfairlytheresultsofoperationsandthefinancialconditionofthecompanytoitsstockholders”,whereascorporatetaxaccounting’sobjectiveisto“minimizecurrenttaxliabilityanddeferpaymentofliabilityaslongaspossible”Thismeansthat”thetaxcodeallowscompaniestodeviatefromfinancialaccountinginspecificareaswhencalculatingtaxableincomewithouthavingtochangethecorporatefinancialreportsissuedtostockholders”
DepreciationDepreciationisanon-cashexpensetothebusiness.Itcanbethoughtofastheestimatedcostofusinganasset.Forinstance,ifamachineispurchasedtobeusedinamanufacturingsetting,
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thedepreciationofthemachinerepresentsthereductioninthevalueofthemachineovertheaccountingperiod.Thismeansthatwhiledepreciationisanexpense,thevalueofthecorrespondingassetreducesbythesameamount.Soifthedepreciationofamachineis$10,000inayear,thiswillimpacttheincomestatement($10,000expense)aswellasthebalancesheet(-$10,000inlong-termassets).Therearedifferentwaystoconstructtherateofdepreciation.Mostcommonisstraight-linedepreciation,wheretheassetisreduceswiththesamevalueeachaccountingperioduntilitreachesitsresidualvalue(itsscrapvalue).Sincedepreciationisanexpenseitwillaffectthetaxableincomeofthefirm.Thiswillaffectcash-flows,eventhoughthedepreciationitselfisnon-cashexpense.
BasicAccountingConcepts• DualAspectConcept-assetsalwaysequalliabilities• AccountingPeriodConcept–IncomeStatementoveraperiodoftime• ConservatismConcept-Chooserecordingmethodthatresultsinthelowestassetor
highestliabilityfigures• AccrualConcept–recordrevenueswhentheyareearned(e.g.whentheproductships)
andrecordexpenseswhentheyareincurred.• CostConcept-recordcosts,notmarketvalue• MaterialityConcept-disregardimmaterialtransactions• RealizationConcept-recognizerevenuewhengoodsaredelivered• ConsistencyConcept–usethesamemethodforrecordingtransactionsassociatedwith
specificassets/events• EntityConcept-accountingforanentity,notindividuals• GoingConcernConcept-assumecontinuingoperations• MatchingConcept-matchcostsassociatedwithrevenueinsameperiod• MoneyMeasurementConcept-moneyisthecommonmeasure
AccountingChoicesTheaccountantdoeshavechoiceshowtoreportdifferenttransactions;thesamesupplychainactioncanappeardifferentwaysinfinancialreports,andthesecanhavedifferentimpactonthefinancialreportsdependingonhowtheyarerecorded.Therearethreesetsofchoicestobeawareof:
• Productcosting.Theaccountantisfreetodeterminehowtoallocateoverheadandhowtocategorizeexpensestocreateasaninsightfulresultaspossible.
• Depreciationmethod.Therearemanywaystosettherateandperiodlengthfordepreciation.Forsometypesofassets,however,thereareestablishedaccountingpractices.
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• Assetorexpense.Itisnotalwaysclearwhetheratransactionshouldbeclassifiedasacapitalinvestmentoranexpense.Oneexampleisaprototype.Theaccounthasleewayindecidinghowtoclassifythis.
LIFOvsFIFOTherearetwoverydifferentwaystoestimatethevalueofgoodsinaninventory:
• LIFOusesthemostrecentcostofinventorytoassigntosales,whichresultsinlowerstatedprofits(assumingmaterialcostsincreaseovertime).Asaresult,theremaininginventorycanbeundervalued.
• FIFOusestheoldestcostofinventory,whichresultsinpotentiallyhigherprofitsbutneartermtaxobligations.Asaresult,theremaininginventorycanbevaluedatcurrentreplacementcost.
CostingSystems
CostAccountingWhilecostaccountingisatypeofreporting,ithasadifferentpurposethanthefinancialreports.Thepurposeofcostaccountingispurelyinternaltothefirm–itisdesignedtomeasurecoststoenableperformanceanalysis,decision-makingandinternalreporting.So,whileinfinancialreporting,costsareclassifiedbasedontypeoftransactionforexternalreporting;incostaccounting,costsareclassifiedbasedonneedsofmanagementforinternaluse(decision-makingsupport).Thismeansthatcostaccountingdoesnothavetofollowgenerallyacceptedaccountingpractice.
OverheadandOtherTypesofCostsTherearemanytypesofcoststoconsiderinthecostaccountingprocess:
• Fixedcosts:thesecostsdonotvarywithvolume.o Ex.Monthlypaymentsforplant,property,equipment
• Variable&Semivariablecosts:coststhatvarywithvolumeo Ex.Costformaterialsusedtoproduceaproduct;morematerialsareneededto
makemoreunitsofproductiono Ex.Semivariable:costforsalariedemployeeswhogetcommissiononsales
• Directcosts:coststhatcanbeattributedtotheproductionofaspecificproducto Ex.Costforrawmaterialsorlaborhourstoproducetheproduct
• Indirectcosts(overhead):coststhatcannotbeattributedtotheproductionofaspecificproduct
o Ex.Legalfees,SG&A,insurance
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Muchofthechallengeofthecostsystemistofindarepresentativewaytoallocatetheindirectcosts–theoverheadcosts.Thesecostsincludedepreciationofassets,supervision,qualitycontrol,andmanyothercosts.Toproperlyunderstandthecostofproducingcertainproducts/services,thecosttoservecertaincustomers,orthecosttorelyoncertainsuppliers,managersneedtoallocatetheseoverheadcostsinarepresentativeway.Thisisnoteasy,sincethereisoftennodirectrelationshipbetweenthecostandtheproduct!Differentcostsystemapplydifferentlogicforthisallocation,asyouwillseebelow.
TraditionalCostSystemsThemostcommonwaytoallocatecostsisusinga“traditional”costsystem.Withsuchacostsystem,“standardcosts”arecalculatedandusedtoallocatetheoverhead.Thestandardcostistheanticipatedoverheadcostforaprocessorproduct.Astandardrateisthencalculatedbasedonsomemeasure,e.g.throughputorlaborhours.Forinstance,iftotalstandardcostformanufacturingis$100,000andbudgetedthroughputis1,000,thestandardratetobeappliedis$100perunit.Whilethesesystemsoftenperformwellinmanyinstances,therearecertaininstanceswheretheyareproblematic.Thisincludesinstanceswhendepreciationandotheroverheadcostsaccountforalargershareandincomplexenvironmentswithmany(customized)productsand/orprocesses.
