CHAPTER TWO

SUPPLY CHAIN OPERATIONS: PLANNING & SOURCING

A useful model of supply chain operations

There are four categories of operations in supply chain

• Plan
• Source
• Make
• Deliver
Plan

This refers to all the operations needed to plan and organize the
operations in the other three categories .We will investigate three
operations in this category in some detail: demand forecasting;
product pricing; and inventory management.
Source

Operations in this category include the activities necessary to acquire

the inputs to create products or services. We will look at two
operations here. The first, procurement, is the acquisition of
materials and services. The second operation, credit and collections, is
not traditionally seen as a sourcing activity but it can be thought of as,
literally, the acquisition of cash. Both these operations have a big
impact on the efficiency of a supply chain.
Make
This category includes the operations required to develop and build
the products and services that a supply chain provides. Operations
that we will discuss in this category are: product design;
production management; and facility and management. The SCOR
model does not specifically include the product design and
development process but it is included here because it is integral to
the production process.
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Deliver
These operations encompass the activities that are part of receiving
customer orders and delivering products to customers. The two main
operations we will review are order entry/order fulfilment and
product delivery. These two operations constitute the core
connections between companies in a supply chain.

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Demand Forecasting (Plan):-
Supply chain management decisions are based on forecasts that define which products will
be required, what amount of these products will be called for, and when they will be needed.
The demand forecast becomes the basis for companies to plan their internal operations and
to cooperate among each other to meet market demand.
All forecasts deal with four major variables that combine to determine what market
conditions will be like. Those variables are:
1. Demand
2. Supply
3. Product Characteristics
4. Competitive Environment
1. Demand: - refers to the overall market demand for a group of related products or services.
Is the market growing or declining? If so, what is the yearly or quarterly rate of growth or
decline? Or maybe the market is relatively mature and demand is steady at a level that has been
predictable for some period of years. Also, many products have a seasonal demand pattern.
For example, snow skis and heating oil are more in demand in the winter and tennis rackets
and sun screen are more in demand in the summer.
2. Supply: - is determined by the number of producers of a product and by the lead times that
are associated with a product. The more producers there are of a product and the shorter
the lead times, the more predictable this variable is. When there are only a few suppliers
or when lead times are longer, there is more potential uncertainty in a market. Like
variability in demand, uncertainty in supply makes forecasting more difficult. Also, longer lead
times associated with a product require a longer time horizon over which forecasts must be
done. Supply chain forecasts must cover a time period that encompasses the combined lead
times of all the components that go into the creation of a final product.
3. Product Characteristics: - include the features of a product that influence customer
demand for the product. Is the product new and developing quickly like many electronic
products or is the product mature and changing slowly or not at all, as is the case with
many commodity products? Forecasts for mature products can cover longer timeframes
than forecasts for products that are developing quickly. It is also important to know
whether a product will steal demand away from another product.
4. Competitive Environment:-it refers to a actions of a company and its competitors.
Answer question like-what is the market share of a company? Regardless of whether the
total size of a market is growing or shrinking? What is the trend in an individual company
market share?

Forecasting Methods
There are four basic methods to use when doing forecasts.
1. Qualitative
2. Causal
3. Time Series

