SUPPLY CHAIN MANAGEMENT

Supply Chain Management can be defined as the management of flow of products and services, which begins from
the origin of products and ends at the product’s consumption. It also comprises movement and storage of raw
materials that are involved in work in progress, inventory and fully furnished goods. The main objective of supply
chain management is to monitor and relate production, distribution, and shipment of products and services. This can
be done by companies with a very good and tight hold over internal inventories, production, distribution, internal
productions and sales.

SUPPLY CHAIN
Supply chain refers to the way that materials flow through different organizations, starting with
raw-materials and ending with finished products delivered to the ultimate customer.
A supply chain is a sequence of suppliers, transporters, warehouses, manufacturers, wholesalers or
distributors, retail outlets and final customers. Different companies may have different supply
chains due to the nature of their operations and whether they are primarily a manufacturing
operation or a service operation.

SUPPLY CHAIN MANAGEMENT

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Supply chain management is a collection of actions required to co-ordinate and manage all activities
necessary to bring a product to market, including processing raw-materials, producing goods,
transporting and distributing those goods and managing the selling process. - Jules Abend

Supply chain management is a ability to get closer to the customer. - Marty Weil
Supply chain management is the process of planning, implementing and controlling the operations
of the supply chain with the purpose to satisfy customer requirements as efficiently as possible.
Supply chain management spans all movement and storage of raw-materials, work-in-process
inventory and finished goods from point-of-origin to point-of-consumption.

IMPORTANCE OF SUPPLY CHAIN MANAGEMENT

1. The total time for materials to travels through the entire supply chain can be quiet long (say six
months to one year or more). Since the materials spend so much time waiting in inventory at various
stages in the supply chain, there is a great opportunity to reduce the total supply chain cycle time
leading to a corresponding reduction in inventory, increased flexibility, reduced costs and better
deliveries.
2. The goals of supply chain management are to reduce uncertainty and risks in the supply chain.
3. The design, planning and operation of a supply chain have a strong impact on overall profitability
and success.
4. Supply-chain management has become a hot competitive advantage as companies struggle to get
the right stuff to the right place at the right time.
5. Supply chain management includes transportation vendors, suppliers, distributors, banks, credit
and cash transfers, bills payable and receivable, warehousing and inventory levels, order fulfillment
and sharing customer, forecasting and production information.
6. Increase their competitiveness via product customization, high quality, cost reductions and speed-
to-market.
7. Supply chain management builds a chain of suppliers that focus on both minimizing waste and
maximizing value to the ultimate customer
OBJECTIVES OF A SUPPLY CHAIN
1. To maximize the overall value generated
2. To achieve maximum supply chain profitability. Supply chain profitability is the total profit to
be shared across all supply chain stages.
3. To reduce the supply chain costs to the minimum possible level
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FLOWS IN SUPPLY CHAIN MANAGEMENT
There are three different types of flow in supply chain management:
 Material flow
 Information/Data flow
 Money flow

Material Flow
Material flow includes a smooth flow of an item from the producer to the consumer. This is possible through various
warehouses among distributors, dealers and retailers. The main challenge we face is in ensuring that the material
flows as inventory quickly without any stoppage through different points in the chain. The quicker it moves, the
better it is for the enterprise, as it minimizes the cash cycle. The item can also flow from the consumer to the producer
for any kind of repairs, or exchange for an end of life material. Finally, completed goods flow from customers to
their consumers through different agencies. A process known as 3PL is in place in this scenario. There is also an
internal flow within the customer company.

Information Flow

Information/data flow comprises the request for quotation, purchase order, monthly schedules, engineering change
requests, quality complaints and reports on supplier performance from customer side to the supplier. From the
producer’s side to the consumer’s side, the information flow consists of the presentation of the company, offer,
confirmation of purchase order, reports on action taken on deviation, dispatch details, report on inventory, invoices,
etc. For a successful supply chain, regular interaction is necessary between the producer and the consumer. In many
instances, we can see that other partners like distributors, dealers, retailers, logistic service providers participate in
the information network. In addition to this, several departments at the producer and consumer side are also a part

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of the information loop. Here we need to note that the internal information flow with the customer for in-house
manufacture is different.

Money Flow

On the basis of the invoice raised by the producer, the clients examine the order for correctness. If the claims are
correct, money flows from the clients to the respective producer. Flow of money is also observed from the producer
side to the clients in the form of debit notes. In short, to achieve an efficient and effective supply chain, it is essential
to manage all three flows properly with minimal efforts. It is a difficult task for a supply chain manager to identify
which information is critical for decision-making. Therefore, he or she would prefer to have the visibility of all flows
on the click of a button.

PROCESS VIEW OF A SUPPLY CHAIN

Two different way to view the process performed in a supply chain are:

1. Cycle view
2. The push-pull view
1. Cycle view: According to this view, the processes in a
supply chain are divided into a series of cycles,
each performed at the interface between two successive
stages of a supply chain.
All supply chain processes can be broken down into the
following four process cycles.
Customer order cycle
Replenishment cycle
Manufacturing cycle
Procurement cycle

a) Customer order cycle

a. Customer arrival refers to the customers visiting the location (super market or retail store) where he
or she has access to his or her choices and make a decision regarding what to buy, how much to buy
and so on.
b. Customer order entry refers to customers telling the retailer what products they want to buy and the
retailer allocating those products to customers.

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 c. Customer order fulfillment refers to process by which the customer order is filled and sent to the
customer. ◦Customer order receiving refers to the process by which customer receives what he has
ordered and takes ownership of the products ordered.

b) Replenishment cycle

a. Retail order trigger: As and when the retailer fills customer order, inventory is depleted which must
be replenished to meet future demand. The retailer devises a replenishment or ordering policy which
triggers an order on the distributor so as to maximize profitability by balancing product availability
and cost.
b. Retail order entry: The retailer places the order with the distributor or manufacturer. The purpose of
the retail order entry process is to ensure that an order is entered accurately and conveyed quickly to
all supply chain processes affected by the order.
c. Retail order fulfillment: This is a process by which retail order is filled by the distributor or
manufacturer. The objective is to get the replenishment order to the retailer on time while minimizing
costs.
d. Retail order receiving: When the replenishment order arrives at a retailer, the retailer must receive it
physically, update all inventory records and settle all product from distributor to the retailer as well
as information and financial flows. This process helps to update inventories and displays quickly at
the lowest possible cost.

c) Manufacturing cycle: This occurs at the distributor or manufacturer interface and includes all processes
involved in replenishing distributor (or retailer) inventory.

The process involved in the manufacturing cycle include

Order arrival from the distributor, retailer or customer

Production scheduling
Manufacturing and shipping and
Receiving at the distributor, retailer or customer

d) Procurement cycle: This occurs at the manufacturer or supplier interface and includes all processes necessary
to ensure that materials are available for carrying out manufacturing as per the schedule. The manufacturer
orders components from suppliers to replenish inventories. Competent orders are based on the production
schedule.

2. Push / Pull view of supply chain process

All processes in the supply chain fall into one of two categories:
1) Push processes
2) Pull processes
In pull processes, execution is initiated in response to a customer order.

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In push processes, execution is in anticipation of customer order.
At the time of execution of pull process demand is known with certainty, whereas at the time of execution of push
process demand is not known but forecasted.
A push or pull view of the supply chain is useful when considering strategic decisions relating to supply chain
design. This view facilitates a more global consideration of supply chain processes as they relate to a customer order.
Pull processes may be regarded as reactive processes because they react to customer demand. Push processes may
be regarded as speculative process because they respond to forecast (speculative) demand rather than actual demand.
The push or pull boundary in a supply chain helps to separate, push processes from pull processes. For example: In
a computer manufacturing company manufacturing personal computers the beginning of assembly process
represents the push or pull boundary. All processes carried out prior to assembly are push processes and all processes
carried out after and including assembly are pull processes because they are initiated in response to a customer order

Supply Chain Macro Processes in a Firm

All supply chain processes discussed in the two process views and throughout this book can be classified into the
following three macro processes, as shown in Figure 1-8:

1. Customer Relationship Management (CRM): all processes that focus on the interface between the firm
and its customers
2. Internal Supply Chain Management (ISCM): all processes that are internal to the firm
3. Supplier Relationship Management (SRM): all processes that focus on the interface between the firm and
its suppliers

DECISION PHASES IN A SUPPLY CHAIN

1. Supply chain strategy or design

2. Supply chain planning and
3. Supply chain operation.

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 SUPPLY CHAIN STRATEGY OR DESIGN

1. The location and capacities of production and warehousing facilities

2. Products to be manufactured or stored at various locations
3. Modes of transportation to be made available along different shipping legs
4. Type of information system to be utilized

SUPPLY CHAIN PLANNING

The planning phase starts with a forecast for the coming year of demand in different markets. Supply chain planning
includes decision regarding the following:
Which market to be served from which locations
The subcontracting of manufacturing
Policies regarding back up locations in case of a stock out and
The timing and size of marketing promotions
SUPPLY CHAIN OPERATIONS
During this phase, companies make decisions for the time horizon (weekly or daily) regarding individual customer
orders. The supply chain operation aims at implementing the operating policies in the best possible manner.
Various activities involved in these phases are:
Allocating individual orders to inventory or production
Setting dates for fulfilling orders
Generating pick lists at a warehouse
Allocating an order to a particular shipping mode or shipment
Getting delivery schedules of trucks and
Placing replenishment orders.
DRIVERS OF SUPPLY CHAIN PERFORMANCE

How a company can improve supply chain performance in terms of responsiveness and efficiency,
we must examine the logistical and cross–functional drivers of supply chain performance :
facilities, inventory, transportation, information, sourcing, and pricing. These drivers interact to
determine the supply chain’s performance in terms of responsiveness and efficiency.

