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Chapter 10
Supply Chain Strategy

©The McGraw-Hill Companies, Inc., 2006

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OBJECTIVES

 Supply-Chain Management
 Measuring Supply-Chain

Performance
 Bullwhip Effect

 Outsourcing

 Value Density

 Mass Customization

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What is a Supply Chain?

 Supply-chain is a term that describes
how organizations (suppliers,
manufacturers, distributors, and
customers) are linked together

Suppliers Service support Local Customers

Services operations service
providers
Inputs Transformation Localization Output
Supply networks

Manufacturing Suppliers Manufacturing Distribution Customers

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What is Supply Chain

Management?

 Supply-chain management is a total

system approach to managing the
entire flow of information, materials,
and services from raw-material
suppliers through factories and
warehouses to the end customer

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 What recent changes have caused supply

chain management to gain importance?
a. Competitive pressures from foreign firms.
b. Elevation of product quality to a very high level of
importance.
c. International marketing and international
purchasing.
d. Trends towards choosing sole-source suppliers
and long term relationships.
e. Product varieties and ranges are rapidly
changing, and speed of delivery to market is
essential.

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f. Product life cycles have shortened necessitating

knowledge and control of inventories in the
various pipelines.
g. Adoption of JIT production has changed supplier
relationships and has also increased the focus on
reducing inventories.
h. Trends in the legal system hold manufacturers
liable for product failures, even though causes of
failure may lie outside of the production system
itself.
i. Use of EDI in purchasing.
j. The growth of supplier development.

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Formulas for Measuring Supply-

Chain Performance

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Formulas for Measuring Supply-

Chain Performance
 One of the most commonly used measures in
all of operations management is “Inventory
Turnover”
Cost
Costof
of goods
goods sold
sold
Inventory turnover 
Inventory turnover 
Average
Averageaggregate
aggregateinventory
inventoryvalue
value
 In situations where distribution inventory is
dominant, “Weeks of Supply” is preferred and
measures how many weeks’ worth of inventory
is in the system at a particular time
Average
Averageaggregate
aggregateinventory
inventoryvalue
value
Weeks
Weeksof supply
of supply 52
 52weeks
weeks
 Cost of goods sold
Cost of goods sold 
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Example of Measuring Supply-

Chain Performance
Suppose
Suppose aa company’s
company’s new new annual
annual report
report
claims
claims their
their costs
costs of
of goods
goods sold
sold for
for the
the
year
year is
is $160
$160 million
million and
and their
their total
total average
average
inventory
inventory (production
(production materials
materials ++ work-in-
work-in-
process)
process) isis worth
worth $35
$35 million.
million. This
This
company
company normally
normally hashas anan inventory
inventory turnturn
ratio
ratio of
of 10.
10. What
What isis this
this year’s
year’s Inventory
Inventory
Turnover
Turnover ratio?
ratio? What
What does
does itit mean?
mean?

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Example of Measuring Supply-

Chain Performance (Continued)
Cost
Cost of
of goods
goods sold
sold
Inventory turnover
Inventoryturnover
Average
Averageaggregate
aggregateinventory
inventoryvalue
value
==$160/$35
$160/$35
==4.57
4.57

Since
Sincethe
thecompany’s
company’snormal
normalinventory
inventoryturnover
turnoverration
rationis
is
10,
10,aadrop
dropto
to4.57
4.57means
meansthat
thatthe theinventory
inventoryisisnot
not
turning
turningover
overasasquickly
quicklyas
asitithad
hadin inthe
thepast.
past. Without
Without
knowing
knowingthe
theindustry
industryaverage
averageof ofturns
turnsfor
forthis
this
company
companyititisisnot
notpossible
possibleto tocomment
commenton onhow
howthey
they
are
arecompetitively
competitivelydoing
doingin
inthe
theindustry,
industry,but
butthey
theynow
now
have
havemore
moreinventory
inventoryrelative
relativeto totheir
theircost
costof
ofgoods
goods
sold
soldthan
thanbefore.
before.
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Bullwhip Effect
The
Themagnification
magnificationof
of variability
variabilityin
inorders
ordersin
inthe
thesupply-
supply-
chain
chain