ActualCostSystemsActualcostsystemstrytouseactualcostsorquantitiestoprovideamoreaccuratepicturecomparedtostandardtraditionalsystems.Therearedifferentvariations:
• Actualcostusingactualquantitiesandstandardprices• Actualcostusingstandardquantitiesandactualprices• Actualcostusingactualquantitiesandactualprices
Itishoweverdifficulttouseactualpricessincethiswillnotbeavailableuntilaftertheperiodisover.
Activity-Based-Costing(ABC)Anincreasinglycommonwaytohandletheshortcomingoftheothercostingsystemsistouseanactivitybasedcostingapproach.Withthisapproach,relevantactivitiesaredefined,andalloverheadcostsarerelatedtotheseactivities.Basedonthenatureoftheactivity,acostdriverisidentifiedwhichisthenusedtocalculatetheoverheadcostfordifferentobjects(e.g.products,customer,suppliers).ThegeneralstepstofollowwhenusingABCarethefollowing:
1. Identifyallrelevant(repetitive)activities(aformalapproachwouldinvolvecreatingaprocessmodel).Notethatarelevantactivityisoftenoftheform“verb+object”,e.g.“scheduleproduction”.
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2. Identifytheresourcesconsumedinperformingtheactivities.Basedoninterviews,reports,orotherinformation,identifytherelevantresourcesconsumedineachoftherelevantactivities.
3. Determinethecostsoftheactivities.Basedontheinsightsfromstep2,findthetotalcostforeachrelevantactivity.
4. Determinecost-driversoftheactivities.Thisisthe“unit”thatdrivesthecostoftheactivity:unitsproduced,batches,orders,shipments,etc.
5. Determinecost-driverratefortheactivities.Basedonthetotalcostoftherelevantactivity,useitstotalactivityleveltodeterminetherateforthecost-driver.Forinstance,if“numberoforders”isthecost-driver,findthetotalnumberofordersovertheaccountingperiod,thisistheactivitylevel.Tofindthedriverrate,dividetotalactivitycostwiththeactivitylevel.
6. Tracecoststo(secondary)costobjects.Onceyouhavealldriverrates,usetheinformationyouhaveabouteachobjecttomultiplethatobjectsactivitylevelwiththedriver-rate.
Activity-BasedCostingprovidesadifferentandpotentiallymoreaccuratecostforproducingproductsandprovidingservices.ABCcanbehelpfulfordecisionmakersassessingtheprofitabilityofvariousproducts,servicesorsegmentationsofthosebycustomerorgeography.
WorkingCapitalTheworkingcapitalisabasicmeasureofbothacompany'sefficiencyanditsshort-termfinancialhealth.Itisdefinedas:
Workingcapital=Currentassets–Currentliabilities
Positiveworkingcapitalenablesthefirmtocontinueitsoperationsandtosatisfybothmaturingshort-termdebtandupcomingoperationalexpenses.Basically,theycanpaytheircurrentbillswhendue.Negativeworkingcapitalmeansthattherearenotenoughcurrentassets(cash,accountsreceivable,inventory)tosatisfytheircurrentliabilities(accountspayable,maturingshort-termdebtandupcomingoperationalexpenses).Thismaybegood,ifthefirmcollectsitsbillsbeforepayingsuppliers.Butitmayalsobeabadthing:thecompanycannotconvertassetsintocashquickenoughtopayoffliabilities.Acompanycanhaveassets&profitsbutlackliquidityifassetscan’treadilybeconvertedtocash.KeepinmindthatafirmcanhaveanegativeCCCandpositiveworkingcapital.Sometimesworkingcapitalisanalyzedthroughthe“currentratio”.Ifthisratioissomewherebetween1and2itisconsideredahealthycompany.
Currentratio=currentassets/currentliabilities
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Anothertestiscalledthe“acidtest”,andlooksonlyatthecurrentassetsthatcanbequicklyconvertedtocash.Iftheacidtestislessthanthecurrentratio,thecurrentassetsarehighlydependentoninventory.
Acidtest=(Cash+AccountsReceivables+shortterminvestments)/currentliabilitiesAthirdimportantmeasureistheworkingcapitalturnover.Thisdescribeshoweffectivelyacompanyisusingitsworkingcapitaltogeneraterevenues.Ingeneral,ahigherturnoverispreferable.
Workingcapitalturnover=sales/workingcapital
Cash-to-CashCycle(CCC)AlsoknownastheCashConversionCycle,theoperatingcycleorsimplythecashcycle.Thisisaliquiditymeasurethatcanhelpacompanyplanitstimingofworkingcapitalrequirements.Itmeasuresthenumberofdaysthatacompany'scashistiedupintheproductionandsalesprocessofitsoperations,andthebenefititgetsfrompaymenttermsfromitscreditors.Theshorterthecycle,themoreliquidthecompany’sworkingcapitalposition.Themeasureconsistsofthefollowingthreeparts:
• DaysOfInventoryOutstanding(DIO)–thisistheaverageinventoryinthesystem,expressedinnumberofdays
DIO=(AverageInventory/CostofSales*)x365
• DaysofSalesOutstanding(DSO)–thisistheaveragenumberofdaystocollectrevenuesfromasale,thatis,thecredittimegiventocustomers
DPO=(AverageAccountsPayable/CostofSales)x365
• DaysofPayablesOutstanding(DPO)–thisistheaveragenumberofdaysbeforepayingsuppliers
DSO=(AvgAccountsReceivable/TotalSales*)x365
TheCash-to-cashCycle,ortheCashConversionCycle,isthenfoundas:CCC=DIO+DSO-DPO
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SupplyChainCashFlowsTherearethreeflowsinthesupplychain:thephysicalflow(goods),thefinancialflows(money),andtheinformationflows(data).Sincewemayusecontractorsformanyofourfirm’soperations,physicalflowsmaynotpassthroughourfirmatall.Financialflows,however,will.Consequently,thedesignofthefinancialflowsinthesupplychainwillhaveanimpactonthevaluewearecreatingandthereforehowvaluableoursupplychaindesignsare.