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First, we provide some definitions. Supply chain responsiveness includes a supply chain’s ability to do the
following:

• 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
• Handle supply uncertainty

These abilities are similar to many of the characteristics of demand and supply that led to high implied
uncertainty. The more of these abilities a supply chain has, the more responsive it is.

Responsiveness, however, comes at a cost. For instance, to respond to a wider range of quantities demanded,
capacity must be increased, which increases costs. This increase in cost leads to the second definition:

Supply chain efficiency is the inverse of the cost of making and delivering a product to the customer. Increases
in cost lower efficiency. For every strategic choice to increase responsiveness, there are additional costs that
lower efficiency.

Lowest cost is defined based on existing technology; not every firm is able to operate on the efficient
frontier, which represents the cost- responsiveness performance of the best supply chains. A firm that is not
on the efficient frontier can improve both its responsiveness and its cost performance by moving toward the
efficient frontier. In contrast, a firm on the efficient frontier can improve its responsiveness only by

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increasing cost and becoming less efficient. Such a firm must then make a trade-off between efficiency and
responsiveness. Of course, firms on the efficient frontier are also continuously improving their processes
and changing technology to shift the efficient frontier itself. Given the trade-off between cost and
responsiveness, a key strategic choice for any supply chain is the level of responsiveness it seeks to provide.
Supply chains range from those that focus solely on being responsive to those that focus on a goal of
producing and supplying at the lowest possible cost.

The more capabilities constituting responsiveness a supply chain has, the more responsive it is. Seven-Eleven
Japan replenishes its stores with breakfast items in the morning, lunch items in the afternoon, and dinner
items at night. As a result, the available product variety changes by time of day. Seven-Eleven responds
quickly to orders, with store managers placing replenish- ment orders less than 12 hours before they are
supplied. This practice makes the Seven-Eleven supply chain very responsive.

First we define each driver and discuss its impact on the performance of the supply chain.

1. Facilities are the actual physical locations in the supply chain network where product is stored,
assembled, or fabricated. The two major types of facilities are production sites and storage sites. Decisions
regarding the role, location, capacity, and flexibility of facilities have a significant impact on the supply
chain’s performance.

For example, in 2009, Amazon increased the number of warehousing facilities located close to customers to
improve its responsiveness. In contrast, Blockbuster tried to improve its efficiency in 2010 by shutting
down many facilities even though it reduced responsiveness. Facility costs show up under property, plant
and equipment, if facilities are owned by the firm or under selling, general, and administrative if they are
leased.

2. Inventory encompasses all raw materials, work in process, and finished goods within a supply chain.
The inventory belonging to a firm is reported under assets. Changing inventory policies can dramatically
alter the supply chain’s efficiency and responsiveness.

3. Transportation entails moving inventory from point to point in the supply chain. Transportation can take
the form of many combinations of modes and routes, each with its own performance characteristics.
Transportation choices have a large impact on supply chain responsiveness and efficiency.

4. Information consists of data and analysis concerning facilities, inventory, transportation, costs, prices,
and customers throughout the supply chain. Information is potentially the biggest driver of performance
in the supply chain because it directly affects each of the other drivers. Information presents management
with the opportunity to make supply chains more responsive and more efficient. For example, Seven-

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 Eleven Japan has used information to better match supply and demand while achieving production and
distribution economies. The result is a high level of responsiveness to customer demand while production
and replenishment costs are lowered. Information technology–related expenses are typically included
under either operating expense (typically under selling, general, and administrative expense) or assets.
For example, in 2009, Amazon included $1.24 billion in technology expense under operating expense and
another $551 million under fixed assets to be depreciated.

5. Sourcing is the choice of who will perform a particular supply chain activity such as production, storage,
transportation, or the management of information. At the strategic level, these decisions determine what
functions a firm performs and what functions the firm outsources. Sourcing decisions affect both the
responsiveness and efficiency of a supply chain. After Motorola outsourced much of its production to
contract manufacturers in China, it saw its efficiency improve but its responsiveness suffer because of the
long distances. To make up for the drop in responsiveness, Motorola started flying in some of its cell
phones from China even though this choice increased transportation cost. Flextronics, an electronics
contract manufacturer, is hoping to offer both responsive and efficient sourcing options to its customers.
It is trying to make its production facilities in high-cost locations very responsive while keeping its
facilities in low-cost countries efficient. Flextronics hopes to become an effective source for all customers
using this combination of facilities. Sourcing costs show up in the cost of goods sold, and monies owed to
suppliers are recorded under accounts payable.

6. Pricing determines how much a firm will charge for the goods and services that it makes available in the
supply chain. Pricing affects the behavior of the buyer of the good or service, thus affecting supply chain
performance. For example, if a transportation company varies its charges based on the lead time provided
by the customers, it is likely that customers who value efficiency will order early and customers who
value responsiveness will be willing to wait and order just before they need a product transported.
Differential pricing provides responsiveness to customers that value it and low cost to customers that do
not value responsiveness as much. Any change in pricing impacts revenues directly but could also affect
costs based on the impact of this change on the other drivers.

COMPETITIVE AND SUPPLY CHAIN STRATEGIES

A supply chain strategy determines the nature of procurement of raw materials, transportation of materials
to and from the company, manufacture of the product or operation to provide the service, and distribution of
the product to the customer, along with any follow-up service and a specification of whether these processes
will be performed in-house or outsourced. Supply chain strategy specifies what the operations, distribution,

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and service functions, whether performed in-house or outsourced, should do particularly well.

A company’s competitive strategy defines, relative to its competitors, the set of customer needs that it seeks
to satisfy through its products and services. For example, Wal-Mart aims to provide high availability of a
variety of products of reasonable quality at low prices. Most products sold at Wal-Mart are commonplace
(everything from home appliances to clothing) and can be purchased elsewhere. What Wal-Mart provides is
a low price and product availability. McMaster-Carr sells maintenance, repair, and operations (MRO)
products. It offers more than 500,000 products through both a catalog and a Web site. Its competitive strategy
is built around providing the customer with convenience, availability, and responsiveness. With this focus
on responsiveness, McMaster does not compete based on low price. Clearly, the competitive strategy at Wal-
Mart is different from that at McMaster.

ACHIEVING STRATEGIC FIT

Strategic fit requires that both the competitive and supply chain strategies of a company have aligned goals.
It refers to consistency between the customer priorities that the competitive strategy hopes to satisfy and the
supply chain capabilities that the supply chain strategy aims to build. For a company to achieve strategic fit, it
must accomplish the following:
1. The competitive strategy and all functional strategies must fit together to form a coordinated overall
strategy. Each functional strategy must support other functional strategies and help a firm reach its competitive
strategy goal.
2. The different functions in a company must appropriately structure their processes and resources to
be able to execute these strategies successfully.
3. The design of the overall supply chain and the role of each stage must be aligned to support the supply
chain strategy.

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A company may fail either because of a lack of strategic fit or because its overall supply chain design,
processes, and resources do not provide the capabilities to support the desired strategic fit.

How Is Strategic Fit Achieved?

