Logistics and Competitive Strategy

Throughout the history of mankind wars have been won or lost through logistics

strengths and capabilities. It has been argues that the American War of Independence was lost by the British

since they did not have proper supply lines and relied heavily on Britain. This resulted in poorly equipped and demoralized troops. Proper supply lines were established only in 1781 by which time it was too late to have any impact on the war.

Whilst Generals and Field Marshalls from the earliest times understood the importance of logistics it is only recently that organizations have come to realize the importance of managing logistics.

Competitive Advantage

A central theme of these series of articles is to show that effective logistics management can provide a major source of competitive advantage.

The source of competitive advantage is found firstly in the ability of the organization to differentiate in the eyes of the customer, from its competition and secondly from operating at lower cost and hence at lower cost and greater profit.

Put simply, successful companies either have a productivity advantage or they have a value advantage or a combination of the two. The productivity advantage gives a lower cost profile and the value advantage gives the product or offering a differential over competitive offerings.

Let us take a brief look at the two methods of competitive advantage.

Productivity advantage - In any industry we will find that there is one company that is able to achieve highest sales and thereby also achieve the lowest cost per unit due to economies of scale. There is substantial evidence to prove that in these cases that 'big is beautiful' when it comes to cost advantage.

The experience curve has its root in the earlier concept of the learning curve. The learning curve effect was discovered in the second world war where is was seen that as the number of units produced increased every additional unit produced could be created using less time and resources. Subsequently Bruce Henderson of the Boston Consultancy Group extended this concept to state that all costs - production related or not reduced and the volume of output increased. In fact to be more precise, the relationship exists between real unit costs and cumulative volume. Further it is recognized that cost decline exists only for value added and not for bought in supplies.

Hence it has been accepted that one of the principle ways of improving cost advantage is through greater production and sales. However, through logistics we will demonstrate that there are multiple methods and means of improving cost efficiency through better logistics management.

Value advantage - it has long been an axiom in marketing that customers don't but products they buy benefits. Put another this means that the product is not purchased for itself but for what it will deliver. The benefits may be intangible such as image or reputation. Unless the product can be differentiated in some way from the competition it will be seen as generic and will get only commodity prices. The values of the market can

only be fully realized by segmenting the market and creating distinct value segments. In other words different groups in different markets place different values to benefits.

Adding value through differentiation is a powerful way of achieving a defensible advantage in the market.

Gaining Competitive Advantage through logistics

One of the distinguishing features of the value chain is to postpone the final creation of the product as much as possible. The idea behind this is that maximum flexibility can be achieved through postponement by obtaining time place and form utility. This can be achieved by aggregating production systems rather than catering to individual customer requirements.

Competitive advantage cannot be understood by looking at a firm as a whole. It stems from the many discrete activities a firm performs in designing, producing, marketing, delivering, and supporting its product. Each of these activities can contribute to a firm's relative cost position and create a base for differentiation... the value chain disaggregates a firm into its strategically relevant activities in order to understand the behaviour of costs and the existing and potential sources of differentiation. A firm gains competitive advantage by performing these strategically important activities more cheaply or better than its competitors.

Understanding logistics management

The mission of logistics management is to plan and coordinate all activities necessary to achieve desired levels of delivered service and quality at lowest possible cost. Logistics must therefore be seen as the link between the market and the company. The scope of logistics spans the organization from raw material management to delivery of the final product.

To achieve companywide integration requires quite a different orientation than what is seen in the conventional organizations.

The supply chain and competitive performance

Traditionally most organizations view themselves as entities that exist independently from others and indeed need to compete with them in order to survive. However such a philosophy can be self-defeating if it leads to unwillingness to corporate in order to compete. Behind this seemingly paradoxical concept is the idea of supply chain management.

The supply chain is the network of organizations that are involved, through upstream and downstream linkages in the different processes that produce value in the form of products and services in the hands of the ultimate consumer.

A typical example of the new type of organization that we discuss is Apple Computers where over 90% of the cost of sales of a typical Apple computer is purchased content.

Clearly this trend has many implications for logistics management, not the least being the challenge of integrating and co-ordinating the flow of materials from a multitude of suppliers, often offshore, and similarly managing the distribution of the finished product

by way of multiple intermediaries.

There are still some companies that will reduce cost and improve profit margins at the expense of supply chain partners. These companies do not realize that they are simply transferring costs upstream and downstream and this does not make them any more competitive. All costs incurred by intermediaries will ultimately reflected in the price charged from the end-user. The leading logistics companies recognize the fallacy of this conventional approach and instead seek to recognized

Logistics management is simply the management of flows of materials within the organization but supply chain management recognizes that this is simply not enough and linkages with external supply chain partners upstream and downstream is essential.

For the purposes of clarity we define supply chain management as:

"The management of upstream and downstream relationships with suppliers and customers to deliver superior customer value at less cost to the supply chain as a whole"

The changing logistics environment

As the new competitive context of business continues to change, brining with it new complexities and concerns for management generally, it also has to be recognized that the impact of these changes on logistics can be considerable. Of the many issues facing organizations today perhaps the most challenging are in the area if logistics.

The pressing issues facing organizations today are listed below:

The customer service perspective

Time compression

Industry globalization

Organizational integration

The new rules for competition

We are entering the era of supply chain competition - the fundamental difference here is that the company cannot act individually but must act as a supply chain entity to ensure competitiveness in the marketplace.

In today's marketplace the order winning criteria are more likely to be service-based than product based.

The essence of competitiveness is given in the formula below:

Competitive Advantage = Product Excellence X Process Excellence

Whilst that are many implications of the pressures that are brought by supply chain management there are three key issues which will be recurring themes throughout the book: responsiveness, reliability, reliability and relationships.

Customer Service Dimensions

The ultimate or primary objective of any business in to provide excellent service. It follows then that the main purpose of any logistics system also is to satisfy customers. It is an activity that might not be well understood if you are a manager responsible for production scheduling or inventory control which are activities that seem to be some distance from the marketplace.

The objective of supply chain should be to establish a chain of customers that links people at all levels in the organization directly or indirectly to the marketplace.

The marketing and logistics interface

The right product at the right place at the right time has rarely been considered in mainstream marketing to be very important. However, there are signed to show that this is quickly changing.

The power of the brand has steadily declined and customers are willing to experiment with substitutes even technology differences between products has been removed so that it is harder to maintain competitive edge through the product itself.

The source of competitive advantage is found firstly in the ability of the organization to differentiate in the eyes of the customer, from its competition and secondly from operating at lower cost and hence at lower cost and greater profit. In these situations it is customer service that can provide the distinctive difference between the company's offer and that of its competitors.

In the now famous management book 'In search of excellence' it was identified that excellent companies are those that can attract customers and maintain long term relationships with them.

Secondly, it is also recognized that there is a slow but indubitable movement to commodity type markets. By this it is meant that increasingly the power of the brand is diminished as technologies of competing products converge, thus making product differences difficult to perceive at least to the average buyer.

What is customer service?

In practice many companies have varying views of customer service. A major study conducted recently has suggested that customer service could be examined under the following 3 headings:

Pre-transaction elements

Transaction elements

Post-transaction elements

Pre-transaction elements of customer service relate to corporate policies or programs i.e. written statements of service policy, adequacy of organizational structure and system flexibility.

The transaction elements are those customer service variables directly involved in performing the physical distribution function e.g. product and delivery reliability.

The post transaction elements of customer service are generally supporting of the product while in use e.g. product warranty, parts and repair service, procedures for

customer complaints and product replacement.

In any particular product market situation, some of these elements may be more important than others and there may be factors other than those listed above which have significance in a specific market.

Customer service and customer retention

It is apparent from issues discussed that organizations that compete only on the products features will find themselves at a severe disadvantage to those companies that augment the basic product with value-added services.

The concept that should be recognized here is that the product in the warehouse is very different from the product in the customers hands since the customer looks at the benefit from the product rather than the product itself.

For example the core product can be said to be quality, product features, technology, durability and augmented product can be delivery and lead time flexibility, delivery reliability and consistency, single point of contact, ease of doing business and after sales support.

Another important concept that should be clearly recognized is the lifetime value of a customer is much greater than the profit generated from just a single deal with that customer. A simple formula follows:

Lifetime value = Average transaction value * Yearly frequency of purchase* customer life expectancy

More on customer service and customer lifetime value can be found here.

Service driven logistics systems

The role of logistics can be seen as the development of systems and the supporting co-ordination processes to ensure that customer service goals are met. The main idea of service driven logistics systems is to meet predefined service goals.

Ideally all logistics service systems are defined along the following lines:

1. Identify customers' service needs

2. Define customer service objectives

3. Design the logistics system

Identify customers service needs

The approach to service segmentation suggested here follows a three stage process:

1. Identify the key components of customer service as seen by customers themselves.

2. Establish the relative importance of those service components to customers.

3. Identify 'clusters' of customers according to similarity of service preferences.

Identifying key components of customer service.

Establishing relative importance of customer service components

Identify customer service segments

Defining customer service objectives

Setting customer service priorities

As the new competitive context of business continues to change, bringing with it new complexities and concerns for management generally, it also has to be recognized that the impact of these changes on logistics can be considerable. Of the many issues facing organizations today perhaps the most challenging are in the area if logistics.

Setting service standards

We are entering the era of supply chain competition - the fundamental difference here is that the company cannot act individually but must act as a supply chain entity to ensure competitiveness in the marketplace.'

Managing the supply chain

The customer-responsive organization not only seeks to put the customer at the

center of the business but designs all its systems and procedures with the prime objective of improving the speed and response and the reliability of that response.

Creating the logistics vision

These days more companies are using mission statements as an articulation of the vision of the business. The mission statement seeks to define the purpose of the business, its boundaries and its aspirations. It is not uncommon for the company to have different mission statements for its components and also one for the business as a whole.

The purpose of the logistics vision statement is to give a clear indication of the basis whereby the business intends to build a position of advantage through closer customer relationships.

Ideally the logistics vision should be built around how the company intends to use logistics and supply chain management to create value to its customers. To operationalize the vision will require an understanding of how the customer value is created and delivered in the markets in which the business competes. Value chain analysis will be a fundamental element in this investigation as will the definition of core competencies and capabilities of the organization.

The problems with conventional organizations

It has been recognized that one of the key problems in implementing the logistics concept is organizational and to be more precise the organizational structure that the most businesses are burdened with. The companies cannot achieve the competitive advantage that comes from integrated logistics management.

The concept of integrated logistics management where flows of information and material between source and user are coordinated and managed as a system has been widely recognized as an important means of competitive advantage.

However, in conventional organizations this poses an immediate problem. Most

companies are organized on a functional basis. So in this organization we might find a sales function, purchasing function, production function and so on. The heads of these functions are regularly senior managers who jealously guard their turf. Further reinforcing the functional or vertical orientation in the conventional organization is the budgeting system. Typically each function will be driven by a budget that seeks to control the resources consumed by those functions. It is almost as if the company is working on the assumption that the prime purpose of any enterprise is to control the consumption of resources.

If individual functions are encouraged to optimize their own costs - because of the budgeting system - then this will be at the expense of substantially increased inventory costs across the system as a whole. What happens if production attempts to reduce per unit costs by increasing production runs to larger batches and also what if purchasing buys in bulk for greater discounts - these can only lead to more inventory and greater financial burden in terms of higher working capital.

Cost of material flows across functional areas are not easy to measure - hence the real cost the serve different customers with different product mixes are rarely revealed. Once again the problem is that the conventional organization will identify costs only at functional levels and even then it will be aggregated figures. Hence we may well know our total transport cost in total but not necessarily how they vary from customer to customer or by delivery characteristics. The main problem is that costing systems are designed to measure inputs to functional areas and not to measure flow or output costs.

Developing the logistics organization

It has been suggested that the solution to the problems outlined above lies in creating a higher level of authority in the form of a logistics function that links together the purchasing, production and distribution tasks. This may seem attractive at first but it only helps to add another level of management and really does not add value.

Radical restructuring may be required - of the conventional 'vertical' organization to convert it to the horizontal or market facing organization. The horizontal organization has a number of distinguishing characteristics:

Organized around processes not tasks

Flat and de-layered

Built upon multi-functional teams

Guided by performance metrics that are market based

It is the focus on processes rather than functions that is the key to the horizontal organization. The basic precept of process management is that it is through processes that customer value is created. Hence the logic of seeking to manage processes on an integrated basis.