InvestmentsandfuturecashflowsTheprimarysourceforcapitalforafirmisfromitsstockholders,orequityinvestors.Theseinvestorspurchasestockinthefirmtoprovidethefirmwithcapital.Thefirmmaythencontractoutwithdebtors,banks,orbondholderstoraiseadditionalcapitalthatcanbeusedforinvestments.Thereisacontractualagreementwiththesedebtors.Forinstance,ifyouborrowmoneyfromabankyouwillhaveacontractwhereyoupaythembackoveracertainperiodoftime.Thisisnotthecasewithinvestors.Forthese,thefirmhopestomakeenoughmoneytopaythemback.How?Byinvestingthecapitalinoperationalassetstogeneratefuturecashflows.Thegoalistomanagetheassetsinthesupplychainwellenoughsothatrevenuesaregreaterthanexpenses.Investorscompareafirm’sresultwiththeotherinvestmentoptionstheyhavetocreateaportfolioofoptionsthatwillgivethemfuturereturns.Soinvestors’investmentinafirmisapartoftheirportfolio.Giventhefirm’sabilitytoprovidereturns,itwillbemoreorlessattractivetoinvestors.
InvestmentevaluationNormally–thosethathavethemoneyinanorganizationarealsothosethatdecidesonwhichinvestmentstomake.Followinggeneralcorporatefinanceguidelines,investmentsareevaluatedaccordingtothefollowingsteps:
1. Estimatetherelevantcashflows–thisincludesalsothecashoutflowofmakingtheinvestment
2. Calculateafigureofmeritfortheinvestment–thisistocomeupwiththe“value”oftheinvestment
3. Comparethefigureofmerittoanacceptancecriterion
Notethatthesameprocessmaybeusedtoevaluateprojects.
EBITandEBITDAToseparatedifferenttypesofoperatingincome,wewillusethefollowingconcepts:
• EBIT–EarningsBeforeInterestandTaxes.Thesearetheearnings,ortheprofit,beforeanyfinancialaspectsareadded.
• EBITDA–EarningsBeforeInterest,Taxes,DepreciationandAmortization.Thesearetheearnings,ortheprofit,beforefinancialaspectsaswellasdepreciationandamortization.Thatis,itisthegrossincomeminusCOGSandSG&A.
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ProjectedcashflowsCashcominginareconsideredpositivecashflows;cashgoingoutisconsiderednegativecashflows.Tohandlethecashflowsintheevaluationmodels,theyareaggregatedin“bins”–normallyeachyearisabin.Commonpracticeassumescashflowsoccurattheendoftheprojectedperiod,orbin.Theappropriatetimehorizontoconsiderdepends–thedecisionmakerssimplyhavetocometoanagreement.However,onemustalsoconsidercashflowsattheendofthedecisionhorizon–assetsmaybedivestedand,whentheyare,incurasalvagevalue.
InflationTherearetwodifferentwaystothinkaboutinflationwhenevaluatingcashflows:
• Nominalcashflow:incorporateinflationinprice/cost.Theinflationratesmaydifferbetweendifferentcomponents.
• Realcashflows:donotincludeinflationinprice/cost.
Thechoicebetweennominalorrealcashflowsinfluencesthediscountrateusedwhencalculatingthefigureofmerit.
RelevantCashFlowsWeneedtomakesurethatthecashflowsweareprojectingarerelevanttotheparticularinvestmentorprojectweareevaluating.Sohowdowedeterminewhatisarelevantflow?
1. Cashflowprinciple:onlycashflowswheremoneymovesarerelevant.Thatis,acashfloweithergoesoutofthefirmorcomesintothefirm.Forinstance,depreciationisnotamovementofmoney,soitisnotarelevantcashflow.However,depreciationalsoaffectstaxes,whichisarelevantcashflow.
2. With-withoutprinciple:onlycashflowsthataredifferentwiththeinvestmentcomparedtowithouttheinvestmentarerelevanttothedecision.Notethatthisisdifferentfrom“beforeandafter”,sincewearelookingintothefutureattwodifferentworlds–weareonlyinterestedinthedifferencebetweenthoseworlds.Forinstance,ifrevenueswillnotdifferbetweenouralternatives,thentheyarenotrelevantcashflows.
Notethatthisalsomeansthatsunkcostsarenotrelevantcashflows.Opportunitycostofassetsshould,however,beincludedintheevaluation–itdiffersbetweenthealternativesandisthusarelevantcashflow.
FreeCashFlowsThefreecashflows(FCF)arethefundsavailableto(theequity)investorsafterthefirminvestscapitalandpaystaxes.Itprovidesaconvenientwaytocalculatecashflowstocompareinvestments,byrelyingonpostsinthefinancialreportsratherthanseparatelineitems.Forfreecashflowcalculationsweneedtoconsiderrevenues,COGS,operatingexpenses,andtaxesaswellascapitalexpendituresandworkingcapital.Notethatsomeofthesearefoundintheincomestatementwhereasothersarefoundinthebalancesheet.Startingwiththeincomestatement,relevantcashflowsincludetaxes.
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Tomakesurewecapturetheeffectoftaxes,wemakeuseoftheNetOperatingProfitAfterTaxes(NOPAT).
NOPATt=(1-taxrate)*EBITt.
UsingNOPAT,whichtakesdepreciationintoaccount,wecanfindtherelevantcashflowsoftheincomestatementbyaddingthedepreciation“backagain”,thatis.Relevantcashflowsfromtheincomestatementattimet:
NOPATt+DAt
Fromthebalancesheet,wegetthecapitalexpenditureandthechangeinnetworkingcapitalrequirement.Relevantcashflowsfromthebalancesheetattimet:
CapExt,ΔNetWCt
CombingthedatafromtheincomestatementandthebalancesheetwegetFCFt=NOPATt+DAt-CapExt-ΔNetWCtFCFt=(1-taxrate)*EBITt+DAt-CapExt-ΔNetWCt
WorkingCapitalCashFlowsTheworkingcapitalcashflowisthenetchangeinworkingcapitalrequirementsfromthepreviousperiod.Forinstance,adecreaseinworkingcapitalrequirementsmeansthatmorecashisfreedup(notetheminussignintheFCFformula).Notethatworkingcapitalcashflowsoccurwhenthechangetakesplace.Forinstance,achangeininventorylevelaffectsworkingcapitalrequirementswhenwenextreplenishstock.
