Chapter 8: Supply Chain Management

Basic Concepts in Supply Chain Management

Supply chain management (SCM) aims to integrate different parties in the supply chain in order to satisfy the customer needs with maximum profitability. There are different definitions for supply chain management. According to the Council of Supply Chain Management Professionals (CSCMP), supply chain management encompasses the planning and management of all activities involved in sourcing, procurement, conversion, and logistics management. It also includes coordination and collaboration with channel partners, which may be suppliers, intermediaries, third-party service providers, or customers. In essence, supply chain management integrates supply and demand management within and across companies. Supply chain management is also defined as a set of approaches utilized to efficiently integrate the supply chain members in order to maximize total supply chain profitability. Supply chain management aims to produce and distribute the products to the right locations, at the right time, at the right quantities, in order to maximize systemwide profitability while satisfying customer service levels. To satisfy the customer needs, raw materials are procured from suppliers and products are manufactured at manufacturing facilities. Then, they are sent to warehouses or distribution centers in order to be delivered to retailers and customers. Every facility that has a role in satisfying customer needs and has an impact on cost needs to be taken into consideration in supply chain management. These facilities range from supplier and manufacturing facilities through warehouses and distribution centers to retailers and stores. It might also be necessary to consider the suppliers’ suppliers and the customers’ customers in the system if they have an impact on supply chain performance.

Development of Supply Chain Management

Supply chain management has attracted increasing attention and analyzed in further detail starting in 1990s, however its roots go back many years, back to industrial revolution and mass production operations. The first applications of supply chain management was related to logistics operations, which prove its importance and were analyzed deeply starting with World War II. In 1940s and 1950s, managers mostly focused on their transportation and logistics operations to improve their businesses. In 1960s, inventory management and cost control became to be the main focus. In 1970s, materials requirement planning (MRP) systems start to emerge and operations management tactics started to be used in businesses. In 1980s, MRP systems became much more advanced and MRP II systems began to be used. Globalization increased at this era and many organizations started to integrate global sources into their business. The supply chain management term was first used at this era in 1982. With the advances in Japan, Just-in-Time philosophy and lean production systems also emerged at this period and companies started to modify their businesses accordingly.

In 1990s, companies began to focus on their core competencies and specialization became the main focus. Companies started to integrate their purchasing, manufacturing, distribution, financials etc., with the help of growing Enterprise Resource Planning (ERP) systems. Also, integrating other companies into core operations of the businesses led to SCM systems to emerge in this era. In 2000s, the definition of SCM has broadened to include things like supply chain strategy, co-innovation and supply chain design, and was named as SCM 2.0. In addition, with the development of Internet and ebusinesses, different supply chains and management techniques developed in this period. Real-time decision support systems, synchronized and collaborative extended supply chain networks are a few of the developments in this era. Lately, in today’s world, environmental and social considerations are becoming much more important and managers are trying to increase sustainability in their supply chains and decrease their carbon footprints.

Views of Supply Chain Processes

Supply chain systems are analyzed via different views. Cycle View and Push/Pull View are two of the most commonly used ways to view the processes in a supply chain:

Cycle View: In every supply chain there are different relations between the supply chain members. A supply chain can be analyzed as a combination of these relations. According to this view, the operations between the customers and the retailers are named as the Customer Order Cycle. In this cycle, customers place the orders and the retailers aim to satisfy these orders. Customer Relationship Management (CRM) approaches are mostly utilized at this cycle. In order to satisfy the customer orders, the retailer needs to replenish the inventories from the distributors. The relation between the retailers and distributors is analyzed through the Replenishment Cycle. Distributors obtain the products from the manufacturers and this relation is named as the Manufacturing Cycle. Finally, manufacturers need raw materials in order to produce their products and they obtain these raw materials from the suppliers. The operations between the suppliers and manufacturers are analyzed via the Procurement Cycle. Supplier Relationship Management (SRM) approaches are widely utilized in this cycle.

Push/Pull View: According to push/pull view, processes in a supply chain are divided into two groups depending on whether they are executed in response to a customer order (pull) or in anticipation of a customer order (push). A pull system is a reactive one and execution is initiated in response to a customer order. On the other hand, a push system is a speculative one and execution is initiated in anticipation of customer orders. A make-to-order system in which manufacturing is done according to customer orders is an example of a pull system. In this system, first the customer makes the order and specifies the product characteristics and then the manufacturing processes start. The product is delivered to the customer after a certain time period, called as the lead time. On the other hand, a retail store that places the products on the shelves and waits customers to come and buy them is an example of a push system. In this system, products are manufactured and delivered to retail stores first, and then the customers arrive to the system and buy the products.