Horizontal organizational focus - in most organizations there will only be a limited number of core processes and the following are likely to be central to most businesses.

Brand development (including new product development)

Consumer development (primarily focused on building loyalty with end-users)

Customer management

Supplier development (strengthening upstream and alliance relationships)

Supply chain management - the cash-to-cash process

Typically companies that focus upon process management have recognized that they are best managed by cross functional teams. These teams will comprise of specialists drawn from functional areas and will be led by integrators whose job it is to focus process teams around the achievement of market based goals. In such organizations a different set of skills profile is clearly required for managers at all levels. It may be obvious but the basis for any organization should be to generate orders and fulfill those orders. Everything a company does should be directed at facilitating this process. This leads to the conclusion that the customer order fulfillment process should be designed as an integrated activity with the conventional functions of the business supporting that process.

A customer order management system is a planning framework that links the information system with the physical flow of material required to fulfill demand. To achieve this requires the central management of forecasts, requirements plans, material and production control and purchasing.

Eliminating non-value adding activities - The order processing system is a good way of identifying non value adding activities. It is often discovered that that no one has ever questioned the way in which the paperwork is managed or the sequence in which the activities take place or why the activities take place. Where possible the goal should be to look for opportunities to combine steps in the processes, to integrate separate groups of people performing adjacent tasks and to simplify processes by reducing paperwork and reports.

Order fulfillment groups - Companies have experimented with the idea of using cross departmental, cross functional team to take the responsibility for the management of orders. This team is the order fulfillment group. Instead of seeing separate activities in the order fulfillments process we can see a single activity both physically and operationally if the group is at the same location. Also the possibility of culling non-value adding activities increases in scope.

The effect that such groups can have is often dramatic. All the people to be involved in the order fulfillment process are brought together and linked by a common entity the order - they are better able to sort out problems and eliminate bottlenecks.

Logistics as the vehicle for change

To compete and survive in global markets requires a logistics oriented organization. There has to be nothing less than a shift from a functional focus to a process focus. Such radical change means a regrouping within the organization so that tasks become the management of cross-functional work flows. Breakthroughs in information technology has made it possible for companies to develop processes that accurately measure market driven demand and make JIT order fulfillment a reality.

The need for integration

One of the biggest implications for the customer-responsive organization of challenges that have been described is the priority that must be attached to integration. Not just integration within the organization but integration with suppliers and customers. This integration is logistical rather than vertical on other words we do not mean domination

or ownership of the supply chain but greater emphasis on the linkages of organizations through the sharing of information.

Supply base rationalization - an example of this rationalization is Rover that had about 2000 suppliers that number was drastically reduced and with the remaining suppliers the requirement was for new systems and not cheaper components. For example a single first tier supplier was responsible for the complete dashboard for a particular type of car, complete with all the controls, displays and wiring ready for installation as a single unit - and the entire dashboard was delivered on a just in time basis.

Supplier development programs - Procurement function has been usually given the objective of purchasing at the lowest cost. This involves having more than one supplier and negotiating suppliers among these suppliers. This idea has chained drastically with the new emphasis been on developing close relationships with suppliers with production specialists working closely with suppliers on means of improving production processes as well as better means of interfacing with the suppliers.

Early supplier involvement in design - most of the design innovation in the motor industry is as a result of supplier participation. For example the ABS (breaking system), engine management systems and improved suspension systems comes a large from suppliers to the auto-industry.

Integrated information systems - the use of Electronic Data Interchange (EDI) coupled with the growing acceptance of the JIT philosophy led to a realization that the benefits of fully transparent information systems could be considerable. There are no orders, no delivery notes, no invoices - only a single source of information that provides the basis for a timely physical response which itself triggers a payment to the supplier.

Centralization of inventory - Traditionally dealers carried a stock of cars which may or may not have matched the requirements of their customers. If a customer demanded an option that was not available a 'swap' was arranged with another dealer who did have the required vehicle. The new system does not work in the same way - the dealer only has demonstration vehicles and a direct link to the car manufacturer and the customer demands and input on an on-line basis and delivery time is indicated and is this is acceptable to the customer the order is entered in the on-line system with the car manufacturer.

Managing the supply chain as a network

The new competitive paradigm that has been described places at the center of an inter-dependent network - a confederation of mutually complementary competencies and capabilities - which competes as an integrated supply chain against other supply chains.

Collective strategy development - Traditionally members of a supply chain have never considered themselves to be part of a marketing network and have not shared with each other their strategic thinking. For network competition to be truly effective requires

a significantly higher level of joint strategy development.

Win-win thinking - Perhaps of the stumbling blocks to supply chain management is to break free from the often adversarial nature of buyer/ supplier relationships that existed in the past. There is now evidence to prove that co-operation between network partners usually leads to improved performance generally. The issue then becomes how the results of the improved performance can be shared amongst the various players. It does not means that the benefit should be shared 50/50 but all players should be better off as a result.

Open communication - With the advent of information technology making the exchange of information between supply chain partners so easy and advantageous has resulted in paradigm change in most industries. The textile industry in the United States has has benefited tremendously from the use of shared information which originates from the retail store but is then transferred from the retail store to garment manufacturer to material manufacturer this results in much better response times to market changes lower inventory and less risk of obsolescence. For network marketing to work full transparency is required throughout the supply chain.

Process integration and ECR

Quick response logistics have been alternatively termed ECR or efficient consumer response is an umbrella term that describes a number of related philosophies and techniques that seeks to enable the delivery of superior consumer value in shorter time frames and at less cost.

Demand management

Develop strategy and capacbility

Optimize assortments

Optimize promotions

Optimize introductions

Supply management

Integrated suppliers

reliable operations

synchronized production

Continuous replenishment

Cross docking

Automated store ordering

Enabling technologies

EDI or electronic data interchange

Electronic fund transfer

Item coding and database management

Activity based costing

The fundamental principle of ECR is that through partnership within the supply chain, significant cost reduction can be achieved through a better allocation of shelf space in the retail store, fewer wasteful promotions and new product introductions and more efficient physical replenishment. The key to the achievement of these goals is shared information, in particular information gathered at the checkout counter and transferred directly to suppliers.

The basics of ECR

New product introduction

Trade and consumer promotions

Range and assortment

Product replenishment

Improve success rate

Improve consumer targeting

Match to consumer and shopper needs

Improve of shelf availability

Reduce time to market

Improve return on investment

Reduce duplication

Reduce cost

Improve return on investment

Co-operation across the supply chain

Improve return on space

Reduce inventory

Improve quality reduce cost

Co-makership and logistics partnerships

From the examples that have been analyzed it is clear that most supply chain problems are related to the lack of co-ordination and linkage between various parties in the chain. Indeed there is a growing recognition by many companies that partnership and co-operation achieves more than narrow self-interest and conflict.

The benefits of co-maker relationships

Shorter delivery lead times

Reliable delivery promises

Less schedule disruption

Lower stock levels

Faster implementation of design changes

Fewer quality problems

Stable competitive prices

Orders given higher priority

Supplier development

The purpose of supplier development is to seek out with suppliers ways in which the

relationship between the two parties can be made more mutually beneficial.

Comparison of conventional purchasing with co-makership

Purchasing dynamicsConventional purchasing

Co-markership

Supplier/ buyer relationships

Adversarial Partnership

Tenure of relationships Variable long term

Tenure of contract short long

Order quantity large small

Transportation strategy

Full truck load of single item

JIT delivery

Quality assurance Inspect and re-inspect No incoming inspection

Means of communication to supplier

Purchase order Verbal release

Frequency of communication

Sporadic continuous

Impact on inventory An asset a liability

Number of suppliersMany the more the better

Few or single

Design processDesign the product then ask for the quote

Ask for supplier ideas, then design the product

Production quantity Large lots small lots

Delivery schedule Monthly Weekly or daily

Supplier location Widely dispersed As compact as possible

Warehouse Large, automated Small, flexible

Logistics ManagementHow the leading-edge companies manage logistics

A study carried out for the companies that were at the leading edge of logistics

management found that they had the following characteristics in common.

Exhibit overriding commitment to customers

Emphasize planning

Encompass a significant span of functional control

Commit to external alliances with service suppliers

Have a highly formalized logistical process

Place a premium on operational flexibility

Employ comprehensive performance measurement

Invest in state of the art information technology

Most of us work in organizations that are hierarchical, vertical and functionally defined. The organization chart of a typical company resembles a pyramid like structure where every individual knows his function in relation to others. There is no doubt that this structure has helped businesses a lot in the past but there are an increasing number of questions that are asked whether they will be suitable for a future where highly responsive and evolutionary structures are required.

From functions to processes - conventional organizations have been vertical in design or in other words they have been designed around functions such as production, marketing, sales and distribution. The problem with this design is that it emphasizes the use of resources and rather than the creation of output. The only method that output can be measured is in terms of customer satisfaction achieved at a profit. This can only be achieved by co-coordinating and cooperating horizontally across the organization. These horizontal linkages mirror the materials and information flows that connect the customer with the business and its suppliers.

From profit to performance - there is no doubt that in the long run sustained profit has to be the prime reason for the existence of any commercial organization. In most management meeting what get discussed are key profit figures and revenue and cost structures that brought about the profit. As the management philosophy says what gets measured gets managed - this implies that most of our attention goes to cost and revenue management and not to improving performance with depends critically on customer satisfaction. Some of the key non-financial performance indicators that should be measured are:

Customer retention

Brand preference

Dealer satisfaction

Service performance

Flexibility - set up times, common components and materials, reduce complexity

People commitment - employee turnover, suggestions implemented,

internal service climate and culture, training and development.

From products to customers - Although the marketing concept has found widespread acceptance there is still a tendency to manage products rather than customers. This has resulted in measuring profits based on products accurately but not knowing profit per customer which is critical. It has been discovered that 20% of a business' customers generate 80% of profit. More importantly studies have shown that some customers contribute to the loss.

Our articles on customer relationship management gives further insight.

From inventory to information - It has been said that 'uncertainty is the mother of inventory' this means that companies are unsure of future demand and stock up on goods on a just-in-case basis. This has severe impact on the bottom-line. The conventional solution to uncertainty is to make forecasts. But to make forecasts accurate information is required. To get information to the production floor and purchasing it is important that marketing side of the organization has a means of communicating quickly and accurately there requirements. For example in the fashion industry where preferences change very quickly it is important to have on-line links to the garment factories and to purchasing people to ensure that orders reach the market before time.

From transactions to relationships - The drive in the past has been to winning customers and not to retaining them. This has led to low profitability in companies in an attempt to meet market share targets. Therefore the need to avoid these costs is to develop long term profitable relationships with customers rather than dealing only on individual transactions. Studies have shown that the longer that the customer stays with you the more profitable he becomes - since he is easier to maintain and more easy to satisfy. Please look at our detailed report on customer relationship management.

The following table summarizes the paradigm changes that need to take place for logistics to achieve true value addition in the business context.

Paradigm shift Leading to Skills required

From functions to processes

Integral management of materials and goods flow

Cross functional management and planning skills

From products to customers

Focus on markets and the creation of customer value

Ability to define, measure and manage service requirements by market segment

From revenue to performance

Focus on the key performance drivers of profit

Understanding of the cost to serve and time based performance indicators

From inventory to information

Demand based replenishment and quick response systems

Information systems and information technology

From transactions to relationships

Supply chain partnership

Relationship management and win-win orientation

Reconfiguring the value chain

One of the distinguishing features of the value chain is to postpone the final creation of the product as much as possible. The idea behind this is that maximum flexibility can be achieved through postponement by obtaining time place and form utility. This can be achieved by aggregating production systems rather than catering to individual customer requirements.

The role of information in the virtual supply chain

It has been recognized that the key to supply chain management is the information system. It has been more recently discovered that demand and supply can be matched in multiple markets with different needs, in ever shorter time frames through good information systems.

Supply chain management: The concept

Obviously, supply chain management is about managing the supply chain. So, what is a supply chain and why does it need to be managed?

In simple terms, a supply chain is the link between a firm or business and its suppliers and customers. And supply chain management is about managing the activities which support the movement of a product from a firm's supplier to a firm's customers, as in Figure 1.1.

