The Value of Information: Mcgraw-Hill/Irwin

Chapter 5
The Value of
Information
McGraw-Hill/Irwin
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
5.1 Introduction
Value of using any type of information
technology
Potential availability of more and more
information throughout the supply chain
Implications this availability on effective
design and management of the integrated
supply chain
1-2
Information Types
Inventory levels
Orders
Production
Delivery status
1-3
More Information
Helps reduce variability in the supply chain.

Helps suppliers make better forecasts,
accounting for promotions and market changes.
Enables the coordination of manufacturing and
distribution systems and strategies.
Enables retailers to better serve their customers
by offering tools for locating desired items.
Enables retailers to react and adapt to supply
problems more rapidly.
Enables lead time reductions.
1-4
5.2 Bullwhip Effect

While customer demand for specific
products does not vary much
Inventory and back-order levels fluctuate
considerably across their supply chain
P&Gs disposable diapers case
Sales quite flat

Distributor orders fluctuate more than retail
sales
Supplier orders fluctuate even more
1-5
4-Stage Supply Chain

FIGURE 5-5:
The supply
chain
1-6
Effect of Order Variability
FIGURE 5-6: The increase in variability in the supply chain

1-7
Factors that Contribute to the

Variability - Demand Forecasting
Periodic review policy

Characterized by a single parameter, the base-stock
level.
Base-stock level =
Average demand during lead time and review period +
a multiple of the standard deviation of demand during
lead time and review period (safety stock)
Estimation of average demand and demand variability
done using standard forecast smoothing techniques.
Estimates get modified as more data becomes
available
Safety stock and base-stock level depends on these
estimates
Order quantities are changed accordingly increasing
variability
1-8

Variability Lead Time
Increase in variability magnified with increasing

lead time.
Safety stock and base-stock levels have a lead
time component in their estimations.
With longer lead times:
a small change in the estimate of demand variability

implies
a significant change in safety stock and base-stock
level, which implies
significant changes in order quantities
leads to an increase in variability
1-9

Variability Batch Ordering
Retailer uses batch ordering, as with a (Q,R) or

a min-max policy
Wholesaler observes a large order, followed by
several periods of no orders, followed by
another large order, and so on.
Wholesaler sees a distorted and highly variable
pattern of orders.
Such pattern is also a result of:
Transportation discounts with large orders

Periodic sales quotas/incentives
1-10

Variability Price Fluctuations
Retailers often attempt to stock up when

prices are lower.
Accentuated by promotions and discounts at
certain times or for certain quantities.
Such Forward Buying results in:
Large
order during the discounts

Relatively small orders at other time periods
1-11

Variability Inflated Orders
Inflated orders during shortage periods
Common when retailers and distributors
suspect that a product will be in short
supply and therefore anticipate receiving
supply proportional to the amount ordered.
After period of shortage, retailer goes back
to its standard orders
leads to all kinds of distortions and variations

in demand estimates
1-12
Impact of Centralized Information

on Bullwhip Effect
Centralize demand information within a

supply chain
Provide each stage of supply chain with
complete information on the actual customer
demand
Creates more accurate forecasts rather than
orders received from the previous stage
1-13
Managerial Insights
Variance increases up the supply chain in
both centralized and decentralized cases
Variance increases:
Additively with centralized case

Multiplicatively with decentralized case
Centralizing demand information can

significantly reduce the bullwhip effect
Although not eliminate it completely!!
1-14
Methods for Coping with the Bullwhip
Reducing uncertainty. Centralizing

information
Reducing variability.
Reducing variability inherent in the customer
demand process.
Everyday low pricing (EDLP) strategy.
1-15
Methods for Coping with the Bullwhip
Lead-time reduction
Lead times magnify the increase in variability due to

demand forecasting.
Two components of lead times:
order lead times [can be reduced through the use of crossdocking]

Information lead times [can be reduced through the use of
electronic data interchange (EDI).]
Strategic partnerships
Changing the way information is shared and inventory

is managed
Vendor managed inventory (VMI)
Manufacturer manages the inventory of its product at the

retailer outlet
VMI the manufacturer does not rely on the orders placed by a
retailer, thus avoiding the bullwhip effect entirely.
1-16
5.3 Information Sharing And

Incentives
Centralizing information will reduce variability

Upstream stages would benefit more
Unfortunately, information sharing is a problem
in many industries
Inflated forecasts are a reality
Forecast information is inaccurate and distorted
Forecasts inflated such that suppliers build capacity

Suppliers may ignore the forecasts totally
1-17
Contractual Incentives to Get True