What does a company need to do to achieve that all-important strategic fit between the supply chain and
competitive strategies? A competitive strategy will specify, either explicitly or implicitly, one or more
customer segments that a company hopes to satisfy. To achieve strategic fit, a company must ensure that its
supply chain capabilities support its ability to satisfy the needs of the targeted customer segments.
There are three basic steps to achieving this strategic fit, which we outline here and then discuss in more
detail:

1. Understanding the Customer and Supply Chain Uncertainty: First, a company must understand
the customer needs for each targeted segment and the uncertainty these needs impose on the supply chain.
These needs help the company define the desired cost and service requirements. The supply chain uncertainty
helps the company identify the extent of the unpredictability of demand, disruption, and delay that the supply
chain must be prepared for.
2. Understanding the Supply Chain Capabilities: Each of the many types of supply chains is
designed to perform different tasks well. A company must understand what its supply chain is designed to
do well.
3. Achieving Strategic Fit: If a mismatch exists between what the supply chain does particularly well
and the desired customer needs, the company will either need to restructure the supply chain to support the
competitive strategy or alter its competitive strategy.

UNDERSTANDING THE CUSTOMER AND SUPPLY CHAIN UNCERTAINTY

The Quantity of the Product Needed in Each Lot: An emergency order for material needed to repair a
production line is likely to be small. An order for material to construct a new production line is likely to be
large.
\The Response Time That Customers Are Willing to Tolerate: The tolerable response time for the
emergency order is likely to be short, whereas the allowable response time for the construction order is apt
to be long.

The Variety of Products Needed: A customer may place a high premium on the avail- ability of all parts of
an emergency repair order from a single supplier. This may not be the case for the construction order.
The Service Level Required: A customer placing an emergency order expects a high level of product

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availability. This customer may go elsewhere if all parts of the order are not immediately available. This is
not apt to happen in the case of the construction order, for which a long lead time is likely.
The Price of the Product: The customer placing the emergency order is apt to be much less sensitive to
price than the customer placing the construction order.
The Desired Rate of Innovation in the Product: Customers at a high-end department store expect a lot of
innovation and new designs in the store’s apparel. Customers at Walmart may be less sensitive to new
product innovation.
CHALLENGES TO ACHIEVING AND MAINTAINING STRATEGIC FIT

The key to achieving strategic fit is a company’s ability to find a balance between responsiveness and
efficiency that best matches the needs of its target customer.

Increasing Product Variety and Shrinking Life Cycles

One of the biggest challenges to maintaining strategic fit is the growth in product variety and the decrease
in the life cycle of many products. Greater product variety and shorter life cycles increase uncertainty while
reducing the window of opportunity within which the supply chain can achieve fit. The challenge gets
magnified when companies continue to increase new products without maintaining the discipline of
eliminating older ones. Apple has had great success limiting its product variety while continuing to
introduce new products. This has allowed the company the luxury of dealing only with high-demand
products for which it becomes easier to design an aligned supply chain. In general, however, firms must
design product platforms with common components and maintain a tailored supply chain that contains a
responsive solution to handle new products and other low-volume products and a low-cost solution to
handle successful high-volume products. Simultaneously, variety must be limited to what truly adds value
to the customer. This often requires the continuous elimination of older products.

Globalization and Increasing Uncertainty

Globalization has increased both the opportunities and risks for supply chains. The 21st century has started
with significant fluctuations in exchange rates, global demand, and the price of crude oil, all factors that
impact supply chain performance. In 2008 alone, the euro peaked in value at about $1.59 and went as low
as $1.25. In 2001, the euro went as low as $0.85. After demand for automobiles in the United States peaked
at more than 17 million vehicles, demand dropped significantly between November 2007 and October 2008.
In October 2008, auto sales in the United States dropped by more than 30 percent relative to the same month

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 the previous year. The drop in sales of larger vehicles was much more significant than the drop for smaller,
more fuel-efficient cars. Crude oil peaked at more than $145 a barrel in July 2008 and was less than $50 a
barrel by November 2008.
Supply chains designed to handle these uncertainties have performed much better than those that ignored
them. For example, Honda built flexible plants that were a great help in 2008 as demand for SUVs dropped
but demand for small cars increased. Honda’s flexible plants that produced both the CRV and small cars
on the same line continued strong operations. In contrast, companies that had built plants dedicated to
producing only large trucks and SUVs had a lot of difficulty in 2008 as demand dried up. Clearly, firms
must account for global risks and uncertain- ties if they want to maintain strategic fit.

Fragmentation of Supply Chain Ownership

Over the past several decades, most firms have become less vertically integrated. As companies have shed
noncore functions, they have been able to take advantage of supplier and customer competencies that they
themselves did not have. This new ownership structure, however, has also made aligning and managing the
supply chain more difficult. With the chain broken into many owners, each with its own policies and
interests, the chain is more difficult to coordinate. This problem could potentially cause each stage of a
supply chain to work only toward its own objectives rather than the whole chain’s, resulting in the reduction
of overall supply chain profitability. Aligning all members of a supply chain has become critical to
achieving supply chain fit.

THE ROLE OF FORECASTING IN A SUPPLY CHAIN

Various functional areas based on demand forecast are

1. Production
2. Marketing
3. Finance
4. Human resource

Production is concerned with scheduling inventory planning and control and aggregate planning
Marketing is concerned with sales force allocation sales promotion and new product launching
Finance is concerned with capital investment in plant and equipment and budgeting
Human resource is concerned with the manpower planning, hiring, layoff etc

Demand forecast can be of can be classified on the basis of time Horizon

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 1. Long term forecast
2. Medium term forecast and
3. Short term forecast
Long term forecast are for a period of three or more than 3 years. These forecast are of long term
nature and especially for strategic business planning. Long term forecast have at times not very
accurate and they have high rate of error.

The medium term or the intermediate term forecast are for a period of 1 to 3 years.
The short term forecast are for short interval time which can run from few weeks to few months
and they are generally more accurate. Various category of forecast includes Demand forecast
Sales forecast
Price forecast

The objectives of the forecast are

1. To manage uniform level of production
2. To avoid the situations of out of the stocks
3. To lower the safety stock reserves
4. To take the benefit of price discount in bulk purchase
5. To manage product getting obsolete and also
6. To manage the transportation cost

Demands can be based on nature of demand anticipation i.e push based demand or pull based
command. A company must be knowledgeable about numerous factors that are related to the
demand forecast, including the following:

The demand also depends upon

1. The past demand
2. The lead time required to fulfil the demand
3. Any planned advertising or marketing activities
4. Prevailing Trends in the market ( Fashion )
5. Seasonal factors
6. State of the economy
7. Any planned discounts to be offered and
8. Demand also depends upon the action of the computers in case for example pepsi offers
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 buy 1 get 1 free then the coke has to come up with the similar offer which will increase the
demand for the product based on the promotion scheme offered by the competition

Demand forecasts form the basis of all supply chain planning. All push processes in the supply
chain are performed in anticipation of customer demand, whereas all pull processes are performed
in response to customer demand. For push processes, a manager must plan the level of activity, be
it production, transportation, or any other planned activity. For pull processes, a manager must plan
the level of available capacity and inventory but not the actual amount to be executed. In both
instances, the first step a manager must take is to forecast what customer demand will be.

Product demand also depends upon the various stages of the product life cycle PLC.
The demand of the product varies from one stage to another stage. In the nascent stage which is the
introductory stage the demand may be low and the demand may subsequently increase when the
product enters into the growth stage. The demand saturates or remains the same at the saturation
stage and may even subsequently decrease in the decline stage.

Bull-Whip effect refers to the fluctuation in the orders which increase as they move up the supply
chain from retailers to manufacture and finally to the suppliers The error in demand forecast
increases from one stage to the another stage as we move we move up the supply chain, this effect
is known as the Bull Whip effect.

Forecasting methods are classified according to the following four types:

Qualitative: Qualitative forecasting methods are primarily subjective and rely on human
judgment. They are most appropriate when little historical data are available or when experts
have market intelligence that may affect the forecast. Such methods may also be necessary to
forecast demand several years into the future in a new industry.
Time series: Time-series forecasting methods use historical demand to make a forecast. They are
based on the assumption that past demand history is a good indicator of future demand. These
methods are most appropriate when the basic demand pattern does not vary significantly from
one year to the next. These are the simplest methods to implement and can serve as a good
starting point for a demand forecast.
Causal: Causal forecasting methods assume that the demand forecast is highly corre- lated with
certain factors in the environment (the state of the economy, interest rates, etc.). Causal
forecasting methods find this correlation between demand and environmental factors and use

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estimates of what environmental factors will be to forecast future demand. For example, product
pricing is strongly correlated with demand. Companies can thus use causal methods to determine
the impact of price promotions on demand.
Simulation: Simulation forecasting methods imitate the consumer choices that give rise to demand
to arrive at a forecast. Using simulation, a firm can combine time-series and causal methods to
answer such questions as: What will be the impact of a price promotion? What will be the impact of
a competitor opening a store nearby? Airlines simulate customer buying behavior to forecast
demand for higher fare seats when there are no seats available at the lower fares.