DiscountedCashFlowAnalysisWenowfocusonthetwosubsequentstepsininvestmentevaluation:howtocalculateafigureofmeritbasedontheprojectedrelevantcashflows,andcomparethisfiguretoanacceptancecriterion.Thebasicideaunderlyingthesecalculationsisthattoday’smoneyisworthmorethanmoneyinthefuture.Tocorrectforthiswhenwemakeinvestmentdecisions,weuseadiscountratetofindtoday’svalueoffuturecashflows.Whyistoday’scashmorevaluablethantomorrow’s?Thereareprimarilythreereasons:
• Opportunitycost–nothavingthemoneynowresultsinforegoneinvestmentreturns• Inflation–thisreducespurchasingpowerovertime• Risk/uncertainty–receiptofcashisnotguaranteedovertime
Owingtothis,weneedtocalculatethepresentvalueoffuturecashflowswhenevaluatingsupplychaindesigns.Aswesawinthislesson,thereareseveralwaystodothis.Commonforalldiscountedcashflowanalysis,isthatisquantifiesthevaluecreatedbyinvestments.
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FigureofMeritThefigureofmeritisasinglenumberthatestimatestheeconomicvalueofaninvestment.Thisnumbercanbecomparedwithacriterionestablishedbythefirm.Thereisnouniversalcriterion.Therearealsoseveraldifferentfiguresofmerit,whichyouwillseemoreofbelow.
PaybackPeriodThepaybackperiodisthetimeuntilthecumulativecashflowisequaltoourinitialinvestment.Usingthisfigureofmerit,theacceptancecriterionistoinvestifthepaybackperiodisshorterthanthecut-offpoint.Thefirmdecidesthecut-offpoint.Thisisafairlysimplemeasure,whichiseasytocommunicate.Themaindrawbackisthatitdoesnotconsiderthetimingofcashflows.Forinstance,cashupfrontisnotvalueddifferentlythancashlater.Neitherdoesitconsidercashflowsafterthepayback-period,eventhoughthesemaybesignificant.
ReturnonAssets(ROA)Thereturnonassets(ROA)isdefinedby:
ROA=Netincome/AssetsTheacceptancecriterionusingthisfigureofmeritistomakeaninvestmentifROAisgreaterthansometargetreturn.“Assets”areforaninvestmentthetotalinvestmentincapital,whichwilldepreciateovertime.Thismeansthatlaterincomingcashflowsaregivenahigherweightinthecalculation,eventhoughearliercashflowsaregenerallymoredesirable.ROAisverymuchlinkedtothefinancialstatement.However,itisbasedonaccountingcalculationsandnotcashflows.Also,justlikethepaybackperiod,itdoesnotconsiderthetimingofcashflows.
PresentValueThepresentvalueofafuturecashflowsisgivenby:
PV=FV/(1+r)n
wherePVispresentvalue,FVisfuturevalue,risthediscountratefortheperiod,andnisthenumberofperiods.Notethatyoumusthavethesametimeperiodforyourrateandyournumberofperiods.Often,westicktoannualvalues.Thediscountrateisbasedoninvestors’expectedrateofreturn.Thisissometimesreferredtoasthehurdlerate–itsetsthehurdlebywhichwehavetorunouroperationstoexceedtheexpectationsofourinvestors.
NetPresentValueThenetpresentvalueisthesumofalldiscountedcashflowsfromallrelevantfutureperiodsofaninvestment:
NPV=c0+c1/(1+r)1+c2/(1+r)2+…+cT/(1+r)T
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wherecirepresentsthenetcashflowinperiodi.Notethatwearenotdiscountingthecashflowofperiod0–thisisthepresentvaluealready!NPViseasilyimplementedinyourspreadsheetsoftware.Ifusingthebuilt-infunction,keepinmindthatperiod1isthefirstperiodinthefunction,period0cashflowsneedtobeaddedseparately.Thenetpresentvalueisafigureofmeritthatcanbeusedtoevaluateaninvestmentonitsownorcomparedifferentinvestmentswitheachother.TheacceptancecriterionforasingleinvestmentisthattheNPVisgreaterthanzero.
InternalRateofReturnWhiletheNPVhasalotofnicepropertiesforafigureofmerit,itisdependentonpickingtherightdiscountrate.Theinternalrateofreturn(IRR)addressesthisproblemby,insteadofconsideringtheNPVgivenacertaindiscountrate,considersthediscountrateatwhichtheNPV=0.Consequently,managementcancomparethetargetreturnwiththeIRR.ThecriterionofacceptanceisthustoinvestaslongasthetargetrateofreturnisbetweenzeroandtheIRR.TheIRRisfoundasthesolutionto
0=c0+c1/(1+IRR)1+c2/(1+IRR)2+…+cT/(1+IRR)TThereisnoclosedformsolutionforthis.Therearehoweverspreadsheetfunctionsavailabletocalculatethis.
TerminalValueWemaywanttoconsiderhowassetsthatlastbeyondourfinancialprojectionsshouldbehandled.Wehavetoucheduponthesalvagevaluebefore.Theremaybecashflowstoconsidereveniftheinvestmentisnotsalvaged–maintenance,certaininventorypolicies,etc.TheterminalvaluehandlesallthecashflowsthatareincurredafterperiodT,whichisthelastperiodofourprojections.AfterperiodT,cashflowsareassumedtobestable.Therearenormallytwoapproaches:
• Perpetuity:estimatedvalueofstablecashflowsthatcontinueindefinitely• Annuity:estimatedvalueofstablecashflowsfordefiniteperiodbeyondtheunique
projections
Youcanincorporategrowthintotheanalysisaslongasgrowthisstable.Aperpetuityisgeometricseriesthatconvergesto:
PV=C/rwhereCisthestablecashflowperperiod.Anannuityisthenetpresentvalueofstablecashflowsoveragivennumberofperiods.Theannuityisthusgivenby:
PV=C/r-C/(r*(1+r)^T)
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InventoryHoldingCostIninventorymanagementweuseaholdingcost(orcarryingcost)forcalculatinghowmuchinventorytokeep.Thisisanannualcost,anditconsistsofseveralcomponents:
• Capitalo Opportunitycostofcapital
• Operatingo Warehouse(power,propertytaxes…)o Equipmento Labor(handling,stockkeeping,…)o Disposal,scrap(directorthirdpartycosts)
• Lostrevenueo Obsolescenceo Depreciation(realmarketvalue!)o Deteriorationo Shrinkageo Damageo Insurancetopreventlostrevenue
Oftentimes,werefertothelasttwocategoriesasnon-capitalholdingcosts.Buthowisthisincorporatedintodiscountedcashflowanalysis?Well,thesecashflowshavetobeevaluatedlikeanyothercashflows:
o Opportunitycostofcapitalisimplicitlyincludedinthediscountrate,andisnotarelevantcashflow.
o Thenon-capitalcosts(operatingcost,lostrevenue)arerelevant,projectedcashflows
Consequently,whenyoureduceinventory,yougettheworkingcapitalcashoncetoreinvestandyouavoidoperatingexpensesand/orlostrevenueovertime.