Forecasts from Buyers
Capacity Reservation Contract
Buyer pays to reserve a certain level of capacity at

the supplier
A menu of prices for different capacity reservations
provided by supplier
Buyer signals true forecast by reserving a specific
capacity level
Advance Purchase Contract
Supplier charges special price before building

capacity
When demand is realized, price charged is different
Buyers commitment to paying the special price
reveals the buyers true forecast
1-18
5.4 Effective Forecasts
Retailer forecasts
Distributor and manufacturer forecasts
Typically based on an analysis of previous sales at the

retailer.
Future customer demand influenced by pricing, promotions,
and release of new products.
Including such information will make forecasts more
accurate.
Influenced by factors under retailer control.
Promotions or pricing.
Retailer may introduce new products into the stores
Closer to actual sales may have more information
Cooperative forecasting systems
Sophisticated information systems

iterative forecasting process
all participants in the supply chain collaborate to arrive at
an agreed-upon forecast
All parties share and use the same forecasting tool
1-19
5.5 Information for the Coordination

of Systems
Many interconnected systems
manufacturing, storage, transportation, and retail

systems
the outputs from one system within the supply chain
are the inputs to the next system
trying to find the best set of trade-offs for any one
stage isnt sufficient.
need to consider the entire system and coordinate
decisions
Systems are not coordinated
each facility in the supply chain does what is best for

that facility
the result is local optimization.
1-20
Global Optimization
Issues:
Who will optimize?
How will the savings obtained through the
coordinated strategy be split between the
different supply chain facilities?
Methods to address issues:

Supply contracts
Strategic partnerships
1-21
5.6 Locating Desired Products
Meet customer demand from available retailer

inventory
What if the item is not in stock at the retailer?
Being able to locate and deliver goods is sometimes

as effective as having them in stock
If the item is available at the competitor, then this is a
problem
Other Methods
Inventory pooling (Chapter 7)

Distributor Integration (Chapter 8)
1-22
5.7 Lead-Time Reduction
Numerous benefits:
The ability to quickly fill customer orders that cant be filled

from stock.
Reduction in the bullwhip effect.
More accurate forecasts due to a decreased forecast horizon.
Reduction in finished goods inventory levels
Many firms actively look for suppliers with shorter lead

times
Many potential customers consider lead time a very
important criterion for vendor selection.
Much of the manufacturing revolution of the past 20
years led to reduced lead times
Other methods:
Distribution network designs (Chapter 6)

Effective information systems (e.g., EDI)
Strategic partnering (Chapter 8) (Sharing point-of-sale (POS)
data with supplier)
1-23
5.8 Information and Supply Chain

Trade-Offs
Conflicting objectives in the supply chains
Designing the supply chain with conflicting
goals
1-24
Wish-Lists of the Different Stages
Raw material suppliers
Manufacturing
Minimizing transportation costs through: quantity discounts,

minimizing inventory levels, quickly replenishing stock.
Retailers
High productivity through production efficiencies and low

production costs
Known future demand pattern with little variability.
Materials, warehousing, and outbound logistics
Stable volume requirements and little variation in mix

Flexible delivery times
Large volume demands
Short order lead times and efficient, accurate order delivery
Customers
In-stock items, enormous variety, and low prices.

1-25
Trade-Offs: Inventory-Lot Size
Manufacturers would like to have large lot sizes.
Modern practices [Setup time reduction, Kanban and CONWIP]
Per unit setup costs are reduced

Manufacturing expertise for a particular product increases
Processes are easier to control.
Reduce inventories and improve system responsiveness.
Advanced manufacturing systems make it possible for
manufacturers to meet shorter lead times and respond more
rapidly to customer needs.
Manufacturer should have as much time as possible to react to

the needs of downstream supply chain members.
Distributors/retailers can have factory status and manufacturer
inventory data:
they can quote lead times to customers more accurately.

develops an understanding of, and confidence in, the
manufacturers ability.
allows reduction in inventory in anticipation of manufacturing
problems
1-26
Trade-offs
Inventory-Transportation Costs
Company operates its own fleet of trucks.
Outside firm is used for shipping
quantity discounts
TL shipping cheaper than LTL shipping
In many cases
Fixed cost of operation + variable cost

Carrying full truckloads minimizes transportation costs.
demand is much less than TL

Items sit for a long time before consumption leading to higher
inventory costs.
Trade-off cant be eliminated completely.
Use advanced information technology to reduce this effect.