Market research method : This is a planned approach to determine the product demand by
conducting a survey and taking the customer experience into consideration. This method is used
to forecast demand for medium term and long term. Market research or consumer survey
provides the first hand information which helps in estimating the product demand. This method
can be expensive and time-consuming. The quality of the forecast also depends upon the
questionnaire used for the survey

Delphi Method : In this method views of the experts are taken into consideration. The frontline
staff has first-hand knowledge of the market and are better aware with the ground realities. This
group provides necessary information to the decision makers involved in the process of demand
forecasting. The forecast is prepared on the general consensus. In this process panel of experts
is made and their inputs are taken into consideration for making the forecast. This process can
be time consuming may also lead to errors arising because of poorly designed questionnaires

1.1 INVENTORY MANAGEMENT

1.2 Introduction
A business can run smoothly its operating activities only when appropriate amount of inventory is
maintained. Inventory affects all operating activities like manufacturing, warehousing, sales etc. The
amount of opening inventory and closing inventory should be sufficient enough so that the other
business activities are not adversely affected. Thus, inventory plays an important role in operations
management.

1.3 Meaning & Types of Inventory

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Inventory is an asset that is owned by a business that has the express purpose of being sold to a
customer. Inventory refers to the stock pile of the product a firm is offering for sale and the
components that make up the product. In other words, theinventory is used to represent the aggregate
of those items of tangible assets whichare –

 Held for sale in ordinary course of the business.

 In process of production for such sale.
 To be currently consumed in the production of goods or services to be
available for sale.

The inventory may be classified into three categories:

 Raw material and supplies: It refers to the unfinished items which go

inthe production process.
 Work in Progress: It refers to the semi-finished goods which are not
100%complete but some work has been done on them.
 Finished goods: It refers to the goods on which 100% work has been
doneand which are ready for sale.

1.4 Meaning of Inventory Management

Inventory management is the practice overseeing and controlling of the ordering, storage and use of
components that a company uses in the production of the items it sells. A component of supply chain
management, inventory management supervises the flow of goods from manufacturers to
warehouses and from these

KMBI 802 SCM – Dr Rajiv Ratan Page 18

facilities to point of sale. Inventory control means efficient management of capitalinvested in raw
materials and supplies, work- in – progress and finished goods.

1.5 Significance of holding inventory

Inventory is considered to be one of the most important assets of a business. Its management needs
to be proactive, accurate and efficient. Inventory is essentialfor every organization to ensure smooth
running of the production process, to reduce the ordering cost of inventory, to take advantage of
quantity discount, avoid opportunity loss on sales, to utilize and optimize the plant capacity and to
reduce the overall price. Thus, it can be said that inventory is inevitable and has tobe maintained in
appropriate quantity. However, the concept of Just In Time (JIT) is becoming popular which is an
inventory strategy companies employ to increase efficiency and decrease waste by receiving goods
only as they are needed in the production process, thereby reducing inventory costs. This method
requires producers to forecast demand accurately.

1.6 Objectives of Inventory Management

The objective of inventory management is to maintain inventory at an appropriate level to avoid
excess or shortage of inventory. Inventory management systems reduce the cost of carrying
inventory and ensure that the supply of raw material and finished goods remains continuous
throughout the business operations. The objectives specifically may be divided into two categories
mentioned below:

A. Operating objectives: They are related to the operating activities of the

business like purchase, production, sales etc.

a. To ensure continuous supply of materials.

b. To ensure uninterrupted production process.
c. To minimize the risks and losses incurred due to shortage of
inventory.
d. To ensure better customer services.
e. Avoiding of stock out danger.

KMBI 802 SCM – Dr Rajiv Ratan Page 19

 B. Financial Objectives:
a. To minimize the capital investment in the inventory.
b. To minimize inventory costs.
c. Economy in purchase.

Apart from the above objectives, inventory management also emphasize to bring down the adverse
impacts of holding excess inventory. Holding excess inventory lead to the following consequences:

 Unnecessary investment of funds and reduction in profit.

 Increase in holding costs.
 Loss of liquidity.
 Deterioration in inventory.

1.7 Factors affecting the level of inventory

The level of inventory should be appropriate. The appropriateness of the amountof inventory
depends upon a number of factors. Some significant factors affecting the level of inventory are
explained as follows:

1. Nature of business: The level of inventory will depend upon the nature of
business whether it is a retail business, wholesale business, manufacturing
business or trading business.

2. Inventory turnover: Inventory turnover refers to the amount of inventory

which gets sold and the frequency of its sale. It has a direct impact on the
amount of inventory held by a business concern.
3. Nature of type of product: The product sold by the business may be a
perishable product or a durable product. Accordingly, the inventory has to
be maintained.
4. Economies of production: The scale on which the production is done also
affects the amount of inventory held. A business may work on large scale
in order to get the economies of production.
5. Inventory costs: More the amount of inventory is held by the business,
more will be the operating cost of holding inventory. There has to be a
trade-off between the inventory held and the total cost of inventory which

KMBI 802 SCM – Dr Rajiv Ratan Page 20

 comprises of purchase cost, ordering cost and holding cost.
6. Financial position: Sometimes, the credit terms of the supplier are rigid
and credit period is very short. Then, according the financial situation of
the business the inventory has to be held.
7. Period of operating cycle: If the operating cycle period is long, then the
money realization from the sale of inventory will also take a long duration.
Thus, the inventory managed should be in line with the working capital
requirement and the period of operating cycle.
8. Attitude of management: The attitude and philosophy of top management
may support zero inventory concept or believe in maintaining huge
inventory level. Accordingly, the inventory policy will be designed for the
business.

1.8 Techniques of inventory control

Inventory control refers to a process of ensuring that appropriate amount of stock are maintained by
a business, so as to be able to meet customer demand without delay while keeping the costs
associated with holding stock to a minimum. Inventory control signifies a planned approach of
finding when to shift, what to shift, how much to shift and how much to stock so that costs in buying
and storingare optimally minimum without interrupting production or affecting sales. To solve these
problems of inventory management various techniques are there.

These techniques are divided into two categories – modern techniques and traditional techniques.

(1) MODERN TECHNIQUES

(a) Economic Order Quantity (EOQ)

(b) Re-Order Point (ROP)

(c) Fixing Stock Levels

(d) Selective Inventory Control

(i) ABC Analysis

(ii) VED Analysis

(iii) SDE Analysis

(iv) FSN Analysis

KMBI 802 SCM – Dr Rajiv Ratan Page 21
(2) TRADITIONAL TECHNIQUES

(a) Inventory Control Ratios

(b) Two Bin System

(c) Perpetual Inventory System

(d) Periodic Order System

1.9 Modern Techniques

Modern techniques of inventory control refers to those techniques which areevolved through a
scientific process. These techniques involve the use of a formula or a method which is logically
derived to keep control on the inventory levels. These techniques are explained as below:

(a) ECONOMIC ORDER

QUANTITY (EOQ)
The optimal size of an order for replenishment of inventory is called economic order quantity.
Economic order quantity (EOQ) or optimum order quantity is that size of the order where total
inventory costs (ordering costs + carrying costs) are minimized. Economic order quantity can be
calculated from any of the followingtwo methods:

 Formula Method
 Graphic Method
Formula Method: It is also known as ‘SQUARE ROOT FORMULA’ or‘WILSON
FORMULA’ as given below:

EOQ = 2ROC

Where, EOQ = Economic Order Quantity

R = Annual Requirement or consumption in unitsO =
Ordering Cost per order
C = Carrying Cost per unit per yearNo. of
orders = R/EOQ
Time gap between two orders = No. of days in a year/No. of ordersTotal Cost =
Purchase Cost + Carrying Cost + Order Cost
= (R x Unit Price) + (EOQ/2 x C) + (R/EOQ x O)
Graphic Method
KMBI 802 SCM – Dr Rajiv Ratan Page 22
The economic order quantity can also be determined with the help of graph. Under this method,
ordering costs, carrying costs and total inventory costs according to different lot sizes are plotted on
the graph. The intersection point at which the inventory carrying cost and the ordering cost meet, is
the economic order quantity. At this point the total cost line is also minimum.

EOQ

Total Inventory Cost

Carrying Cost

Cost

Ordering Cost

O X

Assumptions: The following assumptions are made:

 The rate of consumption of inventory is assumed to be constant.

 Costs will not change over time.
 Lead time is assumed to be known and constant.
 Per order cost, carrying cost and unit price are constant.
 Carrying or holding costs are proportionate to the value of stock held.
 Ordering cost varies proportionately with the price.