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 4. Simulation
1. Qualitative - methods rely upon a person’s intuition or subjective opinions about a
market. These methods are most appropriate when there is little historical data to
work with. When a new line of products is introduced, people can make forecasts
based on comparisons with other products or situations that they consider similar.
2. Causal- methods of forecasting assume that demand is strongly related to particular
environmental or market factors for example demand for commercial loans is often
closely correlated to interest rates. So if interest rate cuts are expected in the next
period of time, then loan forecasts can be derived using a causal relationship with
interest rates. the relationship between price and demand , . If prices are lowered, demand
can be expected to increase and if prices are raised, demand can be expected to fall.
3. Time series -methods are the most common form of forecasting. They are based
on the assumption that historical patterns of demand are a good indicator of future
demand. These methods are best when there is a reliable body of historical data and
the markets being forecast are stable and have demand patterns that do not vary much
from one year to the next. Mathematical techniques such as moving averages and
exponential smoothing are used to create forecasts based on time series data. These
techniques are employed by most forecasting software packages.
4. Simulation- methods use combinations of causal and time series methods to
imitate the behavior of consumers under different circum- stances. This method can be
used to answer questions such as what will happen to revenue if prices on a line of
products are lowered or what will happen to market share if a competitor introduces
a competing product or opens a store nearby.
A. Aggregate Planning
Once demand forecasts have been created, the next step is to create a plan for the
company to meet the expected demand. This is called aggregate planning and its purpose
is to satisfy demand in a way that maximizes profit for the company. The planning is done
at the aggregate level and not at the level of individual stock keeping units (SKUs). It sets the
optimum levels of production and inventory that will be followed over the next 3 to 18
months.
There are three basic approaches to take in creating aggregate plan:
1. Use production capacity to match demand: In this approach the total amount of production
capacity is matched to the level of demand. The objective here is to use 100 percent of
capacity at all times. This is achieved by adding or eliminating plant capacity as needed and
hiring and laying off employees as needed. This approach results in low levels of
inventory but it can be very expensive to implement if the cost of adding or reducing
plant capacity is high. It is also often disruptive and demoralizing to the work- force if
people are constantly being hired or fired as demand rises and falls. This approach works
best when the cost of carrying inventory is high and the cost of changing capacity plant
and workforce is low.

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 2. Utilize varying levels of total capacity to match demand. This approach can be used if there
is excess production capacity available. If existing plants are not used 24 hours a day
and 7 days a week then there is an opportunity to meet changing demand by
increasing or decreasing utilization of production capacity. The size of the workforce
can be maintained at a steady rate and overtime and flexible work scheduling used to
match production rates. The result is low levels of inventory and also lower average
levels of capacity utilization. The approach makes sense when the cost of carrying
inventory is high and the cost of excess capacity is relatively low.
3. Use inventory and backlogs to match demand. Using this approach provides for stability
in the plant capacity and workforce and enables a constant rate of output.
Production is not matched with demand. Instead inventory is either built up during
periods of low demand in anticipation of future demand or inventory is allowed to run
low and backlogs are built up in one period to be filled in a following period. This
approach results in higher capacity utilization and lower costs of changing capacity
but it does generate large inventories and backlogs over time as demand fluctuates. It
should be used when the cost of capacity and changing capacity is high and the cost of
carrying inventory and backlogs is relatively low.
B. Product pricing (plan):
Companies and entire supply chains can influence demand over time by using price. Depending
on how price is used, it will tend to either maximize revenue or gross profit. Typically
marketing and sales people want to make pricing decisions that will stimulate demand during
peak seasons. The aim here is to maximize total revenue.

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C. Inventor y Management (Plan)

Inventory management is a set of techniques that are used to manage the inventory levels
within different companies in a supply chain. The aim is to reduce the cost of inventory as
much as possible while still maintaining the service levels that customers require. Inventory
management takes its major inputs from the demand forecasts for products and the prices of
products. With these two inputs, inventory management is an ongoing process of balancing
product inventory levels to meet demand and exploiting economies of scale to get the best
product prices.

 Generally inventory means:-The quantity of Goods that is available in hand or stock

 Formats of inventory:-Raw material, Work in process and Finished goods Why hold
inventory
 To protest against uncertainty
 To cost reduction
 To protest against quality defects/replaced
 To stabilize manufacturing
2. Sourcing
Include the activities necessary to acquire the inputs to create the product or services .It
includes:
 Procurement and
 Credit and Collections

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2.1 Procurement ( Source)
Can be broken in to five main activities:
1. Purchasing
2. Consumption Management
3. Vendor Selection
4. Contract Negotiation
5. Contract Management