Figure 1.1 A conceptual model of a basic supply chain

In a competitive environment a firm must be concerned about the efficient management of its immediate supply chain for both its survival and profitability. In the simple example of Figure 1.1, the firm buys from the supplier at an agreed price, and sells it to the customer at a competitive price that will produce profits for the business. In this model the firm adds value to the product by making it available to the customer in the way they desire it, when they desire it and at a place they desire it. These value adding activities are the primary business functions of the firm, and there are costs associated with these. The market price which the customer is willing to pay will depend on the value of the product as perceived by the customer; and if this price does not cover all the costs associated with procurement and value addition plus a reasonable profit for the firm, the business then obviously has no prospect of surviving in the long run.

This simple model of 'supplier - firm - customer' makes two interrelated concepts clear: the value of the product to the customer, which determines price and customer retention; and the costs of managing the supply chain, which also affect price and customer retention. These are the areas of main focus in supply chain management.

This simple model can help us to understand the basic concepts associated with supply chain management, but business organisation is rarely this simple. This model has to be extended to cover practical business situations which are complex and involve multiple supply chains linked to produce a final product which is purchased by the end consumer. This more complex arrangement of supply chains and businesses has given rise to a new concept in supply chain management: the extended supply chain.

In an extended supply chain, there are multiple stages in the manufacturing of a product and multiple inputs before the finished product is sold to the customer. These stages and points of input are the 'links' in the extended supply chain.

Figure 1.2 is a simple representation of an extended supply chain. In reality, each of the links will also have links until the chain resembles more of a 'web', as in Figure 1.3.

Figure 1.2 An extended supply chain: Extending from raw material sourcing to final consumer. (adapted from Stallkamp 1999)

Figure 1.3 An extended supply chain showing how each link will have other links until quite a complex 'web' shape will be formed of interlinked businesses and activities

As you can imagine, as the material flows along this extended supply chain from the raw material stage to the final finished product ready for consumption, the costs and values attached to the product are also transmitted downstream. The final value of the product and the costs attached to it will reflect inputs provided by all the firms in this extended supply chain.

The question we must consider is: How can a firm control all activities from raw material sourcing to marketing to the final consumer when the final product takes its shape by inputs from various firms with specialised skills and expertise, and when often these firms are located over a widely dispersed, and geographically and politically fragmented world?

This is a legitimate question in today's complex business environment. Many large corporations, like Ford motors in the USA , in the past have tended to vertically integrate to control everything from mining to manufacture to marketing. There are many multi national corporations (MNC) which control subsidiary supplier companies at the source in countries around the world. These companies have considerable control over their supply chains. But direct control and management of the extended supply chain is beyond most firms.

However, the appreciation of the extended supply chain is not lacking and new concepts in supply chain management are aimed at optimising a firm's control of its extended supply chain. Figure 1.4 illustrates industry perception about the major drivers of the current focus on supply chain management improvements. Customer satisfaction stands out as the dominant driver.

Figure 1.4 Major drivers of supply chain management improvements. (Source: Stevens)

Supply chain management, as a business discipline, attempts to look at the challenges faced by modern businesses in the management of supplies, manufacturing, inventory and distribution. The aim of SCM is to enable the firm to remain competitive by effective management of activities related with supply chain management.

Supply chain management: Evolution

Academic and industry practitioners are struggling to come up with an universally accepted definition of SCM. The reasons for this difficulty can best be viewed by looking at the historical development of supply chain management. Stadtler (2000) mentions that the term SCM was created by two consultants in 1982. However, the move towards supply chain management followed a definitive industry trend. We will now look at this development.

The evolution and development of supply chain management have been studied quite extensively. All commentators have generally agreed or acknowledged that this discipline has evolved as a separate and distinct subject during the last 50 years as a result of a definitive business culture. focussed on customer orientation and cost minimisation. We will follow the footsteps of Metz (1998) to look at the genesis and evolution of SCM. It will be apparent that supply chain management is based on a systems approach. It is about optimisation of the system and the main enablers of this new science are advanced computer and information technology.

Physical distribution management. In 1963 the National Council and Physical Distribution Management was set up in the USA . At that time most companies appreciated the necessity of separating the distribution and transportation functions from the sales and marketing functions of the company. Practitioners soon discovered the inter-relationships between the warehousing and transportation functions. Physical distribution management integrated these two functions and this resulted in reduced inventory and a more reliable and efficient transportation. These concepts are later covered in the course. At this stage we can only say that by separating these functions from the marketing and sales functions, managers could look at these as distinct functions with specific cost characteristics. This in turn enabled the managers to take effective and integrated decisions to reduce cost and improve service level.

This in turn enabled the company to meet demand with a faster response time allowing shortening of order cycle and improvement of business forecasts. Moreover, the integrated view of warehousing and transportation enabled cost optimisation by aiding decision making regarding the location of warehouses. According to Metz (1998) physical distribution management was enabled by two things: improved data communication between different levels of warehousing and advanced analytical capability.

Figure 1.5: The physical distribution management stage. (adapted from: Meitz, 2001)

Logistics management. The next phase in the development of SCM was the logistics phase where we saw the emergence of the term 'logistics management'. Within the scope of this new concept, the manufacturing, procurement and order management functions were integrated with physical distribution management. This integration was made possible by electronic data interchange, advancement in worldwide communications and the availability of computers for management and analysis of business data.

Figure 1.6 The logistics stage (adapted from Meitz 2001)

Supply chain management. The next stage was the 'supply chain' stage or, as Metz likes to call it, the ' integrated supply chain' stage. At this stage the logistics functions has been extended to add suppliers at one end and customers at the other end. This is what we call a supply chain in simple terms and is vastly more complex than the simple two stage model of the physical distribution chain. The continuing advancements in electronic communication, information technology, e-business and computerised decision support systems have aided in the management of the complexities associated with a 'supply chain'. Metz 's view of a 'super supply chain management' is just an extension of this concept and is in fact the state of supply chain management currently. This view integrates the supply chain functions with product development, marketing and customer service. The enablers in this case are more advanced communication technology, computerised decision support systems and a highly trained human resource.

Figure 1.7 The supply chain concept (adapted from Meitz 2001)

Figure 1.8 The 'super' supply chain concept. (adapted from Meitz 2001)

Introduction

The concept of supply chain management is built on the notion of integration. This integration does not only span the various functional silos within the firm, but also trade partners interlinked with the firm at various stages of the supply chain. Nowadays we often hear about collaborative supply chains which are built upon the notion of integration of business processes across all trading partners. The main driver and enabler of this concept is information technology. The main concern is whether the

current state of information technology can support collaborative supply chain management by efficient information processing which could be used as competitive leverage by all firms in the supply network. The role of information and IT in new look business models can be appreciated by looking at the following figure which maps the six key factors identified as key drivers of world class supply chain systems.

Figure 2.1 Six drivers of fulfilment excellence. (adapted from Cap Gemini Ernst & Young 2001)

Goals of supply chain IT systems

The new and collaborative business model identified in the previous chapter requires business process integration across corporate and inter-firm boundaries. One pre

requisite is information integration. The key drivers of logistics fulfilment excellence identified earlier point to this pervasive attention of firms on information acquisition, processing and utilisation. In the context of supply chain management this requires a system capable of capturing data regarding any product at any stage of the supply chain and making it available to all concerned. There are three basic requirements for this information to deliver 'fulfilment excellence'. These are:

data capture: All relevant data regarding all products and supply chain system components are to be captured continuously in real time.

data visibility: This data must be easily available to all concerned at a single point of contact so that they are accessible in real time.

data analysis: The system must provide the means of making this data actionable. These can then be analysed and converted automatically into meaningful information which decision makers can use for effective decision making, employing sophisticated computerised systems.

The role of information technology in modern business models can be revisited at this stage. The following reading will provide you with industry trends with real life examples of firms gaining competitive advantage by strategic use of IT.

Supply chain IT goals: Challenges and means

The challenges imposed by IT goals are quite stiff. This can be only appreciated if we look at the state of IT prevalent in the industry at the moment and then reconcile that situation with the supply chain goals.

The state of IT systems of firms in the context of supply chain management has to be seen in an historical perspective. Most firms have developed IT systems over the years in a piecemeal basis for each functional or departmental unit with focus on their specific needs. Software and hardware systems were developed and built as a reflection of the needs of each core function of the firm such as warehousing, transportation, inventory management, purchasing, manufacturing, sales, marketing, product development, communication etc.

All these different 'specialist' systems, known as legacy systems, work independently and technically do not 'speak' the same language. These systems, whether supported by vendor-provided or custom made hardware and software, provide the great challenge for information integration. Think about the type of data with which any accounting system deals, and compare this with the technical and engineering data with which most manufacturing systems are concerned. One of the main challenges of supply chain IT systems is to make these isolated systems 'talk' to each other so that relevant data becomes visible and operable in real time to all units. Add to this the complexity of integrating data from trading partners, customers and suppliers, and the challenge becomes awesome indeed, with serious technical and financial implications.

It is therefore obvious that to achieve the goals, the following issues need to be addressed:

Disparate IT systems belonging to different departments and firms have to made compatible by establishing common communication standards.

The IT infrastructure, which includes the network, databases and processors, must be capable of linking and processing information as required by the firms in the supply chain.

The role of e-commerce in the firm's business needs to be appreciated, with cost and business gain implications.

The specific supply chain management issues at all levels of planning need to be supported by the IT system through interfacing with human input for information analysis and decision making.

It needs to be sorted out how supply chain information technology systems can be integrated in view of required investments.

How a firm can overcome these challenges and achieve its goals? There is no perfect solution. At best we can identify a few trends which are aimed at achieving these goals. These are:

standardisation of IT system components. trends in IT infrastructure trends in electronic commerce trends in IT adaptation for supply chain management.

Standardisation

The general IT trend in the last decades has been towards standardisation. There is a move away from proprietary systems to open systems. These standardisations are emerging in software, hardware, operating systems and network specifications. We all are familiar with the universally accepted Windows platform for personal computers. This is a big move away from the earlier trend where software vendors would be tied to a particular hardware manufacturer, making inter machine communication impossible. We all now are so dependent on the open standard of Internet communication and email that we often forget that integration of that level is still not possible for many firms when it comes to business process integration.

General trends in the IT field are increased standardisation of software and hardware. This is especially so with regard to communication and data transfer. There is another parallel development in the industry towards creating standards in supply chain related procedures which make IT implementation easier across the industry. The following examples highlight the emerging trends:

Open Database Connectivity (ODBC) The standards applying to open database connectivity help ensure that software written to comply with these standards can be used with any ODBC-compliant database, making it easier to transfer and access data among different databases. Thus, when data resides in a compliant database, it can be exported, imported or have linked access with another compliant database, so long both are written according to ODBC standards. Database management software written by different vendors, residing within different applications, can be integrated when ODBC standards are followed.

communication protocols Communication protocols make communication possible and there are a number of communication protocols used by companies and organisations of all sizes.

Open Systems Interconnection (OSI) model The International Standards Committee has endorsed the open systems interconnection (OSI) model which serves as standard for network architecture.

The Transmission Control Protocol/Internet Protocol (TCP/IP) TCP/IP has emerged as the major communication protocol for the Internet. There are standards like the X.400 standard which is a set of message handling standards used by international companies for electronic transaction.

For your information: How TCP/IP works

(Transmission Control Protocol) is a set of rules ( protocol ) used along with the Internet Protocol ( IP ) to send data in the form of message units between computers over the Internet. While IP takes care of handling the actual delivery of the data, TCP takes care of keeping track of the individual units of data (called packet s) that a message is divided into for efficient routing through the Internet.

For example: When an HTML file is sent to you from a Web server the Transmission Control Protocol (TCP) program layer in that server divides the file into one or more packets, numbers the packets, and then forwards them individually to the IP program layer. Although each packet has the same destination IP address, it may get routed differently through the network. At the other end (the client program in your computer), TCP reassembles the individual packets and waits until they have arrived to forward them to you as a single file.

TCP is known as a connection-oriented protocol, which means that a connection is established and maintained until such time as the message or messages to be exchanged by the application programs at each end have been exchanged. TCP is responsible for ensuring that a message is divided into the packets that IP manages and for reassembling the packets back into the complete message at the other end. In the Open Systems Interconnection ( OSI ) communication model TCP is in layer 4, the Transport Layer.

http://searchnetworking.techtarget.com/sDefinition/0,,sid7_gci214172,00.htmlTCP

EDI (Electronic Data Interchange) In the last decades there have been tremendous developments in the fields of communication with developments in EDI, Internet, XML (the Extensible Markup Language) and satellite communication. EDI is defined as intercompany computer to computer exchange of business documents in standard formats to facilitate high volume transactions. This facilitates paperless transaction and rapid information processing between partners.