Distribution control systems allow combining shipments of different
products from warehouses to stores
Cross-docking,
Decision-support systems allow appropriate balance between
transportation and inventory costs
1-27
Trade-offs
Lead Time-Transportation Costs
Transportation costs lowest when large quantities of

items are transported between stages of the supply
chain.
Hold items to accumulate enough to combine shipments
Lead times can be reduced if items are transported

immediately after they are manufactured or arrive from
suppliers.
Cannot be completely eliminated
Information can be used to reduce its effect.

Control transportation costs reducing the need to hold items
until a sufficient number accumulate.
Improved forecasting techniques and information systems
reduce the other components of lead time
may not be essential to reduce the transportation
component.
1-28
Trade-Offs
Product Variety-Inventory
Higher product variety makes supply chain

decisions more complex
Better for meeting customer demand
Typically leads to higher inventories
Strategies:
Delayed Differentiation (Chapter 6)

Ship
generic products as far as possible down the

supply chain
Design for logistics (Chapter 11)
1-29
Trade-Offs
Cost-Customer Service
Reducing inventories, manufacturing costs, and

transportation costs typically comes at the
expense of customer service
Customer service could mean the ability of a
retailer to meet a customers demand quickly
Strategies:
transshipping
direct shipping from warehouses to customers
Charging price premiums for customized products
1-30
5.9 Decreasing Marginal Value of

Information
Obtaining and sharing information is not free.

Many firms are struggling with exactly how to use the data they
collect through loyalty programs, RFID readers, and so on.
Cost of exchanging information versus the benefit of doing so.
May not be necessary to exchange all of the available information, or

to exchange information continuously.
Decreasing marginal value of additional information
In multi-stage decentralized manufacturing supply chains many of

the performance benefits of detailed information sharing can be
achieved if only a small amount of information is exchanged
between supply chain participants.
Exchanging more detailed information or more frequent
information is costly.
Understand the costs and benefits of particular pieces of information

How often this information is collected
How much of this information needs to be stored
How much of this information needs to be shared
In what form it needs to shared
1-31
Summary
The bullwhip effect suggests that variability in demand

increases as one moves up in the supply chain.
Increase in variability causes significant operational
inefficiencies
Specific techniques to counteract bullwhip effect
Information sharing, i.e., centralized demand information.

Incentives to share credible forecasts
Alignments of expectations associated with the use of
information.
Interaction of various supply chain stages.
A series of trade-offs both within and between the different

stages.
Information is the key enabler of integrating the different supply
chain stages
Information can be used to reduce the necessity of many of
these trade-offs
1-32

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Chapter 5

Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Helps reduce variability in the supply chain.

5.2 Bullwhip Effect

Sales quite flat

4-Stage Supply Chain

Effect of Order Variability

FIGURE 5-6: The increase in variability in the supply chain

Factors that Contribute to the

Periodic review policy

Factors that Contribute to the

Increase in variability magnified with increasing

a small change in the estimate of demand variability

Factors that Contribute to the

Retailer uses batch ordering, as with a (Q,R) or

Transportation discounts with large orders

Factors that Contribute to the

Retailers often attempt to stock up when

order during the discounts

Factors that Contribute to the

leads to all kinds of distortions and variations

Impact of Centralized Information

Centralize demand information within a

Additively with centralized case

Centralizing demand information can

Although not eliminate it completely!!

Methods for Coping with the Bullwhip

Reducing uncertainty. Centralizing

Methods for Coping with the Bullwhip

Lead times magnify the increase in variability due to

order lead times [can be reduced through the use of crossdocking]

Changing the way information is shared and inventory

Manufacturer manages the inventory of its product at the

5.3 Information Sharing And

Centralizing information will reduce variability

Forecasts inflated such that suppliers build capacity

Contractual Incentives to Get True

Capacity Reservation Contract

Buyer pays to reserve a certain level of capacity at

Advance Purchase Contract

Supplier charges special price before building

5.4 Effective Forecasts

Distributor and manufacturer forecasts

Typically based on an analysis of previous sales at the

Cooperative forecasting systems

Sophisticated information systems

5.5 Information for the Coordination

Many interconnected systems

manufacturing, storage, transportation, and retail

Systems are not coordinated

each facility in the supply chain does what is best for

Methods to address issues:

5.6 Locating Desired Products

Meet customer demand from available retailer

Being able to locate and deliver goods is sometimes

Inventory pooling (Chapter 7)

5.7 Lead-Time Reduction

The ability to quickly fill customer orders that cant be filled

Many firms actively look for suppliers with shorter lead