Retailer’s Orders Wholesaler’s Orders Manufacturer’s Orders

Quantity

Quantity

Quantity
Order

Order

Order
Time Time Time

AAlot
lotofof …can
…canlead
leadto
to …can
…canlead
leadtoto
retailers
retailerseach
each greater
greatervariability
variability even
evengreater
greater
with
withlittle
little for
foraafewer
fewernumber
number variability
variabilityfor
foraa
variability
variabilityinin of
of wholesalers,
wholesalers, single
single
their
theirorders….
orders…. and…
and… manufacturer.
manufacturer.

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 It indicates a lack of synchronization

among supply chain member
 Campbell Soup introduced continuous

replenishment through EDI for the

retailers where they can order and report
their level of inventories and offers an
“everyday low price” that eliminate
discount.
 Through this system CS can cut the

retailers’ inventories to half and in turn

increase profits by 50 percent.
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 Marshall Fisher has developed a

framework to help managers understand
the nature demand for their products.
 The importance aspects of product’

demand are : product life cycle, demand

predictability, product variety, and market
standards for lead times and service.
 He has found that products can be

categorized as either functional of

innovative.

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 Differences between functional and

innovative products :
Functional products are staples that people buy in a
wide range of retail outlets. Typically, they do not
change much over time, have low profit margins,
stable predictable demand and long life cycles.
Innovative products, on the other hand, give
customers additional reasons to buy. Fashionable
clothes and personal computers are examples of
innovative products. Innovative products have short
life cycles, high profit margins, and volatile demand.

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Hau Lee’s Concepts of Supply

Chain Management
 Hau Lee’s approach to supply chain (SC) is one of
aligning SC’s with the uncertainties revolving around
the supply process side of the SC
 A stable supply process has mature technologies and
an evolving supply process has rapidly changing
technologies
 Types of SC’s
– Efficient SC’s
– Risk-Hedging SC’s
– Responsive SC’s
– Agile SC’s

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Hau Lee’s SC Uncertainty

Framework
Demand Uncertainty

Low (Functional High (Innovative

products) products)

Low Efficient SC Responsive SC

Supply (Stable
Ex.: Grocery Ex.: Computers
Process)
Risk-Hedging SC Agile SC
Uncertainty High
(Evolving Ex.: Hydro- Ex.: Telecom
Process) electric power

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 What are characteristics of efficient,

responsive, risk-hedging and agile
supply chains?
 Can a supply chain be both efficient

and responsive? Risk-hedging and

Agile? Why or Why not?

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 Efficient supply chains are designed to minimize

cost that requires high utilization, minimizing
inventory, and selecting vendors based primarily on
cost and quality, and designing products that are
produced at minimum cost.
 Market-responsive supply chains are designed to
minimize lead time to respond to unpredictable
demand, thus minimizing stockout costs and
obsolete inventory costs.
 Risk sharing supply chains are those that share
resources so that risks in the supply chain can be
shared.


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 Agile are those supply chains that are flexible

while still sharing risks of shortages across
the supply chain.
 Generally, these supply chains carry excess
capacity and higher buffer stocks.
 Vendor in responsive supply chains would be
selected for speed, flexibility, and quality.
 It is possible to be both efficient and
responsive, and both Risk-hedging and Agile.

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What is Outsourcing?