Strategic Fit in Supply Chains

Every company also needs to develop a competitive strategy that defines the customer needs to satisfy through its products and services. Based on the competitive strategy, they then need to build a product development strategy that specifies the portfolio of products that the company will develop. Marketing and sales strategy of the company specifies how the market will be segmented, products will be positioned, priced and promoted. Finally the supply chain strategy determines how materials will be procured, transported, manufactured and distributed. All these strategies should be in line with each other and support each other in order for the supply chain to be successful. Supply chains need to be designed to satisfy the customer expectations (the target customers that the company intends to serve), and supply chain management decisions need to support this issue. The consistency between customer expectations and supply chain capabilities and supply chain strategies is defined as the strategic fit. Strategic fit is the consistency between customer expectations and supply chain capabilities and supply chain strategies.

To understand the customer expectations, a company needs to identify the needs of the customer segment that they serve. Every company needs to analyze and understand the characteristics of their customers and decides on several attributes based on their expectations.

Uncertainties in demand also have a significant effect on supply chain strategies. If the demand uncertainty is low, then the company can easily estimate how much product of each type they can sell and can manufacture these products before the actual demand happens. The customers can obtain their products immediately and there is a low risk of unsold items or stock-outs. A push strategy might be more appropriate in this case. However, if the demand uncertainty is high, the company would have a hard time in estimating which products to manufacture at which quantities. There will be a high risk of unsold items and stock-outs in that case. If the customers would be willing to tolerate some waiting times, manufacturing the products after the customer orders in a pull setting and operating in make-to-order fashion might be more appropriate in that case. According to Chopra and Meindl, supply chain responsiveness is defined as the supply chain’s ability to

a. respond to wide ranges of quantities demanded
b. meet short lead times
c. handle a large variety of products
d. build highly innovative products
e. meet a high service level
f. handle supply uncertainty

A supply chain’s responsiveness is measured by its ability to respond to wide ranges of quantities demanded, meet short lead times, handle a large variety of products, build highly innovative products, meet a high service level and handle supply uncertainty.

There is no single right strategy for every supply chain but instead there is a right strategy for a supply chain depending on the needs of its target customers, characteristics of the products and the capabilities of the supply chain.

If demand uncertainty is low, customer expectations can be almost known in certainty beforehand and decisions can be made much easily that will minimize the costs and an efficient supply chain would be a better fit for this system. However, as the demand becomes more uncertain, the supply chain needs to be more responsive and more flexible to handle the changes in demand. In order to satisfy the customer demand and meet customer expectations, higher varieties might be produced, higher capacities might be built and a more flexible production system might be developed.

Supply Chain Management Decisions

The objective of supply chain management is generally to maximize profitability across the entire system. Supply chain managers aim to maximize total systemwide profitability which is mainly the difference between the revenues from sales and the system costs which include material costs, transportation and distribution costs, manufacturing costs and inventory costs among others. Thus, supply chain management does not simply aim to minimize transportation cost or reduce inventories but instead requires a systems approach that includes all operations and related revenue and cost factors in the supply chain.

Supply chain management encompasses the company’s activities and decisions at many levels. These decisions can be classified as strategic, tactical and operational level decisions depending on their significance and the time span that they cover.

Strategic Level Decisions: These decisions are long-term (over several years) decisions and they are generally about the structure of the supply chain. Locations and capacities of facilities, products to be manufactured, information systems to be used, modes of transportation are some examples of such decisions. These decisions are mostly made by the top level managers. Strategic level decisions are long-term decisions that are generally about the structure of the supply chain and made by top level managers.

Tactical Level Decisions: Tactical decisions in supply chains are a set of policies that govern medium term (generally between 6 months and 2 years) decisions and they are constrained by the strategic decisions. Which locations will supply which markets, inventory policies, when and how market promotions will be made, subcontracting and backup decisions are a few examples of tactical decisions.

Operational Level Decisions: Operational decisions are generally daily or weekly decisions that need to be made to operate daily activities. When making these decisions, strategic and tactical decisions are fixed and operating policies are already determined. The main goal is to implement the operating policies as effectively as possible.

Facility Decisions : Facility decisions are among the most important decisions in supply chains. Where to locate the facilities, what should be their capacities, what is going to be done at these facilities are some of the most critical decisions in supply chains. Global companies that produce multiple products decide to produce some items at one location while producing others at other locations. Which products should be produced at which facility, which customers should be supplied from which facilities are a few of the most critical strategic level decisions. Location and capacity decisions about the facilities also should be in line with the supply chain strategy.