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DefiningSupplyChainFinanceSupplychainfinancehasbeenusedasabroadterm.Itcandescribehowwelookatthesupplychainthroughafinanciallens.Ithelpsusidentifiesthefinancialimpactfromsupplychaintransactionsandhowsupplychaindecisionsimpactfinancialstatements.Butinrecentyears,thedefinitionofsupplychainfinancehasbeenformalizedasamethodtoprovideliquiditytobuyersandsellers.ThistypicallymeanspaymenttermsofNet30or2%10,Net30.Themovetoafocusonliquiditystemsfromtheglobalfinancialcrisisof2008,whentheissueofgettingcashtofundbusinessoperationswasexasperated.Ingeneral,buyersareincreasinglylookingforwaystoreducetheirnetoperatingworkingcapitalrequirements–thatis,thefundsnecessarytocontinueoperationofthebusiness.Manybuyerstryextendthepaymentcyclefrom30daysanywhereto150+days.Therefore,manysuppliershavetowaitalongtimetogetpaidandneedtocashtopaybillswhilewaitingfortheinvoicepayment.SupplyChainFinanceisthesetofsolutionsthatallowacompanytofinanceitsownworkingcapital,leveragingitsrolewithinthesupplychainanditsrelationshipswithotherplayersinthechain.SupplyChainFinancehasmanyvariationamongdifferentsolutionsandalsohasdifferentterminologyacrossusers.SCFprovidesfinancing
• “Financingistheactofprovidingfundsforbusinessactivities,makingpurchasesorinvesting.”
• Thirdpartiesofteninvolved:Banks,otherfinancialinstitutions.• Providingfunding/capitaloftentoconsumers(e.g.formortgages),andbusinesses
(capitalimprovements).• Supplychains‘finance’orfundtheirpayables(andsometimesinventory).
Theretwogeneraloptionsforfinancing(debtandequity).When applying these options to Supply Chain Finance (SCF). Most are using debt – or loans – to provide liquidity – cash – to the firm. Some entail selling the asset (e.g. a receivable from the buyer), usually at a deep discount. There are many variations and each have advantages and disadvantages
LiquidityLiquidityisthe“thedegreetowhichanassetorsecuritycanbequicklyboughtorsoldinthemarketwithoutaffectingtheasset’sprice.”Or…..theabilitytoquicklyconvertassetsintocashatvalue.Liquidityallowsthebusinesstooperate,topaybills,tobuymaterials,etc.LiquidityandtheCCCConsidertheCashConversionCycle,CCC(alsoknownasthecash-to-cashconversioncycle).TherearethreecomponentsintheCCC:thecycletimetopaysuppliers,thecycletimetogetpaidbycustomers,andthecycletimetoproduceandsellaproduct(fromorderentrytimetotimeofsale).Toprovidemoreliquiditythefirmcan:arrangeforfasterpaymentsfrom
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customers;worktoreducetheproductionandsalescycletimes,and/orslowdownpaymentstosuppliers.CashConversionCycleAcronyms
SupplyChainFinance:Howdoesitwork? Case: Raw material purchase
• Situation: Buyer agrees to pay seller in X days • Seller can wait X days for payment or consider other options to get cash sooner
BasicFactoringIfthesellerdoesnotwanttowaitoneSellerOptioncalledFactoring:
• Sellthereceivabletoathirdparty(e.g.collectionsagency),calledtheFactor• Thereceivableisanobligationofthebuyertopaytheseller
DIO=DaysofInventoryOutstandingà howlongittakestoproduceandsellDSO=DaysofSalesOutstandingà howlongittakestocollectpaymentDPO=DaysofPayablesOutstandingà howlongthecompanytakestopaysuppliersCCC=CashConversionCyclehowlongtoconvertcashàinventoryàAPàcash
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FactoringWithRecourse:TheFactorcangobacktosellertocollectifthebuyerfailstopay
• IftheBuyerfailstopaytheFactor,thentheFactorcancollectfromtheseller.• The%offinvoicewillbelowerbecausethesellerstillbearstheriskifthecustomerdoes
notpay.FactoringWithoutRecourse:TheFactorhasnooptiontogobacktothesellertocollect,canonlycollectfromthebuyer.
• IftheBuyerfailstopaytheFactor,thentheFactorisstuck.• Nooptiontogobacktothesellertocollect.• The%offinvoicewillbehigherbecausetheFactorbearstheriskifthecustomerdoes
notpay.
There are many options to finance receivables such as factoring. This is probably the most common but can come at a high cost, % of the invoice. Other options vary based on factors including: loan or sale of the receivable, timing of the payments, which party bears the risk of repayment, use of different types of collateral, who initiates the arrangement. Each option has different impact on net operating working capital.