Outsourcing is defined as the act of

moving a firm’s internal activities
and decision responsibility to
outside providers

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Reasons to Outsource

 Organizationally-driven
 Improvement-driven
 Financially-driven
 Revenue-driven
 Cost-driven
 Employee-driven

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Value Density

 Value density is defined as the

value of an item per pound of
weight

 It is used as an important measure

when deciding where items
should be stocked geographically
and how they should be shipped

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 For an example, Assume that the

inventory carrying cost rate is 30
percent per year of the product value.
This cost rate captures the cost of
capital, insurance, warehouse cost, and
so on.
 Our alternative transportation modes

are highway service provided by United

Parcel Service (UPS) by ship and
Federal Express by air.

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 Where :
Break-Even Product Value
= 365 x Shipping cost savings
0.30 x 6
Shipping cost savings
= Air shipping cost – Regular highway
shipping cost

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Mass Customization

 Mass customization is a term used to

describe the ability of a company to
deliver highly customized products and
services to different customers
 The key to mass customization is
effectively postponing the tasks of
differentiating a product for a specific
customer until the latest possible point
in the supply-chain network

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 How to do it?
Principle 1:
A Product should be designed so it consists
of independent modules that can be
assembled into different forms of the
product easily and inexpensively.
Principle 2:
Manufacturing and service processes
should be designed so that they consist
of independent modules that can be
moved or rearranged easily to support
different distribution network design.
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Principle 3:
The supply network-the positioning of
inventory and the location, number, and
structure of service, manufacturing, and
distribution facilities-should be designed to
provide two capabilities.
First, it must be able to supply the basic product to
the facilities performing the customization in a cost-
effective manner
Second, it must have the flexibility and the
responsiveness to take individual customers’ orders
and deliver the finished, customized good quickly.

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Question Bowl

A typical supply chain would include

which of the following?
a. Suppliers
b. Manufacturers
c. Distribution
d. All of the above
e. None of the above

Answer: d. All of the above

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Question Bowl
The supply chain measure of
“Inventory Turnover” is which of the
following ratios?
a. Avg. inventory value/total costs
b. Costs of goods sold/Avg. aggregate
inventory value
c. Total costs of goods/Avg. costs of
goods
d. Weeks worth of inventory/No. of
weeks
e. None of the above
Answer: b. Costs of goods sold/Avg.
aggregate inventory value

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Question Bowl
If the “cost of goods sold” for a company
is $1,000,000 and the “average
aggregate inventory value” is $25,000,
which of the following is the
“inventory turnover”?
a. 10
b. 25
c. 40
d. 50
e. None of the above

Answer: c. 40 (1,000,000/25,000=40)
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Question Bowl
If the “cost of goods sold” for a company
is $250,000 and the “average
aggregate inventory value” is $5,000,
which of the following is the
“inventory turnover”?
a. 10
b. 25
c. 40
d. 50
e. None of the above

Answer: d. 50 (250,000/5,000=50)
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Question Bowl
If the “cost of goods sold” for a company
is $1,000,000 and the “average
aggregate inventory value” is $50,000,
which of the following is the “weeks of
supply” measure for supply chain
performance?
a. 1 week
b. 2.6 weeks
c. 20 weeks
d. 30 weeks
e. None of the above

Answer: b. 2.6 (50,000/1,000,000)x52=2.6)

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Question Bowl
Which of the following refers to the
phenomenon of increasing variability as
we move from the customer to the
producer in the supply chain?
a. Continuous replenishing
b. Stable supply process
c. Evolving supply process
d. Agile supply chains
e. None of the above

Answer: e. None of the above (The correct

term is “Bullwhip effect”.)

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Question Bowl
Which of the following are reasons why an
organization should use “outsourcing”
as a supply chain strategy?
a. Reduces investment in assets
b. Turns fixed costs into variable costs
c. Gives employees a stronger career
d. All of the above
e. None of the above

Answer: d. All of the above

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Question Bowl
Which of the following “transportation
modes” provides flexibility in delivery,
timing and at reasonable rates for
small quantities and over short
distances?
a. Rail
b. Highway (trucking)
c. Water
d. Pipeline
e. Air

Answer: b. Highway (trucking)

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End of Chapter 10

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