(b) RE-ORDER POINT

After determining the optimum quantity of purchase order, the next problem is to specify the point
of time when the order should be placed. Re-order level is that level of inventory at which an order
should be placed for replenishing the current stock of inventory. The determination of re-order point

KMBI 802 SCM – Dr Rajiv Ratan Page 23

depends upon the lead time, usage rate and safety stock. These terms are explained below:

1. Lead Time: Lead time refers to the time gap between placing the order
and actually receiving the items ordered.

2. Usage Rate: It refers to the rate of consumption of raw material per day.

Usage Rate = Total annual consumption / No. of days in a year

3. Safety Stock: It is the minimum quantity of inventory which a firm

decides to maintain always to protect itself against the risk
and losses likely to occur due to stoppage in production
and loss of sale, due to non- availability of inventory.

Formulae:

Re Order Point = (Lead Time x Usage Rate) + Safety Stock or

Re Order Point = Maximum usage x Maximum Re Order Period

Note: ROL – Re Order Level ROQ – Re

Order Quantity

ROQ is also known as EOQ (Economic Order Quantity)

(c) SELECTIVE INVENTORY

CONTROL
Controlling all inventory in the stock is a very difficult task especially where hugeinventories are
maintained of variety of items. In such circumstances, following smart techniques for managing and
controlling the different types of inventories held are as follows:

KMBI 802 SCM – Dr Rajiv Ratan Page 24

 (i) ABC Analysis: ABC analysis may be defined as a technique where
inventories are analyzed with respect to their value so that costly items
are given greater attention and care by the management. Three
categories are created namely A, B and C. Following table represents
the approximate classification of items along with their value and
quantity.

Category % of % of Total
Total Quantity
Value

A 70-80 5-10

B 20-25 20-30

C 5-10 60-70

(ii) VED Analysis: VED stands for Vital, Essential and Desirable. Highest
control is over vital items, medium control is exercised over essential
items and least control is inferred over desirable items.
(iii) SDE Analysis: SDE stands for Scarce, Difficult and Easy. Highest control
is over scarce items, medium control is exercised over difficult items
and least control is inferred over easily available items.
(iv) FSN Analysis: FSN stands for Fast Moving (F), Slow Moving (S) and Non
Moving (N). Highest control is kept over fast moving items, medium
control is exercised over slow moving items and least control is inferred
on non-moving items.

1.10 Practice Problems

Q.1. Calculate the economic order quantity from the following

particulars:Annual requirement =2,000 units

KMBI 802 SCM – Dr Rajiv Ratan Page 25

 Cost of materials per unit =Rs. 20

Cost of placing and receiving one order= Rs. 40

Annual carrying cost of inventory, 20% of inventory value.

Solution: Here, R = 2,000 O = 40 Unit Price = 20C

= 20% of Unit Price = 20% of 20 = 4

EOQ = √2RO / C

= √2(2000)(40) / (4) = 200 units

Q.2. Compute EOQ and the total variable cost from the following information:

Annual demand = 4,000 units

Units Price = Rs. 40

Order Cost = Rs. 20

Storage Rate = 7% Per annum

Interest Rate = 3% Per annum

Solution: Here, R = O= Unit Price =

4,000 20 40

C = 10% of Unit Price = 10% of 40 = 4

EOQ = √2RO / C

= √2(4000)(20) / (4) = 200 units

Total Variable Cost = Carrying Cost + Order Cost

= (EOQ/2 x C) + (R/EOQ x O)

= (200/2 x 4) + (4000/200 x 20) = 400 + 400 = Rs. 800

Total Cost = Purchase Cost + Carrying Cost + Order Cost

= (R x Unit Price) + (EOQ/2 x C) + (R/EOQ x O)

= (4000 x 40) + (200/2 x 4) + (4000/200 x 20) = 1, 60,000 + 400 + 400 = Rs.

KMBI 802 SCM – Dr Rajiv Ratan Page 26

 1, 60,800

Inventory Cost and ABC

Analysis
Learning Objectives
After completion of the unit, you should be able to:

 Explain the meaning and purpose of ABC analysis.

 Describe the Pareto principle and criteria for ABC classification.
 Understand the detailed steps for classifying the items into A, B and
Ccategories.
 Know the applications of ABC Analysis
2 Introduction
Inventory management is very essential for every organization especially manufacturing and trading
organizations. Optimization of the investment in inventory and managing the level of inventory are
the key objectives of inventory management. Inventory control is essential to keep a track on the
types of inventories held and the cost involved. Many techniques are used to control the inventory
namely traditional techniques and modern techniques. This unit will focus upon the most popularly
used selective inventory control technique – ABC Analysis.

2.1 Meaning of Inventory Cost

Maintaining varied types of inventories involve different costs associated with them. Some
inventory items are low priced, some are medium priced and some are very expensive. Thus,
inventory costs has to be looked into first before deciding the type of control to be exercised on it.
The costs associated with inventory include the purchase cost, ordering cost and the holding cost. In
case of selective inventory control technique – ABC analysis, inventory cost plays a very significant
role as the category classification and the kind of control exercised, completely depend upon the cost
of inventory.

2.2 Meaning and purpose of ABC Analysis

Inventory ABC Classification, known as ABC Analysis, is a term used to definean inventory
categorization method used in materials management to exercise selective inventory control.

KMBI 802 SCM – Dr Rajiv Ratan Page 27

The ABC Classification provides a mechanism for identifying the inventory items that captures the
significant portion of the overall inventory cost. It also provides a mechanism for identifying
different categories of stock on which different inventory policy and inventory control practices can
be used.

ABC analysis divides the inventory items into three categories namely A, B and

C. The classification is based on their cost. Costly items are categorized ‘A’ and
highest control is exercised on these items. Least valuable items are categorized
‘C’ and least control is exercised on them and remaining items are categorized as ‘B’ on which
moderate control is exercised.

The basic purpose of ABC Analysis is to provide basis for material management processes and helps
to define how stock is to be managed. Further, it can form the basis for various activities comprising
plans on alternative stock arrangements andreorder calculations. It also helps to determine at what
intervals inventory checks should be carried out. For instance – ‘A’ class items are to be checked
more frequently than ‘C’ class items. Thus, ABC analysis forms the basis of many such activities
and policy frameworks.
ABC analysis also serves the following purposes directly or indirectly:

 Significant reduction in investment in inventory.

 Protection against stock outs.
 Reducing the work load involved in different activities such as ordering,
procuring, receiving, inspecting, handling and storage of inventory items.
 Reduction in obsolescence losses.
 Increase in profits.

2.3 The Pareto Principle

The Pareto Principle is developed by Vilfredo Pareto (1848 - 1923). According to Pareto Analysis,
critical few is separated from the trivial many. Pareto principle is also known as the 80/20 rule.
Pareto principle is based upon the theory that 20%of the population owns 80% of the nation’s
wealth, most of the businesses get 80% of their sales revenue from 20% of the customers, 80% of
the problems are caused because of 80% of the employees and 20% of the items accounts for 80%
of the firms expenditure.

Therefore, the classification of the inventory is done on the basis of the Pareto principle, in which
20% of the impactful items should fall into ‘A’ classification category.

This rule, in general, applies well and is frequently used by inventory managers toput their efforts
KMBI 802 SCM – Dr Rajiv Ratan Page 28
where greatest benefits, in terms of cost reduction as well as maintaining a smooth availability of
stock, are required.

The principle emphasizes on working out the rupee value of each individual inventory item on
annual consumption basis. Then the ratio between the numberof items and the currency value of
the items is calculated and the following categorization is done:

 10-20% of the items ('A' class) account for 70-80% of the consumption
 the next 15-25% ('B' class) account for 10-20% of the consumption
 the balance 65-75% ('C' class) account for 5-10% of the consumption

ABC Classification & The Pareto Rule for Inventory Management

The above figure depicts the classification according to the Pareto principle. All the items are divided
into three broad categories – A, B and C, according to the calculation of the above mentioned ratio.

2.4 Criteria for ABC classification

The ABC analysis suggests that inventories of an organization are not of equal value. It specifies
that the company should rate the inventory items from A to C, based upon their quantity and value.
The three categories A, B and C possess the following characteristics:

"A" Category

KMBI 802 SCM – Dr Rajiv Ratan Page 29

 These items generally represent approximately 15%-20% of an overall
inventory by quantity, but represent 80% of the value of an inventory.
 These are high value items and are extremely important.
 By paying close attention to the optimization of these items in inventory, a
significantly positive impact may be created with a nominal increase in the
inventory management costs.
 Very strict control is kept on these items.
 Accurate records need to be maintained for these items.
 Because of the high value of these items, frequent value analysis is required.
 Appropriate order pattern should be chosen such as ‘Just- in- time’ to
avoidexcess capacity

"B" Category

 These items represent 30%-35% of inventory items by item type, and

about15% of the value.