1. Purchasing
Divide in Two types
a. Direct or strategic materials that are needed to produce the products that the
company sells to its customers
b. Indirect or MRO (maintenance, repair, and operations) products that a company
consumes as part of daily operations.
2. Consumption Management
Effective procurement begins with an understanding of how much of what categories of
products are being bought across the entire company as well as by each operating unit.
There must be an understanding of how much of what kinds of products are bought from
whom and at what prices.
3. Vendor Selection
There must be an ongoing process to define the procurement capabilities needed to support the
company’s business plan and its operating model. This definition will provide insight into the
relative importance of vendor capabilities. The values of these capabilities have to be
considered in addition to simply the price of a vendor’s product. The value of product quality,
service levels, just in time delivery, and technical support can only be estimated in light of what
is called for by the business plan and the company’s operating model.

4. Contract Negotiation
As particular business needs arise, contracts must be negotiated with individual vendors on
the preferred vendor list. This is where the specific items, prices, and service levels are worked
out. The simplest negotiations are for contracts to purchase indirect products where suppliers
are selected on the basis of lowest price. The most complex negotiations are for contracts
to purchase direct materials that must meet exacting quality requirements and where high
service levels and technical support are needed.
5. Contract Management
Once contracts are in place, vendor performance against these contracts must be measured
and managed. Because companies are narrowing down their base of suppliers, the
performance of each supplier that is chosen becomes more important. A particular supplier

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may be the only source of a whole category of products that a company needs and if it is not
meeting its contractual obligations, the activities that depend on those products will suffer.
A company needs the ability to track the performance of its suppliers and hold them
accountable to meet the service levels they agreed to in their contract. Just as with
consumption management, people in a company need to routinely collect data about the
performance of suppliers. Any supplier that consistently falls below requirements should be
made aware of their shortcomings and asked to correct them.

2.2 Cr edit and Collections (Source)

Credit and collection is the sourcing process that a company uses
to get its money. The credit operation screens potential customers
to make sure the company only does business with customers who
will be able to pay their bills. The collections operation is what
actually brings in the money that the company has earned.

The supply chains that a company participates in are often selected on the basis of credit
decisions. Much of the trust and cooperation that is possible between companies who do
business together is based upon good credit ratings and timely payments of invoices. Credit
decisions affect who a company will sell to and also the terms of the sale. The credit and
collections function can be broken into three main categories of activity:
1. Set Credit Policy
2. Implement Credit and Collections Practices
3. Manage Credit Risk

1. Set Credit Policy

Credit policy is set by senior managers in a company such as the controller, chief financial
officer, treasurer, and chief executive officer. The first step in this process is to review the
performance of the company’s receivables. Every company has defined a set of measurements
that they use to analyze their receivables, such as: day’s sales outstanding (DSO); percent of
receivables past customer payment terms; and bad debt write-off amount as percent of sales.
What are the trends? Where are there problems?
2. Implement Credit and Collections Practices
These activities involve putting in place and operating the procedures that will carry out and
enforce the credit policies of the company. The first major activity in this category is to work
with the company sales- people to approve sales to specific customers. As noted earlier,
making a sale is like making a loan for the amount of the sale. Customers often buy from a
company because that company extends them larger lines of credit and longer payment
terms than its competitors. Credit analysis goes a long way to assure that this loan is only made

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to customers who will pay it off promptly as called for by the terms of the sale.

3. Manage Credit Risk

The credit function works to help the company take intelligent risks that support its
business plan. What may be a bad credit decision from one perspective may be a good
business decision from another perspective. If a company wants to gain market share in a
certain area it may make credit decisions that help it to do so. Credit people work with
other people in the business to find innovative ways to lower the risk of selling to new
kinds of customers.
Managing risk can be accomplished by creating credit programs that are tailored to the
needs of customers in certain market segments such as high technology companies, start-
up companies, construction contractors, or customers in foreign countries. Payment terms
that are attractive to customers in these market segments can be devised. Credit risks can be
lowered by the use of credit insurance, liens on customer assets, and government loan
guarantees for exports.

THE END OF CHAPTER TWO