EDI is essentially a closed system as only established and agreed trading partners linked by a network can communicate in standard EDI format (EDIFACT). These communication standards are implemented via transaction sets which provide a single common standard to facilitate information interchange between partners in any industry. This is the limitation of EDI, as multi functional and multi organisational communication cannot be implemented by EDI.

This problem is solved by many firms by the use of value added networks (VANs). The VAN is like a translator which manages different industry transaction sets by sitting in the middle of the communication link. Figure 2.2 illustrates the way VAN works.

Figure 2.2 EDI link and value added networks (VANs). The VAN collects EDI transaction messages and information from a manufacturer and then translates those messages and information into appropriate industry-specific communication standards. (adapted from Supply Chain Logistics Management, Bowersox et al 2002)

Internet The Internet is an open system with high connectivity. The Internet has become the prime choice of businesses for order entry, shipment tracking, inventory status checking, payments and data transfer of any type. The growth of Internet usage among businesses is growing at a very fast rate. The utility and popularity of Internet have aided in the development of exchange portals which can be firm specific, industry specific or cross industry.

These exchange portals act as infomediaries and provide transparent information to all supply chain partners. The Extensible Markup Language (XML) is emerging as the standard Internet language. It is a flexible computer language that facilitates information transfer between a wide range of applications and is readily interpretable to humans. This is preferred over EDI which is very structured, is comparatively expensive and which requires expertise. The current concept is EDI Internet.

While these trends are generally applicable for IT, there are some specific trends related with supply chain systems where standardisation is emerging. The relevant IT issues are concerned with the SCOR model, CPRF (Collaborative Planning Forecasting and Replenishment) and ERP vendor-based standards.

SCOR The Supply Chain Operations Reference (SCOR) is the supply chain metrics promoted by the Supply Chain Council to advance supply chain best practice . The SCOR process reference models attempts to (among other things):

Characterize and describe the management practices and software solutions that will result in best-in-class performance. (Coyle et al 2001)

It is important here to note that as more and more firms adopt SCOR, the software used by firms will become standardised. The following reading discusses the supply chain metrics and its relationship with e-business.

Reading 2.2

Geary, S & Zonnenberg, JP (2000, 1 July) 'What it means to be best in class', Supply Chain Management Review . [7 pages]

The following reading will introduce you to the concept of Internet EDI and trends in standardisation.

Reading 2.3

Angeles, R (2000). 'Revisiting the role of Internet-EDI in the current electronic commerce scene', Logistics Information Management , volume 13, number 1. [13 pages]

CPFR Collaborative planning forecasting and replenishment is a process initiated by consumer products industry by which manufacturers or suppliers share information, either by EDI or Internet, with their customers regarding promotions, forecasts, items data or orders in order to manage production and distribution more efficiently. This sort of collaboration is pushing firms to adopt standard communication systems.

ERP Enterprise resource planning systems are software systems which eliminate many of the independent information systems within an organisation by replacing them with one centralised system for the firm. While ERP systems have been traditionally inward facing, the modern trend of collaborative supply chain is forcing ERP vendors to introduce standardised interface devices which allow linkage between the Enterprise system and other systems in the firm and with trading partners. Software vendors are incorporating ERP standards to ensure the marketability of their products. The following section covers ERP concepts.

Infrastructure

The IT infrastructure is made of the hardware and software around which the IT system is built. The ability of the system to deliver the goals will greatly depend on the strength of the infrastructure.

IT system infrastructure components. Your text provides adequate information on IT infrastructure. The important concept in the context of supply chain IT systems are Datamart and Data warehouse, which are essential for centralised information management systems. The other important concept in this section of your text is that of client/server architecture. This enables firms to implement a centralised information management system with relatively low investment.

The system is made up of specialised servers supporting all computers in the network. The middleware are the 'translators' residing between clients and servers which make communication possible between all clients and servers within the multi functional corporate IT system. Open standards are essential in a client/server system for all specific client/server combinations to be workable. This is important as firms are moving into complex client/server environments with multiple vendors for networks, hardware and software.

Enterprise resource planning systems. Many companies are in the process of setting up enterprise resource planning systems which provide an enterprise wide database and the transaction capability to initiate, track, monitor and report on customer and replenishment orders. An ERP system is based on client/server architecture and a middleware solution. A broad-based ERP system design includes an integrated database along with chapters to support management of supply chains, service and financial operations, and human resource.

Electronic commerce

Electronic commerce (e-commerce) is a rapidly growing field which is shaping the nature of the relationships among business firms. Most business activities today are conducted using electronic data transmission involving computers, telecommunication networks and streamlined work processes. Firstly there is the B2B or business-to-business e-commerce, in which e-commerce transactions are between organisations. The other form of e-commerce is the business-to-consumer e-commerce (B2C) in which consumers use the electronic media to purchase a product or service. The B2B e-commerce sector is a high growth sector with worldwide business-to-business transactions over the Internet projected to grow 18 fold between 2000 and 2004, from US$403 billion to over US$7,300 billion.(Iwata 2000). There are many reasons for this phenomenal growth. Businesses and individuals use e-commerce to reduce transaction costs, to speed the flow of goods and information and to improve the levels of customer service. It also enables close coordination of actions among manufacturers, suppliers and customers. Companies in the automotive and aerospace industries have been involved in e-commerce for decades through the use of EDI. The nature of e-commerce has of course changed with the advent of the internet. Internet EDI, because of its relatively low network costs, has greatly enhanced EDI usage by many other sectors.

The advantages of e-commerce are listed in your text. Go through the details in your text but consider the challenges. One tough challenge for e-commerce is the integration of new Web based e-commerce application systems with traditional main frame computer-based inventory control and production planning systems. The sales rep placing orders on the Web must be able to find out what products are in inventory and available for sale. This requires integration of Web-enabled front-end applications with traditional back-end applications, such as inventory control and production planning. One simple way to partly achieve this is to build internal communication standard (intranet) using the globally accepted Internet standards. This allows customers, suppliers or trade partners to interface smoothly. This enables paperless business transactions involving orders, purchases, payments, complaints handling, after sales consultancy services etc.

E-Commerce is a broad and rapidly evolving subject. You must remember that electronic commerce has evolved from the simple stage of exchange of information to the very complex stage of sharing of business processes among partners in the supply chain. This evolution is the very heart of the collaborative commerce we mentioned earlier. It is quite transparent that the new supply chain business models have been able to evolve only because the internet has been able to shape today's complex e-commerce environment.

Figure 2.3 Web based order processing. ( Stair & Reynolds 2001)

The following reading will provide you with up tp date industry focus on Internet based e-commerce business models.

While Web-based e-commerce is reshaping the way business is conducted, there are many limitations of the Web centric B2B applications. The following reading highlights the problems associated with the current state of web technology and the current technology focus for emerging business models.

Supply chain management issues and IT

The decision making in supply chain management is carried out at three levels: strategic, tactical and operational. (Refer to Chapter 1 in your text, and to chapter 1, for the type of planning required in each of these three decision levels.)

Figure 2.4 Supply chain decision levels. (adapted from Arimand & Roach 1999)

The ERP systems are inadequate to address decision making at all levels because, while they integrate corporate database systems and automate well-structured transaction processes, they are not, despite the name, planning tools. They cannot help managers in decision making at strategic or tactical levels. Supply chain management issues are essentially complex and involve various trade-offs and customer service goals. The decision making processes are essentially dynamic in nature and are best solved by computer-human joint efforts. The tools for this are Decision Support Systems (DSS).

In supply chain management the decision support systems are also known as APS (Advanced Planning Systems) or SCS (Supply Chain Systems). These are essentially planning tools which provide the managers support to plan supply chain activities. The type of planning supported by a particular DSS depends on the way the DSS is designed, ranging from simple vehicle route planning to complex supply chain network designs. The DSSs are widely used by large businesses as essential decision support tools for many functional areas within the business. The cost effectiveness and flexibility of DSSs have influenced firms to increasingly use these in supply chains management.

Integrating the supply chain information systems

The ERP systems are required to provide a common data platform for the supply chain, but these are essentially systems to improve processes within the four walls of the firm. The trend suggests that firms will need to shift focus from internal to external. Research carried out by Forrester Research in the USA suggests that most firms that had been deploying internally focused application software are beginning to move towards new outward focused software. Table 2.1 shows the difference between outward and inward facing applications.

Table 2.1 Source: Stacie Kilgore 2001. ( Ascet, vol 3, 'Supply network apps take off')

Inward Facing Apps. Outward Facing Apps.

buy purchasing

supply planning and optimization

e-procurement.

supplier portals

make product data management (PDM) and product planning

demand planning and forecasting

production planning and scheduling

collaborative product design and development

collaborative planning, forecasting and replenishment (CPFR) and vendor managed inventory (VMI).

move fulfilment (including warehouse management)

transportation planning

order processing and order fulfilment.

international trade logistics (ITL).

transportation execution

sell software to monitor performance of internal business processes and key performance indicators

software to assess trading partner performance and track supply chain activities (e.g., shipment status tracking)

The ideal situation in the management of supply chain future would warrant ERP systems which are dynamic and capable of interacting with data from outside sources without manual intervention. This is a feature which is still in development stage.

The exorbitant costs associated with ERP implementation act as a barrier against implementation of ERP and integration. The DSS tools allow an alternative under the situation with the limitation that data is dispersed among various servers within the organisation and it would require considerable effort to assemble it.

Decision support systems

The DSS is a computerised decision aid and it represents a good balance between human abilities and the processing power of the modern computer for problem solving. It is because the nature of each problem is different and some problems are solved more efficiently by computers while humans solve other types of problems more efficiently. Modern computers can solve a problem very efficiently when the problem is very well structured and when it can formulated in logical terms by decision rules. On the other hand, unstructured problems are solved better by humans.

In real business life most problems are semi structured and a DSS is a suitable tool for bringing human expertise to interact with the computer for effective decision making.

Reading 2.9

Power, DJ (2002) 'A brief history of decision support systems', DSSResources.COM , URL: http://DSSResources.COM/history/dsshistory.html [5 pages]

Figure 2.5 Decision support systems are best for semi-structured problems which can not be solved by computers alone. (McLeod 1995)

Chapter 12 in your text covers details of DSSs for supply chains extensively. We will summarise the main concepts here.

The characteristics of decision support systems

Decision support systems have a number of characteristics that allow them to be effective management support tools. It has to be appreciated that all DSSs work, in principle, in the same way. Some, however, are small in scope and offer only some of the following features (Stair & Reynold 2001)::

Handle large amount of data from different sources. Provide report and presentation facility. Offer both textual and graphical orientation. Support optimization, satisficing and heuristic approaches.

Figure 2.5 Decision making level (adapted from Stair & Reynold 2001)

DSS in supply chain management

DSS are used in supply chain management for all levels of planning. The main type of activities supported by a DSS are:

logistics network design supply chain planning vehicle routing and scheduling

Logistics network design is an extensive exercise using large quantities of data and complex decision parameters. Your text covers the basic concepts quite extensively.

The following reading is technical in nature but will introduce you to the decision elements for a strategic supply chain planning DSS.

Reading 2.10

Mentzer, JT & Gomes, R (1991) 'The strategic planning model: A PC-based dynamic, stochastic simulation DSS generator for managerial planning', Journal of Business Logistics , volume 12, number 2, pp.193-219.

The third chapter in this study guide is on logistics network design and is based on Chapter 2 in your text. This is dealt with in much greater depth in that chapter. See your text for a general description on the use of DSS for other planning activities.

Geographic Information Systems (GIS). One important technological development in the field of DSS has been the GIS or Geographic Information Systems. A GIS is an integrated computer mapping and database management system that provides functions for the storage, retrieval, management, analysis and display of geographic data. The GIS technology is widely used by governments and businesses for many purposes including census and demographic data analysis, market analysis, land use mapping etc.

In supply chain and logistics management, the GIS technology is used for network analysis, site location modelling, transportation modelling and distribution modelling. The integration of GIS in a DSS allows geographic data to be imported with an accurate street level data base for transportation and distribution related analysis. The GIS technology allows visualisation of data in a user friendly graphical form.