 These are intermediary value items.

 These items can generally be managed through period inventory and
shouldbe managed with a formal inventory system.
 Comparatively less control than ‘A’ category items is needed.
 Proper records should be maintained for these items.

"C" Category

 These items represent 50% of actual items but only 5% of the

inventoryvalue.
 These are low value items and are marginally important.
 Most organizations can afford a relatively relaxed inventory process
surrounding these items.
 Least amount of control is required.
 Minimum possible records should be maintained in the simplest form.

2.5 Steps for Classification of Items

KMBI 802 SCM – Dr Rajiv Ratan Page 30
The categorization of the inventory items requires a particular process to befollowed. The inventory
items are first classified, then their total cost is ascertained, thereafter ranking is done followed by
the computation of ratio or percentages. Then finally the A, B and C categories are determined. The
process generally consist of six basic steps as explained below:

1. Identify the objective for ABC analysis. An ABC analysis can accomplish one
of two primary goals: to reduce procurement costs or to increase cash flow
by having the right items available for production.
2. Collect data related to the inventory under analysis. The data can be
obtained from standard accounting if used in the organization. The data
required is the raw material purchased or weighted cost including all
ordering costs and carrying costs.
3. Rank the inventory in decreasing order of their cost.
4. Calculate the cumulative impact for all inventory items by dividing item
annual cost by total inventory annual expenditure, then adding that
amountto the cumulative total of percentage spent.

5. Draw a curve of percentage items and percentage value. Take a holistic

view taking into account the Pareto principle.
6. Mark the limits bifurcating the three classes as A, B and C rationally.
Analyze classes and make appropriate decisions. The key to this step is
follow-up and tracking. The periodic review should be done formonitoring
the success or failure of the decisions and categorization done.

2.6 Difference between A, B and C class items

There is a difference in the various classes A, B and C. Following differences present the suggested
policy guidelines for different categories which may differ for different businesses:

Basis A class items B class items C class items

Control Very strict control Moderate control Least control
Safety stock No or very low Low safety stock High safety stock
safety stock
Order delivery weekly Once in three Once in six months
months
Control report Weekly Control Monthly Control Quarterly Control
report report report

KMBI 802 SCM – Dr Rajiv Ratan Page 31

Follow up Maximum follow Periodic follow up Optional
up
Sources of Should have Should have two Should have
supply as many or more two
sources as reliabl reliable sources
possible e
sources
Forecast Accurate Estimates based on Rough estimate is
forecasts are past data required
needed are
sufficient
Purchasin Should May have Should
g function hav centralised hav
e centralised or e decentralised
purchasing decentralised or purchasing
function a function
combination of
both purchasing
function
Officers Should be Should be Can be delegated
handled by senior handled by to lower level staff.
officers middle
level
officers

KMBI 802 SCM – Dr Rajiv Ratan Page 32

2.7 Applications of ABC Analysis

The ABC classification system leads to grouping of items according to their annual issue value.
Apart from exercising varying degree of control over theinventory items, there are other applications
where ABC analysis has proved to be useful. Following represent some applications of ABC
analysis:

 It highlights specific items on which efforts can be concentrated profitably.

 It provides a sound basis on which the allocation of funds and time is done. 
 It helps in reviewing the stock levels especially minimum and maximum
levels of the inventory items. ‘A’ items will generally have greater impact
on projected investment and purchasing expenditure, and therefore
should be managed more aggressively in terms of minimum and maximum
inventory levels. The inactive items will fall at the bottom of the ‘C’
category. It is the best place to start when performing a periodic
obsolescence review.
 The frequency of usage can be worked out and accordingly the time gap
between orders is decided. ‘A’ category items are very frequently used and
their accurate record balances need to be kept. Thus, frequent stock taking
is done for these items. Accordingly, the strategy is planned for B and C
category items.
 It helps in identifying the inventory items for potential consignment or
vendor stocking.

KMBI 802 SCM – Dr Rajiv Ratan Page 33

  Separate inventory goals may be specified for each category of
inventoryitems.

2.8 Practice Problems

Q. The following data is related to Paroma Ltd.:

Item 11 12 13 14 15 16 17
No.

U
nit 5 10 14 7 6 15 20
os
t
47000 1500 200 700 4700 1100 17000
C
nnual
eman
d

A
D

Categorize the items according to ABC analysis.

Solution:

Total Spending per year

Tota
l
Item Unit Annual Cost
No. Cost Deman per
d yea
r
11 5 47000 235000
KMBI 802 SCM – Dr Rajiv Ratan Page 34
12 10 1500 15000
13 14 200 2800
14 7 700 4900
15 6 4700 28200
16 15 1100 16500
17 20 17000 340000

KMBI 802 SCM – Dr Rajiv Ratan Page 35

Usage of item in total usage

Tota
l %
Item Unit Annual Cost o
No. Cost Deman per f Total
d year Usage
11 5 47000 235000 36.58%
12 10 1500 15000 2.33%
13 14 200 2800 0.43%
14 7 700 4900 0.76%
15 6 4700 28200 4.38%
16 15 1100 16500 2.56%
17 20 17000 340000 52.92%
642400 100%

Sort the items by usage

% of Cumulative
Item Unit Annual Total Cost Total % of total
No. Cost Demand per year Usag
e
17 20 17000 340000 52.92% 52.92%
11 5 47000 235000 36.58% 89.50%
15 6 4700 28200 4.38% 93.88%
16 15 1100 16500 2.56% 96.44%
12 10 1500 15000 2.33% 98.77%
14 7 700 4900 0.76% 99.53%
13 14 200 2800 0.47% 100%
642400 100%

ABC classification

Category Items % Action

usage Needed
A 17, 11 89.5% Close
control
B 15,16,12 9.27% Regular
review

KMBI 802 SCM – Dr Rajiv Ratan Page 36

C 14, 13 1.23% Infrequen
t review

KMBI 802 SCM – Dr Rajiv Ratan Page 37

2.9 Let’s Sum-up

ABC analysis is a valuable tool to enable companies dedicated to strategic cost management to
measure the current status for their materials management system and introduce certain changes in
the inventory control policies in such a manner that it yields the largest cost management benefits in
the near and middle term periods. ABC analysis is based upon the Pareto principle which focuses
on the concept ‘Critical Few Trivial Many’. ABC analysis divides the inventory items into three
categories - A, B and C. These categories are identified on the basis of the number of items and the
total value in rupees for each inventory item. The process starts from the classification of inventory,
then ascertaining their cost and assigning ranks which is followed by the calculation of percentages.
On the basis of these, the categories A, B and C are determined. After determining the categories,
the inventory management policies, control mechanisms, procurement and warehousing policies are
framed for each category in a different manner according to their impact on overall inventory cost.
Thus, ABC analysis suggests that inventories of an organization are not of equal value and so
different policies and treatment should be given in order to minimize the efforts and time as well as
maximize the profits through savings in cost.

2.10 Key Terms

Inventory Cost: It refers to the costs associated with the inventory including the purchase cost,
ordering cost and the holding cost.

ABC Analysis: It is a term used to define an inventory categorization method used in materials
management to exercise selective inventory control.

Pareto Principle: According to Pareto Analysis, critical few is separated from thetrivial many.
Pareto principle is also known as the 80/20 rule. It says that 20% of the impactful items should fall
into ‘A’ classification category and accordingly theother categories may be determined.

KMBI 802 SCM – Dr Rajiv Ratan Page 38

 Logistics and Supply Chain Management

3.1 Introduction
It has been noticed that there has been a drastic change in the manner in which business was
conducted many years ago and now. Due to the improvement in the technology, significant
developments in all the areas of business have been made. Supply Chain Management also evolved
as an improvement over Logistics Management, from past years. Logistics and supply chain are
sometimes used interchangeably. Both these terms are closely related to each other and plays a
significant role in the firm’s value chain process. This unit will discuss about logistics and supply
chain management, the relationship among them and the key points of difference between them.

3.2 Meaning & Concept of Logistics Management

The management process which integrates the movement of goods, services,information and capital,
right from the sourcing of raw material, till it reaches its end consumer is known as Logistics
Management.

According to Phillip Kotler, “Market logistics involve planning, implementing and controlling
physical flow of material and final (finished) goods from the pointof origin to the point of use to
meet customer requirements, at a profit.”

The objectives of logistic management are stated as below:

 To provide the right product with the right quality at the right time in
theright place at the right price to the ultimate customer.
 To offer best service to the consumers.
 To reduce the cost of operations and maximize the profits.
 To maintain transparency in operations.