OptionsforLiquidityintheSupplyChainOptionsforliquidityinthesupplychain DescriptionInvoiceDiscount
-Initiatedbytheseller-Nothirdpartyinvolved-Sellerofferslowerpriceforearlypayment-Buyerchoosestoexercisetheoptiontopayearlyatadiscount-ThepaymentamountZwillbelowerthantheinvoiceamount-Thetimingofthepaymentinexchangeforthediscountisdeterminedbytheseller,butitwillbeshorterthantheoriginalpaymentterm
Financingaloan(InvoiceDiscount+)
-Usethereceivableascollateralforthebasisofaloan(e.g.fromabank)-Initiatedbytheseller-Thirdpartyinvolved-Sellerusesinvoiceascollateralforloanwith3rdParty(e.g.Bank)-Thirdpartyissuesloantoseller,usessellercreditrisktosettherate
t=time,X=paymentdate,Y=amount
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Forfeiting
-Usedforexports/imports-Initiatedbytheseller-Thirdpartyinvolved,usuallywithexpertiseinexport/import-Sellersellsthereceivabletothethirdpartyatadiscount-Thirdpartybuysreceivableatadiscount,collectsfromBuyer
ReverseFactoring
-InitiatedbytheBuyerwhoalsoinitiatesthefinancingoptions(loans)-ThirdpartyinvolvedthroughtheBuyer-Sellerhastheoptiontousethefinancingoptionsoffered-ThirdpartyofferstofinancereceivablebasedontheBuyer’screditrisk,meaninglowercostloan
Dynamic(Invoice)Discount -Initiatedbytheseller-Nothirdpartyinvolved-Sellerofferslowerpriceforearlypayment,timingofpaymentanddiscountratevaries-Buyernegotiatestimingandratesandchoosestoexercisetheoptiontopayearlyatadiscount-ThepaymentamountZwillbelowerthantheinvoiceamount
InventoryFinancing
-Initiatedbytheseller-Thirdpartyinvolved-Sellerarrangesline-of-creditorloaninordertopurchasematerials-ThirdpartyoffersloanwithSeller'sinventoryascollateral-UsefulwhensellermustpayitssuppliersbeforebeingabletosellFGI;alsousedtobuildinventorypriortopeakdemandseason
InvoiceAuction
-Initiatedbytheseller-Thirdpartiesinvited-Sellerarrangesanauctionprocesstosolicitbidsfortheinvoice(Buyerobligationtopay);sellercanuseexistingauctionplatform-Highestbidderwins-LikeFactoringwithoutRecourse,butusinganauctiontofindthirdparty
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AdvancedOptionsUtilizeautomatedprocesses
• Lessuncertaintyintiming• Lowercostloanoperations
Solicitandusemoredetaileddataaboutsellerandbuyer• Moreinformedriskassessments• Canresultinlowerriskandthereforelowercostloans• Favorableratesforincreasedvisibilityandfasterprocessduetoautomatedinfosharing,
betterriskassessmentProactiveuseofinformationtechnologyforfasterandmoreinformeddecisionmakingOtherOptionstoFinancetheSupplyChainUseoperationalmeasurestoreducetheneedforworkingcapital:
• Consignmentinventory(customerspushthecapitalrequirementontothesupplier)• Directshipments(reducetheneedtotieupcapitalinwarehouses)• Variousformsofcollaboration–vendormanagedinventory(VMI),salesandoperations
planning(S&OP),collaborativeplanning,forecastingandreplenishment(CPFR),continuousreplenishment(CRP),etc….Eachofmayreducetheamountofinventorynecessarytomaintainservicelevels
BenefitsofSupplyChainFinanceTherearemanybenefitsofsupplychainfinanceinclude:
• PotentialtoreducetheNetOperatingWorkingCapitalRequirements(NOWC):lowerforbothsellerandbuyerviaquickercashtoseller,lowerinventories
• Potentiallowercostmaterials:viadiscounts;Loweroperatingcostswithuseoftechnologyforinformation
• Potentiallyfastercycletimes:Viafastercash,fasteroperations;ReducingCCC• Potentiallymorerobustsupplychain:Viacollaborativefinancialconnectionsand
ensuringsupplierhealth• Benefitstothirdparties:Morecustomersforloans,potentiallylowerrisk
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AnalyzingFinancialPerformanceWemightaskourselves,whocaresaboutafirm’sfinancialperformance?Theobviousanswerisinvestors,executivesinthefirm,andemployeesofthefirm(ifitaffectstheirbonus).Beyondwhothismattersto,manysupplychainprofessionalaskfurtherquestionsincluding:Howdoyouanalyzefinancialperformance?Howdoyoumeasureit?Howdofinancialanalysisandmeasurementapproachesapplytosupplychainmanagement?Wewilldiscussthesequestioninthenextsection.ThemaingoalsofaCEOareto:provideshareholdervalue.Driversofshareholdervalueinclude:revenuegrowth,operatingmargin,andassetproductivity.Tomonitorthis,CEOsandotherexecutivesgenerallyneedascorecardtoassessthesedrivers.
Source:Lukac,E.G.,&Frazier,D.(2012).Linkingstrategytovalue.JournalofBusinessStrategy,33(4),49-57.
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BalancedScorecard(seeFigurebelow)• “Ultimately,causalpathsfromallthemeasuresonaScorecardshouldbelinkedto
financialobjectives.”• “Wehavefoundthatcompaniesusethreefinancialthemestoachievetheirbusiness
strategies:o RevenueGrowthandMixo CostReduction/ProductivityImprovemento AssetUtilization/InvestmentStrategy”
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DriversofShareholderValue
RatioAnalysisRatioAnalysisisthemathematicalcomparisonofafinancialstatementaccountsorcategories.Theserelationshipsbetweenthefinancialstatementaccountshelpinvestors,creditors,andinternalcompanymanagementunderstandhowwellabusinessisperformingandofareasneedingimprovement.Potentialcomparisonareasoneachstatementorsheet:IncomeStatementSalesCostofGoodsSoldGrossProfitSG&AExpensesDepreciation&AmortizationEBITInterestExpenseIncomeTaxesNetIncomesBalanceSheetCash&EquivalentsAccountsReceivableInventoriesTotalCurrentAssetsNetProperty/Plant/Equipment
𝑅𝑎𝑡𝑖𝑜 = 𝑁𝑢𝑚𝑒𝑟𝑎𝑡𝑜𝑟𝐷𝑒𝑛𝑜𝑚𝑖𝑛𝑎𝑡𝑜𝑟
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TotalLongTermAssetsTotalAssetsAccountsPayableTotalCurrentLiabilitiesLongTermDebtTotalLiabilitiesCommonStockRetainedEarningsTotalStockholder’sEquityTotalLiabilities&Equity Overall measure of financial performance Is there a single metric that can reflect the firm’s financial performance for investors? Or executives?