The supply chain network

We know that the supply and distribution networks of firms differ greatly and that there is no universal model of a supply chain which we can apply to all firms. Each firm is unique and differs from another in many ways. Each deals in different products, has different markets, has different access to capital and finance, has to operate in different political and economic environments, and has its own management and human resources which are different from others in terms of motivation, acumen and vision. All these factors affect the way in which firms operate and compete in the market place. The common reality is the competition and each firm must employ all its resources in its own unique way to emerge as the winner in its own domain.

Remembering the diversities among firms, we can, however, say that the basic structure of any supply chain network would consist of following elements:

the facilities plants, warehouses, distribution centres, retail outlets

the transport systems inbound transport, outbound transport

the information network the communication link and databank

the inventory the inventory in various facilities, and inventory in transit.

While the above is a generalised statement, we should appreciate that a firm's supply chain network can range, in terms of structural complexity, from being quite simple to a highly complex one. For example, the warehouses or distribution centres can be spatially located in a single echelon between a plant and the retail outlets or in multi echelons. In Europe many firms have a European distribution centre (EDC) which directly feeds the retail outlets from this EDC, while many companies have several regional distribution centres (RDC) between the EDC and the retail outlets.

The same observations apply for other elements like transport, which may employ one or many of the transport modes, and inventory. The situation is unique in each case and will vary from industry to industry, firm to firm and area to area.

Network design decisions

Ballou (1993) considers that the design of a logistics system should be based on four business areas. The first deals with customer service levels. Logistics customer service includes the availability of the product, the time required by a customer to receive the product, the condition the product is in when it is received, and the accuracy of filling the customer's order. The second area deals with the location of facilities and the demand allocated to them. The third deals with inventory policy and the fourth with transport decisions. It is apparent that all four of these critical areas are economically interrelated and should be planned collectively.

The network design does not only concern the spatial layout of the facilities (location), but also the flow of materials through the various facilities within the supply chain (allocation). Location and allocation determine the way inventory and transportation are managed by the firm and the costs associated with these activities.

These two dimensions of supply chain network design, location and allocation, are called spatial and temporal aspects of the network design. The spatial aspect deals with the location or geographic placement of the facilities; the temporal aspect deals with the flow of product through the network over time (Ballou 1999). The objectives of the network design are fundamentally different from a simple facility location decision based only on minimum overall transport costs. The network design decision requires an integrated approach and this considers all logistics elements of warehousing, transport and inventory as inseparable parts of a system.

The type of decisions involved in the network planning process provided below are suggested by Chopra and Meindl (2001, pp.304):

Facility role What role should each facility play?

Facility location Where should each facility be located?

Capacity allocation How much capacity should be allocated to each facility?

Market and supply allocation What markets should each facility serve? Which supply sources should feed each facility?

There are many examples of firms gaining considerable advantage by realigning their existing supply chain networks. The following two readings will provide you with practical examples of network design decisions taken by firms with two different objectives.

Design consideration

It is possible to include all facilities, including plants, warehouses, distribution centres and retail outlets of the complete supply chain, but practically it would be prohibitive to consider the entire supply chain within a single solution platform (Rushton & Saw 1993). Though there are planning models which include plants and retail outlets, in most practical cases plants and retail outlets are likely to be excluded from consideration when designing the supply chain network. A plant or a manufacturing unit is more likely to be located at a place which is strategically selected because of its proximity to a source of raw material or to a source of cheap labour, and this is unlikely to be influenced in any medium term planning of the firm. On the other hand, the retail outlets represent

the customers. We will address the design problem in this simplified form keeping in mind that just as each supply chain is unique so are the requirements of planning.

Logistics and facility costs in logistics network configuration

The logistics and facility costs of a supply chain are dependent on:

the number of facilities the locations of the facilities the capacities allocated among the various facilities.

The decisions regarding these are complex. There are many trade offs involved and these include not only the cost elements of the individual elements, but also the service level attainable by a particular configuration.

Read your text for more discussion about the relationships between the number of facilities, their location within a supply chain network, the allocation of capacities with the system wide cost and the logistics service level of the network. These are summarised below:

The number of warehouses determines how close the products are to the customers. It is apparent that with warehouses increasing in number, the specific locations served by each warehouse gets smaller and so does the average distance from the warehouse to the retailer. This allows quicker response to customer orders and better service levels.

The inbound transportation costs generally increase as warehouses are located closer to the market. The outbound transportation costs decrease as distances to retailers decreases.

As the number of warehouses increases, the total safety stock, the aggregate of safety stocks required at each warehouse, also increases. This increases the inventory holding cost connected with safety stock required for the entire network.

Setting up and operating more warehouses involves additional expenses related with set up and overhead costs.

Network configuration. As we saw in the previous chapter, the logistics network design decisions are decisions taken at the strategic level of the firm. The decisions are usually complex because the design requires analysis involving a large number of data with many variables concerning distribution, customer service level, transport and inventory. Additionally, the design must accommodate strategic visions regarding growth with practical constraints in consideration. In supply chain management and logistics, the network design is invariably carried out with the aid of a DSS (decision support system).

The supply chain model

At the heart of the DSS is the model of the supply chain. The models used in computer-based analytical systems are mathematical models and this is simply the formula or equation representing the physical system (McLeod 1995). Mathematical models can describe the relationships among the various elements within a system with precision and modern computers allow us analyse these relationships with comparative ease.

However, in spite of the appreciable power of modern computers, it is usually difficult for the decision support system to model a supply chain. Let's look at some of the relevant problem areas:

the complexity of the network design problem the problem of dealing with location and allocation the complexity of the functional trade offs involved in logistics the existence of complex and ill defined cost relationships the need to understand the complete system behaviour before making changes the risks and capital investment typically involved in any implementation.

Chapter 2 in your text covers the DSS-based design methodology quite extensively. Read the text thoroughly for a clear understanding. In short, the DSS-based network design configuration is based on the following methodology:

Build an extensive database with quality data for all relevant elements of the supply chain. Build a model of a logistics network with appropriate solution technique. Validate the data and model against current configuration. Seek decision support guidance from the DSS.

Data and a network model

The network model is dependent on data about each element of the supply chain network which contributes towards the system wide costs or performance of the supply chain network. This requires the building up of a very large database. If a firm is planning to upgrade its existing network, it should be able to find most of the data from the central database in the ERP system or in the departmental databases. If the logistics network is being modelled on a 'green field' basis, the data will have to be generated by the firm based on its market research and strategic planning process.

Section 2.2 in your text deals quite extensively with the type of data and you will need to study this section very thoroughly. The basic requirement is the collection of data relating to all relevant cost items and encoding and aggregating this data in a way which makes computation feasible.

Data source. Ballou suggests the following as sources of data (Ballou1999):

business operating documents Documents such as sales orders, activity reports regarding purchasing, selling, manufacturing, shipping, storing, handling will provide useful and relevant data.

accounting reports Accounting data focus on identifying the costs of operations, including the costs for logistics activities Although traditional accounting reports will not capture all logistics costs as required by the network designer, accounting reports remain the primary source for cost data.

logistics research Research can be the source of valuable data for defining relationships in network planning such as the sales-service relationship and the transport rate-distance relationship.

published information Industry reports, academic research in logistics and trade journals can provide useful primary and secondary data on cost and industry trends, technological advances, activity levels, and forecasts.

judgement All personnel within and outside the firm connected with the supply chain are valuable sources of data and should be consulted in the network design.

Data encoding. Computation is facilitated by encoding the data. The data type which require encoding would usually be the product and sales data. The bar coding of products greatly facilitates automatic data entry for such information as sales, shipment and inventory location, and this greatly facilitates the processing of product related data. The sales data is usually collected on a customer basis with reference to the name and address of the customer. The logistics network planner requires that the data have reference to a geographic base. This facilitates the analysis of the transportation decision, facility location decisions and inventory decisions. One convenient way of encoding a customer and sale s data would be on the basis of all sales within a postal code or within a suburb which has been given a particular code by the business or planner themselves.

Data aggregation. The text covers the concept of data aggregation quite adequately. As a large firm would normally have a very large number of customers and many products, aggregation is required to bring down the amount of data to be handled by the computer to an acceptable level. The main concern is whether the loss of detail affects the quality of solution. Consult your text for data aggregation techniques.

Aggregation of customer data. This relates to demand or sale forecasts of individual customers and is the basis on which the supply chain is designed. The data is aggregated on the basis of a geographic zone so that all individual customers within the zone are replaced by a customer at the centre of the zone. There are many ways of defining this zone, but a convenient way is to define a zone according to the postal code. As the service requirements of all customers within a zone are not same, the aggregation of customers is made in specified classes. This means that each zone may have two or three different and independent aggregated demand and sales data.

Aggregation of product data. The data regarding the products have to be aggregated. There is no fixed rule for aggregation but the idea is to aggregate products into groups which make the information useful in network analysis. The aggregation can be done on the basis of such characteristics as distribution pattern, product type or transport class of merchandise.

The aggregation of data not only provides manageability for the designer, it also reduces the uncertainties associated with these data. Moreover, the error associated with transport costs due to aggregation of customer data into 150 to 200 points is said to be no more than 1% (Simchi-Levi et al. 2000).

Transportation costs. Transportation is one of the key functions of a firm's logistics activities and the costs associated with a particular logistics network have to be accurately captured in any analysis of the network. Transport costs are associated with all inbound and outbound transport of goods through the network. The network model will require information regarding transport rates for various distances between different echelons of the network and between the distribution centre and demand centres. The rates will reflect the mode, shipment size, class of merchandise, product weight to volume ratio, handling characteristics and hauling distances.

Transport rates. Transport rates determine what a particular shipment will cost per unit weight for transporting a certain distance. The calculation of costs when the transport function is managed internally by the firm's own fleet is different from costs incurred

when the transport is provided by a commercial operator. Transport rates are usually linear with distance, but not with volume. This means that for the same distance and same commodity, unit freight rates will depend on shipment size. This is particularly true for LTL freights. LTL rates are usually based on commodity classification, and are offered on specific weight break. (A weight break is a range within which a particular shipment falls; for example, a weight brake of 500 kg - 750 kg, for a particular commodity, for a particular distance. A shipment which falls within this weight break will usually cost more per unit weight compared to a larger weight break of say, 1000 kg -1250 kg.) Therefore, it is imperative to apply to a particular demand centre a transport rate which reflects all these different attributes.

For incorporating rates in a database, Ballou (1999) has cited the use of shipment profile s based on past data, and the use of this profile to accurately estimate the transport rates to a destination. The following reading from Ballou (1999) deals with estimation of transport rates quite extensively.

Reading 3.3

Ballou, RH (1999) extract from Chapter 14 'The network planning process', in Business Logistics Management , Prentice Hall, pp.545-564.

Mileage estimation. The estimation of mileage for freight cost calculation is vital for supply chain modelling. As different locations of facilities will affect the distances from the retailers, the distance will have to be considered along with the freight rate. In most cases distances can be obtained from road maps or distance tables. The use of latitude and longitude with a circuity factor is a good way of estimating distance in areas with a good network of roads and railroads. Ballou (1999) provides an approximate circuitry factor of 1.21 for road and 1.24 for railroads in well developed networks. These figures are perhaps workable for the USA and EU, but definitely not for Australia which has a different pattern of spatial layout of urban centres.

There are a number of ways in which distances between two points can be found. Gilmour (1993) wrote in 1993 about Transit , a computerised vehicle scheduling system in use in Australia by trucking companies. One of the feature of Transit was a road network incorporated in the computer model based on the Australian Grid Reference System.

Another example cited by Gilmour is Roadnet, another computerised system used by Esso Australia , which incorporates a digital map of all Australian roads and can accurately calculate the distance between Esso's terminals and customers. With GPS and GIS technology widely in use today, estimation of distance is not a challenge anymore. (Refer to chapter 2 and Chapter 12 in your text.)

Warehousing costs. The warehousing or facilities costs have to be available for network analysis. The costs related with a facility can be represented in terms of fixed costs, storage costs and handling costs.

Fixed costs. These are costs which do not change with the level of the activity in the facility. Examples are real estate taxes, rent, supervision and depreciations. The fixed cost is also related to the size of the facility.

Storage costs. Storage costs are those that vary with the amount of stock stored in the facility. Typical storage costs are inventory holding costs or costs of the capital tied up in inventory and the insurance costs associated with the inventory.

Handling costs. Handling costs vary with the facility throughput and include the costs of labour and equipment to handle the inventory while receiving, handling, sorting and dispatching.