Manufacturing Decisions: Manufacturing is one of the main operations in a supply chain and there are various decisions around it. Which products to manufacture for the target customers, how should the products be designed, when, where and how much to produce, what type of machines and manufacturing methods will be used, what should be the production plan and production schedule, how will the demand be forecasted, what should be the quality control, maintenance, research procedures to be used for production are some of the most critical decisions that need to be made in supply chains. Manufacturing decisions are affected by the supply chain strategy such that depending on the target customers, the types, quantities and qualities, the innovation level in products, operating procedures might change. In a responsive supply chain which target high-end customers, highly innovative products with better quality control, and faster and highly automated production methods can be chosen. However, for an efficient supply chain that aims to minimize costs, standard products with lower quality might be acceptable.

Inventory Decisions: Companies in a supply chain keep inventories mainly because of the reasons stated as below:

• Uncertainties in demand and supply: Companies keep inventories as a precaution for unexpected changes in demand and supply. Inventory kept above the expected level of demand is defined as the safety inventory and is used to satisfy the demand if demand happens to be above expectations.
• Economies of scale: Materials and products are bought at large quantities due to fixed order and transportation costs and to benefit from quantity discounts. The inventory used to satisfy demand between receipts of supplier shipments is defined as the cycle inventory.
• Production smoothing: If demand varies at different periods, companies sometimes produce more than the demand at low demand seasons and use the remaining inventory at high demand seasons if production capacity is insufficient. The inventory built up at low demand seasons and used up at high demand seasons is defined as the seasonal inventory.
• Anticipations about price changes: Companies sometimes buy more than what they need if they anticipate a price increase in the near future.

Transportation Decisions: Decisions about the movement of products between the facilities in the supply chain are in scope of the transportation decisions. Which mode of transportation (air, truck, rail, ship, pipeline or electronic transportation) to use, which routes should be selected, what should be the logistics network between the facilities, should the products be shipped directly to the customers or should different distributors be used, should a third party logistics company be utilized or should logistics operations be done with in-house vehicles, are some of the decisions that need to be made related to transportation operations.

Information Decisions: Information systems have a significant effect in the coordination between different parties in the supply chain. A healthy and fast communication between the members of the supply chain is critically important for smooth completion of the operations. In order to make good decisions, companies need to have the necessary information as quickly and as correctly as possible. Information systems is the backbone of the supply chains.

Sourcing Decisions: Sourcing can be defined as the processes to obtain or buy goods or services. Sourcing is concerned with what needs to be purchased, where it should be purchased from, when and why it should be purchased. There are various decisions related to sourcing in supply chains. Supplier selection and evaluation, outsourcing, supplier contracts, single or multiple sourcing are some of these decisions.

Quality, timeliness in delivery, price, reliability, past performances, technical competency, research and innovation capabilities, guarantee and return policies, production capacity and flexibility are some of the major factors that affect supplier selection.

Pricing and Marketing Decisions: Pricing is an important decision that affects the customers whether to buy the product or not. Pricing decisions will directly affect the demand and the sales of the company, which later on affect all the other production, distribution, inventory or sourcing related decisions. Pricing and marketing decisions can be used as very effective strategies to increase supply chain profitability. Depending on the customer expectations and supply chain capabilities, prices can be increased or decreased at different times in order to match supply and demand.

Most of the decisions stated above are actually related with each other. A decision about one of the factors might affect the decisions about others. Improving one part of the system without considering others might lead to unwanted results. In addition, the production capacity might not be enough to satisfy the increased demand, leading to stock-outs and unhappy customers in the system. Thus, a supply chain system need to analyze all of these decisions together in an interrelated setting using a systems approach. A supply chain manager needs to understand the effects of the decisions on all parts of the supply chain and make these decisions accordingly in order for the supply chain to be successful.

Supply Chain and Logistics

The concepts of supply chain and logistics are commonly mistaken for each other. Even though logistics is in relation with the sourcing, manufacturing, marketing and finance departments among others, it is mainly related with the distribution and transportation of products or services between facilities. However, supply chain management is a much larger concept that deals with all the operations from the sourcing of raw materials until the delivery of the product or service to the end-user and it includes logistics activities. Supply chain management includes all the sourcing, manufacturing, information and marketing decisions in addition to logistics or distribution decisions.