• Return on Equity
• Return on Assets
Specific measures of financial performance Revenuegrowth
• Salesgrowth=(Salest/Salest-1)-1• CompoundAnnualGrowthRate(CAGR)=(Salest/Salest-n)1/n-1
Operatingmargin• Grossmargin=GrossIncome/Sales• Operatingmargin=OperatingIncome/Sales• Netmargin=NetIncome/Sales
Assetproductivity• Assetturnover=Sales/TotalAssets• Inventoryturnover=COGS/AverageInventory• Accountsreceivableturnover=CreditSales/AverageAccountsReceivable• Accountspayableturnover=COGS/AverageAccountsPayable• Daysofinventoryoutstanding=AverageInventory/(COGS/365)
𝑅𝑂𝐸 = 𝑁𝑒𝑡𝐼𝑛𝑐𝑜𝑚𝑒𝐸𝑞𝑢𝑖𝑡𝑦
𝑅𝑂𝐴 = 𝑁𝑒𝑡𝐼𝑛𝑐𝑜𝑚𝑒𝑇𝑜𝑡𝑎𝑙𝐴𝑠𝑠𝑒𝑡𝑠
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RatioAnalysisAdviceThere are not any “correct” values for ratios. Ratio values need to be understood in context such as: compare with industry averages, compare with specific competitors; and/or observe trends over time. You will need to develop a framework of several ratios to monitor. In combination, these clues may tell an interesting story.
DuPontAnalysisDuPontanalysisisbasedonareturn-on-investmentformuladevelopedin1914byaDuPontexplosivessalesmannamedDonaldsonBrownandusedbythecompany.Mr.BrownlateruseditasCFOatGeneralMotors,butitwasalreadyknownastheDuPontformula.
TheformulacommonlyusedtodayfocusesonROEforDupontanalysisincorporatesfinancialleverage:
𝑅 = 𝑇×𝑃 𝑤ℎ𝑒𝑟𝑒𝑅= 𝑟𝑎𝑡𝑒𝑜𝑓𝑟𝑒𝑡𝑢𝑟𝑛𝑜𝑛𝑐𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑛𝑣𝑒𝑠𝑡𝑒𝑑,
𝑇= 𝑟𝑎𝑡𝑒𝑜𝑓𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟𝑜𝑓𝑖𝑛𝑣𝑒𝑠𝑡𝑒𝑑𝑐𝑎𝑝𝑖𝑡𝑎𝑙, 𝑎𝑛𝑑
𝑅𝑂𝐴 = 𝑁𝑒𝑡𝑀𝑎𝑟𝑔𝑖𝑛×𝐴𝑠𝑠𝑒𝑡𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
𝑁𝑒𝑡𝑀𝑎𝑟𝑔𝑖𝑛 = 𝑁𝑒𝑡𝐼𝑛𝑐𝑜𝑚𝑒
𝑆𝑎𝑙𝑒𝑠 𝐴𝑠𝑠𝑒𝑡𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = 𝑆𝑎𝑙𝑒𝑠
𝑇𝑜𝑡𝑎𝑙𝐴𝑠𝑠𝑒𝑡𝑠
𝑅𝑂𝐸 = 𝑁𝑒𝑡𝑀𝑎𝑟𝑔𝑖𝑛×𝐴𝑠𝑠𝑒𝑡𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟×𝐹𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙𝐿𝑒𝑣𝑒𝑟𝑎𝑔𝑒
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GMROI:GrossMarginReturnonInvestmentGMROI has a Narrower focus than DuPont and is useful in evaluating inventory decisions, and their impact on profitability.
ROICROIC=ReturnonInvestedCapital.ROICIsanoverallmeasureoffinancialperformance.Thisincludesreturnsonallcapitalforinvestorsseekingareturn,notonlyonequity.ROICisagoodmeasureforsupplychainperformance.Itisnotconfoundedbyfinancingstrategies.Itshowsthefundamentalearningpowerofthefirm,i.e.createdbyoperations.ROA=NetIncome/TotalAssetsROE=NetIncome/EquityBothmeasurescanbedistortedbyfinancialleverage,i.e.moredebtROIC=NOPAT/InvestedCapital
• NetOperatingProfitAfterTax(NOPAT)o NOPAT=EBIT(1-Taxrate)o Earningsaftertaxasifitwereallequityfinanced(i.e.,notconsideringinterest
expenseortaxbooks)• InvestedCapital
o IC=Interest-bearingDebt+Equityo Sumofallsourcesofcashonwhichareturnmustbeearned(i.e.,notincluding
accountspayable)o Youmaywanttosubtractexcesscasho PreferthebookvalueofInvestedCapital(i.e.thevalueinvested)ratherthanthe
marketvalue
𝐺𝑀𝑅𝑂𝐼 = 𝐺𝑟𝑜𝑠𝑠𝑀𝑎𝑟𝑔𝑖𝑛×𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
𝐺𝑟𝑜𝑠𝑠𝑀𝑎𝑟𝑔𝑖𝑛 = 𝐺𝑟𝑜𝑠𝑠𝑃𝑟𝑜𝑓𝑖𝑡
𝑆𝑎𝑙𝑒𝑠
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = 𝑆𝑎𝑙𝑒𝑠
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
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RONARONA(ReturnonNetAssets)issimilartoROICandsimilartoROCE(ReturnonCapitalEmployed).Itisareturnonassetsthatareexpectedtoproduceprofit.
RONA = NOPAT / Net Assets
• Net Operating Profit After Tax (NOPAT) o NOPAT = EBIT (1 - Tax rate) o Same as ROIC
• Net Assets o NA = Fixed Assets + Non-cash Working Capital o NA = Total Assets - Current Liabilities - Cash
LearningObjectives• Understandthebasicsoffinancialreportingandaccounting• Understandtheimpactofdepreciationonthefinancialreports• Introduceyoutocostaccounting/costsystems• Becomefamiliarwiththeprinciplesofthedifferentcostsystems• Learnhowtoperformsimpleactivitybasedcosting(ABC)• BecomefamiliarwithworkingcapitalrequirementsandtheCashConversionCycle• Understandrelevantcashflowsandhowtoestimatethem• Understandandlearnhowtofindfreecashflowsfromthefinancialreports• Determinethefreecashflowsovertimeforaninvestment/project• Understandtheunderlyingreasonsfordiscountedcashflow(DCF)analysis• ReviewhowtocalculatetheNetPresentValue(NPV)andtheInternalRateofReturn
(IRR)ofaninvestment,andhowtousethesefigureofmeritsforevaluatinginvestments• HowtohandleinventoryreductionsinDCFanalysis • Understandchangeinpaymenttermstogetcashtofundoperations • Recognizesupplychainfinancedefinitionandthatithasvariations • BecomefamiliarwiththeCashConversionCycle • Reviewdifferenttypesoffinancereceivables • Recognizevariationsacrossfactoringinfinancingreceivables • Understanddifferentoptionstofinancesupplychain • Introductiontoeffectiveanalysistodriversofshareholdervalue • Recognizefinancialmetricsthatcanassesssupplychainperformanceandguidestrategy • Reviewwhichmetricsarebetteratassessingtotalsupplychainperformance
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References• Hawkins,David,CorporateFinancialReportingandAnalysis:TextandCases3rded.,
Irwin,1986• Higgins,R.AnalysisforFinancialManagement.10thed.McGraw-HillIrwin,2011(or11th
ed.,2015),seeChapter1• Anthony,R.N.andBreitner,L.K.EssentialsofAccounting.10thed.PrenticeHill,2009,see
pages1-66[thisisaworkbookthatyoushouldworkthrough,itisnotenoughjusttoreadit!]