The 7 R’s of logistics are as follows:

 Right product
 Right customer
 Right quantity
 Right condition
 Right place
 Right time
 Right cost
KMBI 802 SCM – Dr Rajiv Ratan Page 39
The activities covered under logistic management are illustrated as follows:

(i) Network Design

It is required to determine the number and location of manufacturing plants, warehouses,
material handling equipment’s etc. on which logistical efficiency depends.

(ii) Order Processing

Order processing includes activities for receiving, handling and recording of orders. Efforts are
made to minimize the time between receipt of orders and dateof dispatch of the consignment to
ensure speedy processing of the order. Delays inexecution of orders can become serious grounds
for customer dissatisfaction;which must be avoided.

(iii) Procurement

It is related to obtaining materials from suppliers. It includes supply sourcing, negotiation, order
placement, inbound transportation, receiving and inspection, storage and handling. Its main
objective is to support manufacturing, by providingtimely supplies of qualitative materials, at the
lowest possible cost.

(iv) Material Handling

It involves activities such as handling raw-materials, parts, semi-finished andfinished goods into and
out of the manufacturing plant, warehouses and transportation terminals. Efforts should be made to
minimize losses due to breakage, spoilage etc.

KMBI 802 SCM – Dr Rajiv Ratan Page 40

(v) Inventory Management
The basic objectives of inventory management are to minimize the amount of working capital
blocked in inventories, minimize the holding costs and ensure continuous flow of materials and
goods. Inventory for raw material, semi-finished goods and finished goods has to be maintained.

(vi) Packaging and Labelling

Packaging and labelling are an important aspect of logistics management. Packaging involves
enclosing a product into suitable packets or containers, for convenient handling of the product. Good
and attractive packaging, acts like a silent salesman.

Labelling means putting identification marks on the package of the product. A label provides
information about the date of packing and expiry, weight or size of product, ingredients used,
instructions for safe handling of the product, price payable by the buyer etc.

(vii) Warehousing

Warehousing creates time utility by storing goods from the time of production till the time they
reaches to the ultimate consumers. Here, the management has to decide about the number and
type of warehouses needed as well as the locationof the warehouses.

(viii) Transportation

Transportation is that logistical activity which creates place utility. Transportation is needed for the
movement of raw-materials from suppliers to the manufacturing unit, movement of work-in-
progress within the plant and movement of finished goods from plant to the final consumers.

3.3 Types of Logistics

The logistic activities are divided into two broad categories as mentioned below:

 Inbound Logistics: Inbound Logistics refers to movement of goods and raw

materials from suppliers to the company. It include the activities which are
concerned with procurement of material, handling, storage and
transportation.
 Outbound Logistics: Outbound Logistics refers to movement of finished goods
from your company to customers. It include the activities which are concerned
KMBI 802 SCM – Dr Rajiv Ratan Page 41
 with the collection, maintenance, and distribution or delivery to the final
consumer. The following figure illustrates the concept:

In the above figure, purchasing and warehouse function communicates with suppliers and can be
referred as supplier facing function. Customer service and transport function communicates with
customers and thus, referred as customer facing function.

Logistics may be of various kinds depending upon the purpose for which it is used, the kind of
organization by which it is used and the objective it is requiredto achieve. Following are the
different types of logistics:

KMBI 802 SCM – Dr Rajiv Ratan Page 42

Business Logistics: It is the part of the supply chain process that plans, implements and controls the
efficient flow and storage of goods and services frompoint of origin to point of use or consumption.

Military Logistics: The design and integration of all aspects of support for the operational capability
of the military forces as well as the reliability and efficiencyof the equipments used by them.

Event Logistics: The network of activities, facilities and personnel required to organize, schedule
and deploy the resources for an event are referred as event logistics.

Service Logistics: The activities related to acquisition, scheduling and management of the facilities,
personnel and material with the objective to support and sustain a service operation or business are
termed as service logistics.

International logistics: International Logistics, also known as Global Logistics, focuses on how to
manage and control overseas activities effectively as a single business unit. Therefore, company
should try to transform the value of overseas product, services, marketing, R&D into competitive
advantage.

3PL or Third Party Logistics: 3PL or Third Party Logistics refers to the outsourcing of logistics
activities, ranging from a specific task to broader activities serving the whole supply chain such as
inventory management, order processing and consulting.

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4PL or Fourth Party Logistics: Fourth Party Logistics or 4PL is the concept proposed by
Accenture Ltd in 1996. It refers to a party who works on behalf of client to finalise the contract
negotiations and management of performance of 3PLproviders including the design of the whole
supply chain network and controlling the routine operations performed by them. The reasons for
using 4PL by a company are lack of technology to integrate supply chain process, the increase in
operating complexities and sharp increase in global business operations.

3.4 Meaning and Concept of Supply Chain Management

Supply Chain Management (SCM) is a series of interconnected activities related to the
transformation and movement of raw material to the finished goods till it reaches to the end user. It
is the outcome of the efforts of multiple organisations that helped in making this chain of activities
successful.

‘Supply Chain is the network of organisations that are involved, through upstreamand downstream
linkages, in the different processes and activities that produce value in the form of products and
services in the hands of the ultimate consumer.’
- By Martin Christopher

‘Supply chain management (SCM) refers to the coordination of production, inventory, location, and
transportation among the participants in a supply chain to achieve the best mix of responsiveness
and efficiency for the market being served.’ - By Michael Hugos

The most commonly used supply chain concept is shown below:

Supplier Manufacturer Wholesaler Retailer

KMBI 802 SCM – Dr Rajiv Ratan Page 44

Supply Chain Management has a multi-dimensional approach which manages the flow of raw
materials and work in progress within the organisation and the final product outside the organisation
till it reaches the hands of the final consumer. Allthe activities are done keeping in view the customer
requirements.

The activities included in SCM are stated as follows:

 Integration
 Performance measurement
 Product development
 Logistics
 Information sharing
 Procurement & Manufacturing
 Customer service
 Sourcing
 Supplier relationship management
 Order fulfilment
 Returns management
 Transportation
 Warehousing
 Demand management
 Customer relationship management

The significant components of supply chain management are as follows:

 It is a Network: Many companies have the department that controls

various activities within the supply chain. Supply Chain Management is the
planning, implementing and controlling of the networks.
 Information Flow: supply chain management involves the flow of material,
information and finance. The most important one is information flow or
information sharing. When information is shared from retailer down to
supplier, everyone in the supply chain is not required to maintain heavy
stocks which further results in lower costs for everyone.

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  Coordination: Information sharing requires coordination or integration
among the various network partners.
 Avoid Conflicting Objectives: In the supply chain network, the different
parties involved might have conflicting objectives or in the same
organization different departments may have conflicting objectives. For
example, purchasing people always place the orders to the cheapest
vendors (with a very long lead-time) but production people needs material
more quickly. To avoid conflicting objectives, it must be decided whether
to adopt time-based strategy, low cost strategy or differentiation
strategy. A clear direction is needed so people can make the decisions
accordingly.
 Balance between cost and service: When efforts are made to improve
service, cost goes up. When efforts are directed to cut cost, service suffers.
Thus, there should be a balance between cost and service.
 Foster long-term relationship: To work as the ‘supply chain team’, long-
term relationship is a key. Focus should be on creating long-term
relationship with suppliers of key products and items with limited source
of supply because these are people who can make or break the supply
chain.

3.5 Objectives of Supply Chain Management

Supply chain focuses on ensuring economic supply of goods, supplies, andservices to keep the
company in operation. SCM contribute to profit, growth and

competitive advantage by efficiently managing the supply activities with an aim toreach company‘s
corporate goals.

Supply chain management has the fundamental objective to ‘add value’. Apart from this objective,
it focuses on the accomplishment of the following strategic objectives:

 Reducing working capital

 Build a competitive infrastructure
 Accelerating cash-to-cash cycles
 Increasing inventory turns
 Leveraging worldwide logistics

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  Synchronizing supply chain demand
 Measuring performance globally
 Cost Quality improvement
 Shortening the lead time
 Minimize the total system cost
 Satisfy customer service requirements
 Improve standardization
 Face global competition
 Enhance organizational responsiveness

3.6 Difference between logistics and supply chain management

Logistics Management is a part of Supply Chain Management which deals with the management
of goods in an efficient and effective manner. To understandthe conceptual differences between
logistics and supply chain management, the following points are discussed:

 The flow and storage of goods inside and outside the firm is known as
Logistics. The movement and integration of supply chain activities isknown
as Supply Chain Management.