According to CSCMP, logistics management is defined as the part of supply chain management that plans, implements, and controls the efficient, effective forward and reverse flow and storage of goods, services and related information between the point of origin and the point of consumption in order to meet customers’ requirements. Logistics operations are about the transportation and distribution of raw materials, semifinished goods and finished goods between the facilities up to the customers.

The part of the logistics operations that are about supplying the materials needed for manufacturing from the suppliers to the manufacturers are called inbound logistics and the part that are about delivering the finished goods from the manufacturers to the customers are called outbound logistics. The logistics operations that are performed inside the manufacturing facility are called manufacturing logistics.

The mission of logistics is to provide the right materials at the right place and at the right time, while optimizing a given performance measure subject to a given set of constraints. Supply chain managers need to design their logistics and distribution networks according to their supply chain strategy. There exists different distribution network designs used for delivering the products to customers.

Manufacturer Storage with Direct Shipping: In this system, all the products are stored at the manufacturing facilities. Customers give their orders through retailers or online order systems and manufacturers ship exactly what the customer wants from the manufacturing site directly to the customer. Since there is no distribution center in this system, facility operating costs are minimized. In addition, customized production can be done and the company does not need to keep high levels of inventory. Different varieties of products can be supplied to customers depending on their orders. Generally this system is used for high value products with low demand and high variety. However, this system also has several disadvantages. First of all, since every customer order is shipped separately from the manufacturer site directly to the customer, it causes very high transportation costs. In addition, customers have to wait certain times in order to obtain their products leading to high response times. Customers should be willing to tolerate these response times in order for this system to be usable.

Manufacturer Storage with Direct Shipping and InTransit Merge: This system is just like the above one except that pieces of customer orders coming from different manufacturing sites are merged on the way by the shippers or cargo carriers so that the customer gets a single delivery even if his order is composed of multiple pieces produced at different locations. Cross-docking is a logistics system in which materials from incoming vehicles are directly redistributed to outbound vehicles with minimum handling or storage in between.

Distributor Storage with Carrier Delivery: In this system, products are stored at distribution centers or at retailer warehouses and package carriers deliver these products from these locations to customers. The distribution centers are generally built closer to customers so that response times are much shorter and outbound transportation costs are much lower than manufacturer storage networks. Distributor or manufacturer storage and related e-business systems started to be increasingly used especially with the developments in Internet technologies in today’s world.

Retail Storage with Customer Pick-up: This is the most traditional network design in which products are kept at retail stores and customers go to these retail stores in order to buy the products. The response time is shortest in this setting so that customers can immediately buy the product when they come to the store. In addition, the company does not need to pay any transportation cost to deliver the product to the customer. However, distributing the products from the manufacturers to retailers will require a certain transportation cost.

Supply Chain Structure and Coordination

Supply Chain Structure

The structure of the supply chain defines the length, width and dimensions of the chain as well as the number of  facilities in the chain and their relations with each other. The supply chain structure might vary from a simple serial supply chain to a broad network of supply chain facilities. Figure 8.5 shows different supply chain structures. For each company in a supply chain, facilities that provide materials into that company is called upstream while facilities that take materials from the company are called downstream.

The structure of the supply chain is affected by many factors, such as the customer demand and characteristics, transportation options and costs, economic factors, market culture, financial system etc. Some supply chains can be very short, while some others can be very long. Similarly, some companies prefer a narrow supply chain, in which the materials are supplied only from a few suppliers and products are distributed through a small number of parallel channels.

Coordination and Collaboration in Supply Chains

Supply chains can be classified as centralized and decentralized supply chains based on the collaboration between supply chain members. A supply chain in which independent companies make their own decisions in order to maximize their own profitability is called a decentralized supply chain.

One approach to achieve coordination is contract mechanisms. Under these mechanisms, relationships between suppliers and buyers are established through contracts that define the quality and specifications of the product, pricing and discounting structures, delivery lead times, return procedures etc. Contracts help to align the objectives of independent parties in decentralized supply chains with the objective of the whole supply chain.

Another approach used for supply chain coordination is strategic partnerships between companies. Strategic partnerships can help both members increase their profitability. It is commonly seen in the real world that many manufacturers build strategic partnerships with their suppliers and logistics providers. Manufacturing companies share critical information with their strategic partner suppliers, like their demand data or production schedules so that suppliers can make their own plans in a better manner, leading to timely deliveries of materials with lower cost. Suppliers also share their production capabilities, inventories, production costs and schedules with the manufacturers so that manufacturers can plan their own production according to supplier constraints. This strategic partnership will benefit both the supplier and the manufacturer since the supplier can produce the required items at the right time with a lower cost, and the manufacturer will benefit from this system since they can obtain the materials exactly when they need and can smooth out their production without needing to keep high amounts of raw material inventory.