Facility capacity. The capacity of each facility determines the flow through the facility. The capacities also have to be optimum in order that there be no unwarranted excessive surplus capacity, as this will raise fixed costs associated with the facility. The important concept is the inventory turnover ratio , which is defined as the annual sales divided by the average inventory level of the facility. Assuming regular shipping orders and replenishment of inventory, the maximum storage space required is twice the average inventory level. The physical space required for this maximum inventory level has to be calculated keeping in mind storage, handling and peaking requirements. Reading 3.3 provides a more elaborate practical approach towards capacity determination.

Potential warehouse locations. In real life there are many other factors which influence network design decisions. Chopra and Meindl (2001) points at following factors as having influence on logistics network decisions.

Macroeconomic factors. Taxes, tariffs, exchange rates etc.

Political factors. Political stability is a prerequisite in facility decisions in global supply chain.

Infra-structure factors. A good infra-structure is a pre-requisite.

Competitive factors. A strategic decision based on competitors strategy and firm's own policy.

Logistical and operational factors. The performance of the logistics network with respect to inventory, transportation costs and service level of the firm.

The above factors are relevant when considering facilities within an international dimension.

Activity 3.2

Refer to reading 3.1 and 3.2 and find out the factors considered by Timberland and Toyota regarding location of their facilities.

Service level requirements. The service level is a very important consideration in a supply chain and a design must meet the service level criteria set by the management. The service level in the context of a supply chain network can be defined in various ways. In network design models, the specification of service level is usually considered in terms of distance of a facility from a customer. This distance represents time to service a customer and the costs associated with this service. It is often the case that all customers cannot be served from an warehouse with the same level of service. In such a case, the target service level is set to serve a certain percentage of customers with a specified level of service.

Future demand. The decisions regarding the configuration of the network has significant effect on the overall performance of the firm in the medium term. The facilities, once built or established at specific locations, cannot be upgraded, relocated or closed on short notice and without commitment of heavy financial input. This, of course, is not desirable. The projected and anticipated future growth of the company in terms of sales and customer demand have to be taken into account. The network to be designed

must not only be growth friendly. The optimum network to be selected must provide the best results on the basis of these future scenarios.

The bullwhip effect

We know that a supply chain is made up many firms and each is unique in the way it is configured. However, all chains end up with customers or consumers at the downstream end. The business purpose of all firms in the supply chain is to serve these end customers. In a conventional supply chain, the downstream entity acts as the interface between the supply chain and the customers.

To keep this analysis simple, let us consider a simple supply chain with a manufacturer, a distributor and a retailer at the downstream end. We know that the retailer will keep an inventory to serve its customers and will initiate a replenishment order according to the inventory policy when the time is right. The distributor receives the orders from the retailer and initiates its own replenishment order to the manufacturer when its stock reaches a certain reorder point.

Figure 5.1 The sequential structure of a 'traditional' supply chain generating the bullwhip effect (demand amplification) in the clothing sector (Source: Mason Jones & Towill 2000, from a description in Stalk & Hout 1990)

This practice of order processing by firms at each level in the supply chain gives rise to a phenomenon by which demand information gets distorted as it travels upstream and this is known as the bullwhip effect. The direct result of this effect is wrong perception about the state of real demand, and uncertainty. This results in excess inventory at different levels in the supply chain. The indirect effects are costs, waste and poor customer service.

Forrester (1960) carried out the earliest research into the bullwhip effect and identified its presence in multi echelon manufacturing firms. A more recent study was carried out by Burbidge (1989), who offered an explanation of the phenomenon by calling it the 'Law of Industrial Dynamics'. He stated that:

If demand for products is transmitted along a series of inventories using stock control ordering, then the demand variation will increase with each transfer.

According to Lee et al (1997), the term 'bullwhip' was first used by Proctor and Gamble (P&G) when they experienced extensive demand amplifications for their diaper product 'Pampers'. The following reading is a leading article in this field and should give you good grasp of the concept of the bullwhip effect and its causes.

The reasons for bullwhip effect

Lee et al (1997) identified the four major causes of bullwhip effect as:

demand forecast updating order batching price fluctuation rationing and shortage gaming

The bullwhip effect is mainly caused by any one or more of these causes. We can see that all these are related to the business processes of the firms. Reading 5.1 explains these points quite adequately. the following will complement your reading and text material.

Demand forecast updating. All firms use standard forecasting techniques for production scheduling, capacity planning, inventory control and materials requirement planning. Firms use order history as a proxy for demand from the firm's immediate customers and forecast demand data is generated on the basis of these past sales data. Mason-Jones and Towill (2000) says that the order information is subject to delay, bias and noise before being transferred onto the supplier. The forecasting technique chosen and the way the demand signal is processed are significant contributors to the bullwhip effect. (Although the terms used by Mason-Jones and Towill are different, Reading 5.1 will have covered these concepts adequately. Forecasting is always subjective, as each firm uses different techniques, and the order quantity for a future period very often includes a very subjective 'hunch' on the part of the planner. These variables are sources of bias and noise in the demand signal.)

Apart from the error due to the forecasting technique chosen, it is also the practice of sales personnel to amend the forecast demand figures according to their gut feelings before the close of the planning period (Reddy 2002). This causes an even greater variance in the demand information as it travels upstream.

Batch ordering. In a supply chain, each company places orders with an upstream organisation using inventory control mechanisms decided by the firm's inventory policy. The demands from customers may be small and frequent which deplete the inventory gradually; firms would wait until the inventory level reaches a predetermined minimum level (the reorder point) before order is initiated. This requires firms to order periodically in batches. This order size is large compared to the regular demand faced by the firm. The supplier receives a large, highly erratic stream of orders with a spike during one cycle, but no orders for the rest of the period. This variability is much larger than the demand faced by the downstream firm.

Batch order can also occur for other reasons, such as orders being held until a greater shipment size is reached, as this will result in better transport rates.

Reddy (2002) points out that one way an artificial demand signal is often generated is by sales and marketing department personnel creating an artificial lower price for a product by foregoing a percentage of their own sales commission. Sales made in this way distort demand information and contribute to uncertainty.

Price fluctuation. Just as sales prompt consumers to buy an item in greater numbers compared with their usual buying patterns, special promotions and price discounts from manufacturers or suppliers result in retailers and wholesalers buying in large quantities and stocking them up. The manufacturers or suppliers often offer these to raise sales volume and to meet sales targets for a period. This is commonly known as 'meeting the quarter' in industry circles. The retailer takes advantage of these promotions to maximise profit. There is a similar buying spree when a price hike is expected. Commonly referred to as 'forwarding buying', the retailers and wholesalers make calculated decisions regarding likely future profits from such a move.

Figure 5.2 Increased order due to price promotion and selling through extra inventory over a longer period

The immediate effect is a larger order just before the discount is to end, and a drop in demand over a longer term while businesses sell through extra inventories.

Rationing and shortage gaming. Shortage gaming occurs in an environment of tight supply and when the manufacturer is expected to ration its products. The customers, wholesalers and retailers may order in large quantities with the expectation that they will receive a greater allocation of products that are in short supply.

The impact on the supply chain is significant as the forecasted demand is greatly, and unrealistically, increased with these inflated orders. Eventually orders disappear and cancellations pour in, making it impossible for the manufacturer to determine the real demand for its products.

Quantifying the bullwhip effect

Your text deals with the quantification process quite extensively and you are expected to read the text very thoroughly. Although the derivation of the mathematical quantification formula may not be very obvious, the underlying principle is quite clear. Note that the formula and explanation are based on certain assumptions:

The bullwhip effect is mainly due to demand signal processing between various levels of the supply chain.

One of the main sources of error is the forecasting error and the formula in the text is based on a 'moving average' forecasting technique.

Given the above assumptions, other factors contributing to the bullwhip effect are not considered. This may be a limited view. Nevertheless, it provides insight into one of the main contributors of the bullwhip effect. The explanation is quite simple. The retailer sells a product daily and the daily sales figures represent daily demands for this product. Realistically these daily demands are likely to fluctuate on a day to day basis. When inventory levels approach the reorder point (refer to chapter 4), an order is initiated. The question is: when is this order initiated; what is the quantity; and how does this order quantity relate to the real demand?

You know that the retailer's order decisions are based on inventory policy and this is strongly connected with the estimated demand likely to be faced by the firm in the immediate future. You are aware of the various forecasting techniques used by firms and know that these forecast demand figures are certain to be different from the actual demand experienced by the retailer. How much they will differ will depend on the forecasting technique in use. The points to note are:

Only the retailer faces real time market demand which originates from the customers. The replenishment orders made out by the retailer will be in accordance with the inventory

policy followed by the retailer. The inventory policy can be a two parameter continuous review policy which determines when to order and how much to order; or a single parameter continuous review policy which determines how much to order at every period. (See chapter 4 if you need to refresh your memory.)

The order quantity, whichever policy is chosen, will be affected by the estimated future demand pattern, the likely average demand and the variability of demand. These estimates are the results of the forecasting technique used by the firms and will vary depending on the techniques and parameters chosen.

So, the order that the retailer sends out does not accurately represent the demand information.

This situation can be best explained by using the single parameter inventory decisions mentioned in chapter 4. Remember that the retailer orders whenever the inventory

position falls below the level: .

AVG and STD are forecast average demand and standard deviation of demand during the lead time. The values change from period to period as forecast are updated at each period, the value of S or the target inventory position will change, creating a order pattern which will follow this target inventory which could vary substantially from the demand faced by the retailer.

Figure 5.3 Demand and order - transmission of demand information across a simple supply chain

How much does the order vary from the 'real' demand experienced by the retailer? This is a very basic question and as explained will depend on the inventory policy and the forecasting technique used by the retailer. Experts and academics have faced considerable difficulty in identifying a measure which would adequately represent the way demand information gets amplified. Simchi Levi et al has chosen variance as the appropriate measure, whereas others (Wouters & Fransoo 2000) have based their work on the co-efficient of variation as the preferred measure of bullwhip effect across the supply chain.

The text deals with this problem by assuming that the retailer and other chain members are employing a moving average forecasting technique and following a single parameter continuous review inventory policy. See section 4.2 in your text for a detailed discussion on bullwhip effect and how the effect can be quantified on the basis of these assumption. The derivation of the mathematical formulation is beyond the scope of this study guide and we will conceptually accept the formulae.

In your text the bullwhip effect is given as the ratio between the variances in retailer orders to the manufacturer (Q) and retailer demands (D). This is given by :

where L is the cycle lead time

p is the number of recent most periods used in the forecasting (moving average) to determine the order quantity

The formula is indicative of the likely impact of a long lead time on the bullwhip effect. Conversely, it is also obvious that as 'p', the number of observation periods increases, the bullwhip effect decreases in magnitude.

Information centralisation and bullwhip effect. The bullwhip effect causes distortion in demand information and the distortion is amplified as demand information travels upstream. The magnitude of this amplification, however, depends on whether the supply chain partners share information or not.

We first consider the situation in which all supply chain members act independently without sharing any information. In this case the retailer, the firm situated at the extreme downstream end of the supply chain, does not pass along the actual demand data to the upstream firm (the wholesaler) but transmits orders as discussed earlier based on forecasted demand figures.

The next channel member views these orders as demands and similarly issues its own orders to the next echelon firm. This upstream firms employs a similar forecasting technique to estimate likely average demand for the next period and activates orders to the next echelon when its inventory reaches a predetermined level (ROP). The order quantity is decided in the same way and it does have the same amplifying factors. This process is repeated as orders transmit across the echelons, amplifying the bullwhip effect more and more in the process.

Figure 5.4 Demand amplification across the supply chain

Look at Figure 5.4. Supposing the bullwhip effect amplifies the demand variation by a factor of 1.2 when it reaches the wholesaler, the demand signal processing by the wholesaler amplifies the incoming order variations by a factor of 1.4, and finally the distributor processes the orders from the wholesaler by amplifying the order variation by another factor of 1.5. The cumulative effect is multiplicative when one considers the original demand variation faced by the retailer.

For example, if we denote order variation at the retailer as Var(D), then:

Var( )/Var( D ) = 1.2 or Var( ) = 1.2 Var( D )

Var( )/Var( ) = 1.4 or Var( )/Var( D ) = 1.4 x 1.2 =1.68

Similarly, Var( )/Var( D ) = 1.68 x 1.5 = 2.52

This finding can be mathematically represented as :

We can see how original demand variation in transmitted across the supply chain in a multiplicative way when demand information is decentralised. The formula in your text (page 105) mathematically represents this finding when a moving average forecasting technique is used by each firm in the supply chain.