• Anthony,R.N.andBreitner,L.K.CoreConceptsofAccounting.10thed.PrenticeHill,2010,seepages1-43[thisbookprovidesasummaryoftheEssentialsbook,butthereadershouldgothroughtheEssentialsbookfirstforcompletecoverageofthematerial]
ForCostingSystems
• CostSystemAnalysis,HarvardBusinessSchoolPublishing,Product#9-195-181• MeasureCostsRight,MaketheRightDecisions,HarvardBusinessReview,Sept-Oct1
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Organizational,Process,andPerformanceMetricDesign
SummaryWealsoreviewthreeareasof“soft”design:organizations,processes,andmetrics.Organizationaldesignforsupplychainshasevolvedastheprofessionhaschanged.Supplychainorganizationsstartedasseparatesilo-edfunctionsoractivitiesspreadoutacrossdifferentlargerdivisions,suchasfinance,manufacturing,andmarketing.Theareasstartedcombiningintomaterialsmanagement(coveringtheflowofinboundmaterials)andphysicaldistribution(coveringthemovementoffinalproductstocustomers).Logisticsgroupsemergedlatertobringthesetwofunctionstogetherinordertoworkouttrade-offsbetweenthesometimesconflictinggoalsofinboundandoutboundmanagement.Currently,therearevariousformsoforganizationsusedacrossdifferentcompanies.Themainperspectivesdifferintermsofviewingsupplychainsorlogisticsasasetoffunctions,asaprogram,orwithinamatrix.Thematrixformismostcommoninlargerglobalfirms.Inthesecases,logisticsisahorizontalfunctionthatinteractsdirectlywitheachverticalbusinessunitprovidingsharedservices.Thekeytrade-offinvolvedwithsupplychainorganizationaldesigniswhethertocentralizeordecentralizedifferentactivities.Centralizationimpliesthatalldecisionsaremadeataheadquarterswhiledecentralizationmovesthistotheregionsorindividualbusinessunits.Eachhasarolewiththegeneralruleofthumbshiftingmostprocurement,long-rangeplanning,andnewproductactivitiestocentralandkeepingdailyoperationsdecentralized.Processeswithinsupplychainsareessentiallytransformationsofinputsintooutputs.Procurementtransformsanorderintoproduct.TransportationconvertsmaterialataDCtoproductatthecustomerlocation.Eachoftheseprocessescanbemanagedindividuallyorlookedataswithinagreatersystem.Thedifferentprocesseswithinthesupplychainshouldbedesignedtocomplementeachother.Metricsfollowtheprocessstructure.Allmetricscanbeboileddowntoutilization,productivity,oreffectivenessmetrics.Utilizationmeasuresinputscomparedtosomenorm(capacity,standard,etc.).Productivityorefficiencycomparesinputstooutputs.Effectivenesscomparesoutputtosomenormvalue.Thedifferentmetricscanbeevaluatedforrobustness,integration,usefulness,andvalidity.Thereisnotsinglebestmetric,however,theywillallhavetrade-offsbetweenthesecriteria.Thisiswhysystemsofmetricsshouldbeusedinabalancedscorecardframework.
Centralizationvs.DecentralizationOrganizationaldesigncentersonwhethertocentralizeordecentralizeanactivity.Eachhasaplaceandtherearebasictrade-offsinvolved.
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Centralized• Leverageseconomiesofscale• Harmonizespoliciesandpractices• Allowsforoptimal(global)solutions
Decentralized• Allowsdecisionmakingtobeclosertocustomer• Allowsdecisionstoreflectlocalculturesandcustoms• Allowsforoptimalsolutionswithinaregion• Allowsbusinessunitstoactautonomously
SupplyChainProcessesSupplychainprocessescanbethoughtoftransformationsofoneflowunittoanother.
Process FlowUnit Transformation
OrderFulfillment Orders Receiptoforder =>Deliveryofproduct
Production Products Receiptofmaterials =>Completionofproduct
OutboundLogistics Products Endofmanufacturing =>Deliverytocustomer
Procurement Supplies Fromissuingapurchaseorder =>Receiptofsupplies
CustomerService Customers Arrivalofcustomer Þ Departure
NewProductDevelopment
Projects Productdevelopmentstart Þ Launch
CashCycle Cash Expenditureoffunds Þ Collectionof
revenue
PerformanceMetricsMetricscanbedividedintoUtilization,Productivity,andEffectivenessmeasures.
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PerformanceMetricCriteriaandTrade-offsMetricscanbeevaluatedaccordingtoseveralmetrics–buttheywillalwayshavetrade-offs.
• Robust:Themetricisinterpretedsimilarlybyallusers,iscomparableacrosstime,locationandorganizations,andisrepeatable.
• Valid:Themetricaccuratelycaptureseventsandactivitiesmeasuredandcontrolsforexogenousfactors.
• Integrative:Themetricincludesallrelevantaspectsoftheprocessandpromotescoordinationacrossfunctionsanddivisions(andevenenterprises).
• Useful:Themetricisreadilyunderstandablebydecisionmakersandprovidesaguidetoaction.
BalancedMetricsMetricsystemsshouldbedesignedtobalanceacrossthreekeyareas:Assetutilization(utilizationmetrics),Efficiency(productivitymetrics),andCustomerResponse(effectivenessmetrics).Differentindustrieswillemphasizedifferentaspectsofprocessperformance.
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LearningObjectives• Understandhowsupplychainorganizationsaretypicallyandcanbeorganizedandwhy• Learnstrengthsandweaknessesofcentralizedversusdecentralizedorganizations• Gaininsightsintosupplychainprocesses• Abletodevelopanddesignperformancemetricsystemsforsupplychains