Bullwhip Effect

One of the most interesting dynamics observed in supply chains is called the Bullwhip Effect. The phenomena that small changes in customer demand at the end of the supply chain propagate to the beginning of the supply chain with significantly increased order variations is called the Bullwhip Effect.

Hugos (2011) state five major factors that are attributed to the cause of the bullwhip effect. These factors are stated as demand forecasting, order batching, product rationing, product pricing and performance incentives.

Demand Forecasting: Companies at the lower stages of the supply chain, like suppliers, cannot observe the actual customer demand and can only forecast the demand through orders that they receive from their immediate customers. When they use the order data to forecast the demand, they just add another distortion into the actual demand, leading to much higher variations than there actually exists. This distortion in forecasts are also passed on to the supplier of that company, leading to much higher distortions.

Order Batching: Companies generally give orders to their suppliers at periodic intervals by combining the demand in those periods. Batching the orders in this manner causes variations from the actual demand values and this variation is magnified as it goes to the beginning of the supply chain.

Product Rationing: Product rationing is the practice of controlling the distribution of a scarce product. When companies are faced with more demand than they have in stock, they allocate the existing inventory among its customers and backorder the rest. When the retailers or distributors get less than what they order, in the next periods they artificially increase their orders, thinking that only a portion of their order will be satisfied. When all of this order is satisfied, then they have excess inventory and order much less than the demand in the upcoming periods. This leads to increased variations in orders which is very much different than actual demand variation.

Product Pricing: When product prices fluctuate, demand also fluctuates, leading to variations in sales across periods. These fluctuations cause much increased variations through the end of the supply chain, leading to increased costs and inefficiencies in the system.

Performance Incentives: Generally companies provide several incentives to their workers if they meet certain objectives. However, these incentives do not always work in the best interest of the supply chain. For example, when an incentive is given to the sales force on sales made each period, the sales force would make some discounts or increase their efforts as the end of the period approaches in order to meet the quotas. This behaviour leads to changes in the demand structure and causes variations in demand. Performance incentives might also conflict with company objectives. For example, a transportation manager might try to decrease the transportation costs in order to obtain the performance incentive, however these actions might lead to additional inventory costs and loss in customer service levels, which are not wanted by the supply chain.

Sustainability in Supply Chains

Economic, environmental and social considerations are three main pillars of sustainability and maintaining the balance between them is the key issue to achieve sustainability.

Waste electrical and electronic equipment (WEEE) directive applied by the European Environment Agency promotes reuse, recycle and other forms of recovery of WEEE items in order to reduce the quantity of such waste to be disposed and to improve the environmental performance of the economic operators involved in the treatment of WEEE. The WEEE Directive forces the electronic companies to collect at least a certain portion of their products back from the customers at the end of their useful lives and sets the criteria for the collection, treatment and recovery of waste electrical and electronic equipment. In addition, the regulations in different countries concerning CO2 emissions, working hours and worker rights create new challenges for the companies in their operations.

Companies are trying to find new ways to manage their operations with decreased emissions and aim to move in the direction of more sustainable operations. In addition, transporters are bound by the legislations enforcing driver working hours, and unbalanced working times are seen to create problems among the workers and against the company.

Closed-loop supply chain management refers to the integration of forward and reverse supply chain activities and improves the sustainability of supply chains. Traditional supply chains are generally forward supply chains and deal with the forward movement of products from the supplier to the end customer. On the other hand, reverse supply chain activities consider the collection of used products from the customer and deal with backward movement of products from the customer to the related facilities. Closed-loop supply chain (CLSC) management refers to the integration of forward and reverse supply chain activities and improves the sustainability of supply chains.

Collection of used products from the customers is one of the most important tasks that affects all the other activities in the reverse supply chain.

Remanufacturing is the process of collecting used items, extracting the useful parts and reusing these parts in the production of new products. Remanufacturing has both economical and environmental consequences. In addition to saving from direct material costs, companies also save from disposal and energy costs through remanufacturing.

Closed-loop supply chain management activities help to use less resources, both in terms of materials and energy, and less emission is produced since they utilize already existing products and it is not required to manufacture every piece from scratch. In addition, less number of products are sent for disposal in the world since end-oflife products are collected and re-used instead of going to waste. These activities help to improve the sustainability of the operations and to preserve the world by decreasing the carbon footprints of the supply chain companies. For this reason, these operations are also called green supply chain management activities in different sources.