Supply chain with centralised demand information. In this case the firms share demand information across the supply chain. The retailer only transmits an order to the wholesaler, but also transmits his forecast mean demand. The wholesaler uses this forecast mean demand information to calculate his inventory position and order up to level. The distributor receives the order from the wholesaler, but his order to the next level is again based on the retailer's forecast demand. What is the cumulative effect this time?

Figure 5.5 All supply chain members sharing retailer's forecast demand information

In this case each channel member is ordering on the basis of the retailer's forecast average demand. Each firm orders following the usual inventory control technique using this demand information and its replenishment lead time. The order at any stage of the supply chain, when compared with the retailer demand, will have the incidence of total lead time up to that stage. The effect is additive.

The formula demonstrates that increase in demand variability at each stage of the supply chain is additive instead of multiplicative. Chen et al (1999) has shown that if demand

information is shared, the increase in variability seen by each stage of the supply chain is the same whether the supply chain follows an echelon inventory policy or not.

Measuring bullwhip effect: The practical issues

The above explanation, when read in conjunction with your text should provide a good theoretical base on the effects of information transparency across the supply chain. However, practical measurement of the bullwhip effect is not easy. Wouters and Fransoo (1999) carried out the most recent work in the Netherlands and noted the following difficulties in practical measurement of the effect:

In many supply chains demand data is not available at the level of detail necessary for a good analysis. Instead, data are sometimes incomplete or only available at a highly aggregated product or time level.

As supply chains are complex, data co-relation is often difficult. A wholesaler may give an order to its supplier based on several retailers' orders. It will be impossible to disaggregate the wholesaler's order to study the relationship with respect to orders made by one retailer.

The measurement of total bullwhip effect should provide insight into the specific causes of the bullwhip effect. Specifying which part of the total bullwhip effect can be attributed to a specific cause can be problematic because of:

unclear ordering policies where rules regarding order batching are unclear unavailability of real demand data which requires separating out the effects of price

fluctuations and of shortage gaming from sales figures. Such real data are often not available.

unavailability of real demand data when shortage occurs and price changes as sales at that time do not represent real demand.

Bullwhip effect: Managerial insigh

It is obvious that that the way the retailer estimates his future mean demand and variance (by forecasting) affects his orders and is one of the principal causes of the bullwhip effect. In supply chains spanning several echelons, the effect is a practical reality but mangers should look at ways to minimise the effect.

Look at Figure 4.8 on page 108 in your text. It is apparent that the bullwhip effect exists whether demand information across the supply chain is shared or not. However, the effect of information centralisation is positive as it reduces the variability compared to uncentralised information.

We have also seen that the increasing demand information variability across the supply chain is an increasing function of lead time, and safety stocks and a decreasing function of the number of observations used in the demand forecasting. These insights should help managers minimise bullwhip effects.

Reducing bullwhip effects

The demand amplification or bullwhip effect in the supply chain is system induced and is directly affected by both information and material delays in the supply chain and the feedback process in the decision making process (Mason-Jones & Towill 2000).

We have identified the principal causes of bullwhip effect in supply chains. Additionally we have seen that it is possible to quantify the effect, albeit with certain limitations attached to it. These insights enable us to make effective decisions for minimising or eliminating the bullwhip effect from a supply chain.

In practice, any effort to reduce the bullwhip effect is likely to be difficult and challenging. McCullen and Towill (2001) identify three prime dimensions to the problem of the bullwhip effect. They describe the order aspect of the bullwhip effect as the replenishment dimension affecting the flow of materials and information throughout the system. There are two other prime dimensions which make it difficult to identify and reduce the effect. These are geographical (since activities take place in different locations) and temporal (since activities take place at different times).

Mason-Jones and Towill (2000) provides the following diagram which shows the uncertainties associated with a supply chain and what strategies are available to tackle these.

Demand Side Planning and Control System

postponement of product customisation

partnering schemes

information

good decision support system

single communication channel between plays

push/pull approach

rationalise vendor base

partnering scheme

information sharing

eliminate waste

consistency of product

consistency of process times

Supply Side Manufacturing Process

We can see from our previous discussion that there are a few options available to management to reduce bullwhip effect across the supply chain. These are :

Reducing uncertainty by information visibility across the supply chain as this will reduce the bullwhip effect. Practices that support an effort to reduce uncertainty involve the implementation of systems such as electronic data interchange (EDI) and extensible markup language (XML). Both these technologies allow companies to share information (such as consumer sales) with partner companies in the supply chain. EDI uses specific network services with an agreed information protocol while XML supports information sharing over the Internet. POS (point of sale) data can be transmitted to all chain operators, which will enable them to have a clear picture of consumer demand.

Reducing demand variability is an effective approach to reducing the bullwhip effect as this variability causes the forecast error which in turn is the principal cause of the effect. How can we do reduce variability? As demand at the retailer often fluctuates with the price attached to a particular product, a unvarying price such as EDLP (everyday low price) should reduce demand uncertainty. By eliminating price

fluctuations a retailer can eliminate much of the demand variability associated with the product.

Decreasing the lead time between each level of the supply chain will aid in reducing the bullwhip effect. In fact it has been recognised that time compression is the key to supply chain excellence. Supply chain lead time is made up of the delays in information processing and materials processing. Mason-Jones and Towill ( 2000) refer this as two distinct lead time pipelines: the order information transfer pipeline , moving upstream from point of sale to raw material supplier and the product transfer downstream from raw material to customer. While in the short term the material flow lead time can be reduced by transportation techniques like crossdocking, information pipeline lead time can be reduced by effective information sharing using technology.

The reduction of the overall supply chain lead time is treated with the utmost priority in contemporary supply chain management. This has resulted in rapid response manufacturing practices which are built on the concept of agile manufacturing . This has been made possible by integrating the physical transfer process with information system integration. This enables an agile enterprise to respond rapidly to customer demand, reducing the lead time. These developments have been seen as a new dimension in supply chain management, often referred to as demand management . We will see the concept of 'pull' system demand management in the next chapter. This has been another development in agile business practices and is contributing to shorter lead times. Many industry commentators prefer to use the term demand management

Eliminate echelons in the supply chain: This involves the elimination of echelons and functional interfaces. This reduces time delays and information distortion which precipitate demand amplification. This can lead to a substantially different channel of distribution.

Strategic partnering with other supply chain actors is a prerequisite for implementing the above policies as each depends on closer relationships between customers and suppliers in order to support transparency and greater information sharing. Practical examples of such partnering are VMI (vendor managed inventory), QR (quick response) and ECR (efficient consumer response). Each of these initiatives offers a means to more closely coordinate supply chain inventories, in some cases making the supplier responsible for inventory levels at customer locations. These concepts will be covered in greater detail in the chapter on strategic partnering.

The following table is provided by Mason-Jones and Towill (2000) as a benchmarking guideline for bullwhip effects in a supply chain. The focus is on concurrent improvement of the information pipeline and the material flow pipeline.

Table 5.1 Benchmarking supply chain bullwhip performance (from Performance Improvement Benchmarking: Shrinking the Uncertainty Circle )

Supply Chain Design Strategy

Bullwhip Performance Measure

Overall Bullwhip Performance Benchmark

peak value peak time order recovery

stock recovery

datum design ** ** * * *

information pipeline redesign only

**** ** * *** ***

material pipeline redesign only

* **** ** **** ***

both pipelines redesign

**** **** **** *** ****

Effective forecasts and supply chain integration

One of the main causes of uncertainty in the supply chain has been identified as the forecasting error which is inherent in any forecasting system. The problems associated with this uncertainty are well appreciated by firms. They recognise that these problems directly impact their fundamental business issues of timeliness, market share, margins, sales and customer service levels. Effective forecasting has been found to be strongly co-related with superior supply chain management practice. McCormack (2002) found that organisations working with accurate sales forecasts almost always employ three techniques. They:

use historical data to develop their forecasts support historical data with predictive mathematical models hold weekly planning sessions where they make buying, hiring and other commitments.

Employing all three techniques in parallel allows managers to make incremental, rather than abrupt adjustments. The second most important indicator of success is the degree of collaboration and integration with other departments within the company and with outside partners. This is about information integration about sales promotion, price discounts and shortages in the market which would allow all supply chain actors to take these factors into account when forecasting the anticipated demand in a future period.

A recent trend of academics and industry experts has been to promote the concept of demand chain management, a new dimension in supply chain thinking. The following case study will introduce you to the concept of the demand chain.

Collaborative supply chains and information integration

The positive value of information sharing in supply chain management is well appreciated by leading firms and this has led to various industry initiatives to encourage firms to develop a framework for collaboration for mutual advantage. One such industry initiative is known as CPFR or Collaborative Planning Forecasting and Replenishment Systems . This is a software system which allows retailers and manufacturers to share information on past sales data and future price and promotion measures. This is a relatively new development but is gaining popularity across the industry.

Supply chain systems and information integration

In the highly interconnected network economy, a supply chain system is made up of many independent subsystems. These subsystems may reside within the different functional areas of a firm or with a business partner outside the direct sphere of influence of the firm. The management focus is on integration of all processes which affect the service and cost structure of the firm, and information is the key to that integration. The basic problem remains in finding a common goal which would make this integration readily acceptable, because different subsystems have different operational economics.

What is required is a holistic view of the supply chain and a mechanism by which the integration process can become a win-win situation for all participants. It is important to make this work as optimising the supply chain may cause apparent sub-optimisation of one or more individual elements of the chain. For example, cheaper freight rate for truck

load quantities might encourage a retailer to order in truck load quantities even when the inventory level built up as a result would be too high for the retailer under normal circumstances. When retailers are making their own calculations, they will follow this policy if the savings in transportation costs are more than the extra holding costs attached to the extra inventory.

But this kind of ordering decision will tend to hide real demand information and will create uncertainty in the supply chain, pushing upstream members to keep additional inventory. This will increase the level of inventory at every level and the total system-wide cost could be much greater than the benefit gained by the retailer through cheaper transport rates.

The rational approach would be to work out a system by which the retailer was encouraged to order only as required and other channel members shared the benefits of this reduced variability with the retailer by giving him back some of the savings gained, which would more than compensate for the potential gains from full truck load transportation contracts.

The level of integration required goes well beyond the simple transportation and inventory trade off example and encompasses complex issues like inventory management, manufacturing management and distribution planning. The optimisation requires real time information regarding inventory status, demand and order status, vehicle load status, quantity discounts, capacities at various levels of the supply chain and exceptions at any stage. The supply chain integration challenge is awesome and requires integration of information systems and the availability and management of information.

Transportation and distribution

Transportation is a key logistics function. Efficient and effective management of transportation at each stage of the supply chain is crucial for both cost management and service level guarantees. We have already looked at the incidence of transportation costs on overall supply chain performance in chapter 3 when we discussed the design aspects of logistics networks. Cost remains one of the key concerns regarding transportation management. The 12th Annual State Of Logistics Report ( USA ) provides a figure of total business logistics costs of US$1.006 billion or 10.1 percent of nominal US GDP. Transportation costs alone were 5.9% of GDP (Wilson & Delaney,2001). At the level of the firm, transportation costs are considered to be between 6 to 12% of final revenues (Purchasing 2001).

Apart from the aspect of costs, transportation and distribution management affects the order fulfilment cycle time and is one of the main determinants of the service level and costs associated with the supply chain. The following figure shows the well known concepts of inbound logistics, processing or manufacturing and outbound logistics. The management of the supply chain requires a coordinated approach to manage all activities to provide the greatest value to the customer.

Figure 6.1 Flow of product along the supply chain

Supply chain management is concerned with both inbound logistics and outbound logistics In general terms, we can refer to outbound logistics as management of distribution and it covers both transportation and warehousing decisions.

Inbound transportation

Inbound transportation decisions are often neglected in supply chain management literature. There could be several reasons for this. The principal reason appears to be connected with the nature of the product usually related with inbound transportation. These are usually raw materials and components with very little unit value compared to the final finished product. The total incidence of inbound cost on the final revenue is usually lower than that of outbound freight. A KMPG survey on consumer markets reveals inbound costs to be less than 5 percent for 66 percent of respondents with 35 percent reporting a cost of less than 1 percent. This including international sourcing (KMPG 2002). The same report says that outbound transport costs are generally higher.