 The main aim of logistics is customer satisfaction. On the other hand, the
main aim behind supply chain management is to gain a substantial
competitive advantage.
 There is only one organisation involved in logistics while multiple
organisations are involved in SCM.
 Supply Chain Management is a new concept as compared to Logistics.
Sometimes, it is said that SCM is the refinement of the old concept of
logistics. Thus, SCM is a modern concept.
 Logistics deals with strategy and coordination between the marketing and
production functions of the organization. On the other hand, supply chain
management focuses more on purchasing and procurement along with
other functions.
 SCM include factors relating to inventory, materials and production

KMBI 802 SCM – Dr Rajiv Ratan Page 47

 planning also. On the contrary, logistics includes factors relating to
demand management and forecasting.

Thus, it can be concluded that supply chain management takes care of the design, planning,
execution, control, and monitoring of supply chain activities with the sole objective of creating net
value and leveraging worldwide logistics. Whereas the concept of logistics covers the management
of the flow of goods and the services between the point of origin and the point of consumption in
order to meetthe requirements of customers.

3.7 Key Essentials of Supply Chain

Supply chain to be successfully managed has certain pre-requisites to be fulfilled. Since, many
organizations are involved it is difficult to bring harmony in their operations and establish common
objectives which will provide benefit to all the parties. Thus, in order to make the supply chain
competitive enough to gain market leadership, the following key essentials are required:

1. The firm should try to lower down the end user prices.
2. The firm must focus on reducing the percentage of supply chain
costs in the overall cost in order to make the supply chain more
competitive.
3. End user metrics are necessary to know the level and extent of
customer satisfaction and their involvement.
4. Identify the key areas which might lead to reduction in time and
cut the overall supply chain cycle that moves a product through the
supply chain.
5. Collaborative planning among trading partners, with shared
management of resources, is required.
6. There should be focus on visibility of usage, forecasts, orders,
shipments, and inventories.

3.8 Principles of Supply Chain

Supply Chain Management has become a distinct and important discipline in the field of
management. Thus, there is a need to specify certain key underlying principles of SCM which
provides a crucial base for managing the activitiesinvolved in the supply chain management.
The seven principles as articulated by Andersen Consulting are as follows:

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1. Segment customers on the basis of their service needs: Effective supply-
chain management groups customers by distinct service needs without
considering their industry. Then, they provide them the customized services
to each group.

2. Customise the Supply Chain Management network: In designing their Supply

Chain Management network, companies need to focus intensely on the
service requirements and profitability of the customer segments identified.
Thus, every company frames its own supply chain network which is unique
and based on customized requirements.
3. Identify the market demand pattern and plan accordingly: Sales and
operations planning of the company should include a mechanism wherein it
could detect early warning signals of changing demand in ordering patterns,
customer promotions etc. This demand-intensive approach leads to more
consistent forecasts and optimal resource allocation.
4. Differentiate product closer to the customer: The companies need to
postpone product differentiation in the manufacturing process closer to
actual consumer demand.
5. Strategically manage the sources of supply: Companies should work with the
suppliers strategically to reduce the overall costs associated with materials
and services. The supply chain management leaders enhance margins both for
themselves and their suppliers. Now, the focus should be on sharing of the
gains.
6. Develop a supply-chain-wide technology strategy: The company should
make efforts to develop information technology which support multiple levels
of decision making. It should be capable enough to provide a clear view of
the flow of products, services, and information which will in the long run lead
to a successful SCM.
7. Adopt channel-spanning performance measures: In order to make theSCM
of an organization better than the others, it should monitor the internal
functions and adopt measures that apply to every link in the supply chain.

When the above mentioned principles are followed consistently and comprehensively, then they will

KMBI 802 SCM – Dr Rajiv Ratan Page 49

bring a host of competitive advantages for the company. Thus, every organization must strive for
implementing as many principles as possible to improve the supply chain and enhance the benefits
arisingfrom it.

3.9 Logistics – An Integral Component of Supply Chain

Management
Logistics refers to the activities that occur within the boundaries of a singleorganization and supply
chains refer to networks of companies that work together and coordinate their actions to deliver a
product to market. Logistics focuses its attention on activities such as procurement, distribution,
maintenance, and inventory management. Supply Chain Management includes not only logistics but
also the activities such as marketing, new product development, finance, andcustomer service. Thus,
logistics is an integral part of SCM.

Logistics is the backbone on which supply chains are driven. Logistics facilitates the management
of the flow of goods and supplies involving information, data and documentation between two
entities. Logistics plays important role in post procurement function also. The goods flow through a
network of transportation byroad, rail, air or ship and intermediary warehouses to hold inventories
before moving to the forward locations. The entire activity involves multi-tier suppliers, and
agencies including freight forwarders, packers, customs department, distributors and logistics
service providers, etc.

Supply chain design in an organization would detail, plan and strategize the procurement strategy,
manufacturing location selection, design and develop distribution network and strategy for
finished goods. While logistics planning

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would deal with the details of procurement logistics, finished goods distribution, sales order
fulfilment, and inventory management, etc.

In the case of finished goods distribution, SCM strategy will define overall network design for stock
holding and other channels of distribution. Logistics deals with the entire designing of the
transportation network, partnering with 3rd party logistics providers to establish distribution centres
and warehouses, planning inventory management and operations process including packing,
promotional bundling and at the end the complete documentation and information process for the
entire chain of activities.

Logistics planning drives the strategic direction and framework for its design planning from SCM
Strategy. Logistics therefore is an integral component of Supply Chain Management.

3.10 Let’s Sum-up

Logistics is a very old term, firstly used in the military, for the maintenance, storage and
transportation of army persons and goods. Nowadays, a new term has evolved namely Supply Chain
Management. It is said that SCM is an addition over Logistics Management as well as SCM
comprises of logistics. Both are inseparable. Hence they do not contradict but supplement each other.

The management process which integrates the movement of goods, services,information and capital,
right from the sourcing of raw material, till it reaches its end consumer is known as Logistics
Management. On the other hand, SCM refers to the series of interconnected activities related to the
transformation and movement of raw material to the finished goods till it reaches to the end user.
Logistics include activities like warehousing, transportation, procurement, material handling, order
processing etc. There are various kinds of terms associated with logistics like inbound logistics,
outbound logistics, service logistics, event logistics and international logistics.

SCM includes the coordination and management of the supply chain network partners. The simplest
form of supply chain includes supplier, manufacturer,

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wholesaler and retailer. Thus, logistics is a sub-component and extension
of Supply Chain.

In contemporary times, supply chains can be sources of competitive

advantage as efficient management of the supply chain leads to cost
savings and synergies between the components of the supply chain leads
to greater profitability for the firms.

3.11 Key Terms

Logistics: Logistics is the management of the flow of things between the
point of origin and the point of consumption in order to meet requirements
of customers orcorporations.

Logistics Management: Logistics management is 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 customer's requirements.

Supply Chain: A supply chain is the network of all the individuals,

organizations,resources, activities and technology involved in the creation
and sale of a product, from the delivery of source materials from the
supplier to the manufacturer,through to its eventual delivery to the end
user.

Supply Chain Management: Supply Chain Management (SCM) is a

series of interconnected activities related to the transformation and
movement of raw material to the finished goods till it reaches to the end
user.

1. Logistic management has the following objectives:

(i) Cost Reduction and Profit Maximization:

Logistics management results in cost reduction and profit maximization due to:

 Improved material handling

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  Safe, speedy and economical transportation
 Optimum number and convenient location of warehouses

(ii) Efficient Flow of Manufacturing Operations:

Inbound logistics helps in the efficient flow of manufacturing operations,
due to on-time delivery of materials, proper utilisation of materials and
semi-finished goods in the production process.

(iii) Competitive Edge:

Logistics provide, maintain and sharpen the competitive edge of an enterprise by:

 Increasing sales through providing better customer service

 Arranging for rapid and reliable delivery
 Avoiding errors in order processing

(iv) Effective Communication System:

An efficient information system is a must for sound logistics management.
As such, logistics management helps in developing effective
communication system for continuous interface with suppliers and rapid
response to customer enquiries.

(v) Sound Inventory Management:

Logistics management automatically leads to sound inventory management.

2. The basic purpose of supply chain management is to

enhance the organization’s competitive position by cost
optimization, asset utilization and value creation. SCM
aims to achieve the following key objectives:
 To support operational requirements i.e.
providing an uninterrupted flow of high quality
goods and services that internal customers
require.
 To manage the purchase process efficiently and effectively.
 To manage the supply base i.e. to select,
develop, and maintain sources of supply.
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 To develop strong relationship with other functional groups.
 To support organizational goals and objectives
i.e. aligning sourcing and corporate goals.
 To develop integrated purchasing strategies that
support organizational strategies.

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