Nevertheless, the management of inbound transportation can be quite crucial for firms trying to achieve a JIT manufacturing process when the source of the raw material or components is located very far away. An integrated approach is required which seeks the minimum cost solution with transportation and inventory decisions taken in concert with the required level of product availability for the manufacturing and processing line. The following reading provides the business logic for an integrated transportation and inventory decision.

Distribution

The challenge of distribution of finished goods appears to be more onerous compared to the management of inbound transportation. Firms are more concerned about distribution and there are numerous reasons for this. These are:

Most large manufacturing firms are in control of the distribution of their products and find it logical to implement plans to streamline distribution to decrease cost and to improve service.

The quickness with which a firm can respond to customer orders is greatly dependent on the firm's distribution ability. It is therefore a measure of the firm's customer responsiveness.

The finished products are usually of greater value compared to raw materials.

Centralised versus decentralised control

We have already seen the potential of centralisation in reducing the system wide cost. Centralised decision making can reduce the aggregate level of inventory in the supply chain. The net affect is reduction in cost while the level of service is maintained. The physical centralisation of inventory and the implementation of risk pooling techniques will be feasible, apparently, when the inventories in question are owned by a single owner. But the benefits of centralised decision making, including those related with the required level of inventories at different business units within the supply chain, need not be constrained by the concept of common ownership. It is possible to bring independent business units under the umbrella of a centralised control mechanism so long as each party appreciates the benefits achievable and if a mechanism is in place to share this benefit among the parties in an equitable way. The first step towards centralised decision making is sharing of real time information which enables firms to upgrade their forecasts and to make better decisions. We have already studied the concept of CPFR, which allows firms to share information and plan for replenishment in a way which benefits all firms in this collaborative network.

When we are concerned with distribution, we will need to look at the way centralised information and control can help firms in reducing costs and in improving service levels. As stated often, the concept of benefit has to be considered with respect to the supply chain as a whole and this must address the question of system wide cost and service level.

Distribution strategies

Distribution strategies are concerned with making goods available to customers at the least cost while maintaining a high level of service. The strategies are concerned with that part of the supply chain which typically originates from the manufacturer and ends up with the retail outlets. In principle and in practice, any mode or a combination of transport modes can be employed to manage distribution. The predominant mode in use for distribution is, however, road. Road vehicles provide the flexibility of door to door transportation and are absolutely essential for distribution management. At the same time, it must be appreciated that rail and waterways play an important role in distribution of many products, and that air freight of time sensitive high value products is increasingly used for distribution in markets where the intervening distances are great.

We need to be mainly concerned with distribution and the integrated role of warehouses and transport units, mainly road vehicles. We are aware of the basic inventory decisions and role of warehouses in supply chain management. The capacity and use of

warehouses and the average inventory level in each is dependent on the distribution strategies.

Effective distribution strategies must cater to emerging trends in the industry. Recent trends in the industry suggest that companies are, in an effort to reduce their inventory levels, pushing inventory back to the suppliers with more frequent and smaller size orders. Another recent trend is e-commerce or Internet-based sales of such products as books or CDs. These direct to consumer orders require a distribution centre designed and arranged for individual item picking and systems to effectively manage large numbers of small orders. These trends are driving shipment size even smaller and increasing frequency of shipment (Huppertz 1999).

Huppertz (1999) states that the impact of smaller order quantities is measurable and has caused the rise in overall transportation expenditure of 57% of total logistics costs in the USA in 1995 compared to 44% in 1980. One reason for this rise is the shift of firms to more costly LTL (less than truck load) shipments to manage the distribution of these smaller and more frequent shipments.

These new trends present considerable challenge to transportation management as these imply increasing costs of transportation and distribution due to more transactions, increased handling and smaller freight moves. There are several strategies available to offset some of the cost increases. We refer to three distinct distribution strategies in wide use today:

direct shipment warehousing cross-docking

Direct shipment

In this case, the manufacturer ships directly from the manufacturing plant to the retailer without using a distribution centre or a warehouse. The approach appears reasonable as it apparently would reduce costs associated with warehousing or intermediate distribution centres. The time related to order processing will also be reduced when goods are shipped directly to retail stores.

Figure 6.2 Direct shipping network (adapted from Chopra & Meindl 2001)

This is a valid approach provided the supplier is able to respond quickly and cost effectively. Chopra and Meindl (2001) argues that this distribution strategy is suitable if

retail stores are large enough to make optimal replenishment lot size close to a truckload size. Using LTL carrier, the cost and transit time both increase.

In your text

See example 5-12 , page 134 in your text.

There is another strategy which is a variation of the direct shipment model designed to reduce costs of distribution. This is known as milk run or drop shipping .

Figure 6.3 Milk runs to multiple retailer (adapted from Chopra & Meindl 2001)

A milk run is a route in which a truck delivers products from a supplier to a number of retail outlets. This allows reduction in cost by eliminating the need for direct small shipments using LTL shipments. Toyota uses milk runs both in Japan and in the USA to support its JIT manufacturing (Chopra & Meidl 2001).

Cross docking

This is a strategy made famous by Wal-Mart, the giant USA chain.

In your text

Read example 5-13 in your text, page 135.

The concept of cross docking is built on utilising the economies of scale in transportation without raising the level of inventory at any intermediate stage. When a plant or supplier receives orders from a single retailer but the size does not allow direct shipment to that retailer, cross docking perhaps is the best alternative as the response time to order is not significantly affected; and similarly there is no adverse effect on the level of inventory. In fact, for the particular commodity, the warehouse is nothing more than a transfer point.

In technical terms cross docking covers any distribution method that avoids putting product into storage before sending it on to retail stores or other outlets. Instead, the goods move from the receiving dock to the shipping dock, or are held in a temporary staging area before moving to the outbound dock (Harrington 1993). Cross docking makes two of the four warehousing functions, storage and order picking, redundant.

A cross dock is a transhipment facility at which trucks arrive with goods that must be sorted, consolidated with other products, and loaded onto outbound trucks bound for a retailer.

Figure 6.4 Cross docking practice

The following reading deals quite comprehensively with traditional warehousing practices and cross docking. Note the similarities and differences of cross docking with traditional mixed warehousing strategy.

Warehousing and distribution strategies

We have covered warehousing concepts in Logistics Management and are aware of the traditional functions. Reading 6.3 also deals extensively with warehousing techniques. Warehouses in a supply chain balance the differences between the rates of consumption and production by keeping enough stocks to meet market demands with the required level of service. One of the vital components of the required stock level for a particular SKU or item is the safety stock, the level of which is dependent on the demand variability. What happens to the required safety stock when warehouses are eliminated from the supply chain because of direct shipment and cross docking strategies? The need for safety stock is as strong as ever, but this stock will move to the distribution system with each store keeping a sufficient level of safety stock for a longer lead time.

Transhipment

We have seen how centralisation of inventory, provided certain conditions are met, reduces the aggregate level of safety stock required at a certain level in the supply chain. But managerial decisions may not allow complete closure of a warehouse or total centralisation for many reasons, including service level and response time to the market demands. One effective alternative in this case is the method of transhipment.

Transhipment is enabled by a good information link between the various facilities and a quick and reliable transportation link. The technique of transhipment can be explained by considering a firm with multiple, geographically dispersed stock keeping facilities (retail outlets or warehouses). These facilities are expected to serve all demands originating within a captive geographic area. A transhipment occurs when a facility satisfies demand from a territory other than its own (Evers 1997). Effective transhipment results in reduced safety stock requirement and fewer stock outs. The net effect is similar to risk pooling.

Transhipment refers to shipments of items between two facilities in the same echelon. This assertion should not be confused as what is important is how the demand is satisfied. If we are considering transhipment at the warehouse level, it would be meaningless to ship the required item to another warehouse and then to reship to the retail unit, unless some sort of consolidation or value adding is carried out at the initial warehouse.

Figure 6.5 Transhipment at the warehouse level. Though W/H 1 is shipping direct to a retailer at market B, the demand of W/H 2 is met by stocks kept in W/H 1.

Similarly, it is possible to make shipments between retail outlets to meet varying demand at different locations. When all retail outlets are owned by the same owner, this strategy can be easily implemented provided the demand patterns faced by the various units support the strategy.

Figure 6.6 Transhipment between retail outlets

The benefits of transhipment are similar to risk pooling. It is possible to reduce the aggregate level of inventory within the echelon. It is quite obvious that an efficient system based on transhipment would require readily available information and an efficient transportation system to keep customer order response time to an acceptable minimum. As in the case of risk pooling, in instances where markets exhibit high degrees of demand variability, the use of transhipment should enable firms to reduce inventory

significantly. The main concern here is the increase in transportation costs and this has to be weighed against the gains achievable by transhipment. When one is considering retail outlets owned by different owners, this kind of pooling would require considerable efforts towards integration of information and business processes.

Central versus local facilities

The distribution strategies are intrinsically linked with the location and number of facilities in the supply chain. We have covered the main considerations for effective decision making regarding facility location, numbers and trade offs involved in chapter 3.

In your text

Read Section 5.6 in your text for a revision of many of the concepts.

You will notice that there are numerous factors which a firm must consider before deciding the number of facilities and the extent of centralisation of its distribution network. The following table sums up these factors.

Table 6.1 Factors affecting the number of warehouses (Coyle et al 2003, pp.321-322)

Factor Centralised Decentralised

substitutability low high

product value high low

purchase size large small

special warehousing yes no

product line diverse limited

customer service low high

Push versus pull systems

A supply chain is often described in terms of push or pull systems. More accurately, it is the processes which are categorised as pull or push processes. When a supply chain is made up of processes which are mainly push type, the system can be called a push system. But what does it actually mean? Chopra and Meindl (2001) defines a process as push or pull depending on the timing of the execution of the process with respect to the customer demand. In other words, a push process is forecast driven and executed in anticipation of demand, whereas a pull process is demand driven and is initiated in response to real demand.

We have already seen the shortcomings of forecast driven manufacturing and stocking decisions, and seen how the focus is now on more demand based manufacturing and stocking decisions. The trend is for a shift from a push based system to a pull based system, with the obvious result in the reduction in inventory levels and in superfluous manufacturing and purchasing. But is it possible to transform entire supply chains to 'pull' models? We need to look at the concepts a bit more closely.

Push systems

A supply chain , at least at one end, has the customer interface where the demand of the customer intervenes in the firm's business process. So, at that stage, demand will meet the processes made in anticipation of future demand. This is the push/pull boundary. A push based system will have the boundary at the downstream end. A supply chain of a typical manufacturing firm is a push system. The manufacturer manufactures and amount of goods based on forecast demand and pushes the stock downstream to be available at various locations and retailer outlets. Every store in which a customer can walk in and buy off the shelf without transmission of any prior intention to purchase the item is an example of a push/pull boundary of a push type supply chain system. The uncertainties associated with forecasts (remember the bullwhip effect) makes it imperative that safety stocks be kept; whereas unanticipated demand variability ensures that production requirements have to be geared up or down to meet the changing market dynamics. These all add to the inefficiencies associated with push type systems.

Pull systems

Pull systems are based on real demands and production and manufacturing is done in accordance with demands. In effect, push systems are based on a 'built to stock' concept, while pull systems are based on a 'built to order' concept. At this stage the most obvious question is how long will the customers wait after an order is initiated and before the product is made available? Or what incentive does the customer have to order in advance to wait for a product whereas he or she can walk into another store and buy it off the shelf? Let us look at the supply chain model of Dell computers, which is often cited as a prime example of a pull system.

The following excerpt is taken from Chopra and Meindl (2001):

Dell does not sell through a reseller or distributor but rather directly to the consumer. Demand is not from finished product inventory but from production. The arrival of a customer order triggers production in final assembly. The manufacturing cycle is thus part of a customer order fulfilment process in the customer order cycle. There are

effectively only two cycles in the Dell Supply Chain: (1) a customer order and manufacturing cycle and (2) a procurement cycle.

All processes in the customer order and manufacturing cycle at Dell are thus classified as pull processes because they are initiated by customer arrival. Dell, however, does not place component orders in response to a customer order. Inventory is replenished in anticipation of customer demand. All processes in the procurement cycle for Dell are thus classified as push processes because they are a response to a forecast.

Figure 6.7 Push/pull boundary in Dell's supply chain

As evident from the Dell model, when one considers physical products and the extended supply chain, the system will be a combination of the push/pull system.