International Operations Management

1. International Operations Management MGMT 6367 Lecture 03 Instructor: Yan Qin Fall 2013

2. Outline • Introduction to Supply Chain Management • Definition of Supply Chain Management • Bullwhip effect • Causes and Mitigating strategies • Achieving coordination in practice • Supply chain performance measures • Supplement: Common demand forecasting methods

3. A Supply Chain • This supply chain includes all the interactions among suppliers, manufacturers, distributors, and customers. Each manufacturer can have different tiers of suppliers. S3 S2 Distributor(s) S1 Manufacturer S2 Retailer(s) Tier 1 Suppliers Tier 2 Suppliers Tier 3 Suppliers Customers

4. Example: Supply Chain of Bottled Water • YouTube Video: http://www.youtube.com/watch?v=Mi1QBxVjZAw • This video “describes the complex supply chain of a simple product, a bottle of water. The video also illustrates the importance of supply chain managers and their skill sets in our modern global economy for both manufacturing and service industries.”

5. Supply Chain Management • Definitions of Supply Chain Management • Supply Chain Management is the integration of the activities that procure materials and services, transform them into intermediate good and final products, and deliver them to customers. • Supply Chain Management deals with the management of materials, information, and financial flows in a network consisting of suppliers, manufacturers, distributors, and customers. -- Prof. Hau Lee, Stanford Supply Chain Forum

6. Typical Questions to ask • Examples of questions to be answered in a Supply Chain: • It is less costly to transport product by boat or truck, but air freight sometimes can save you a lot of time. So which one to pick? • Number, size, and location of warehouses, plants, and terminals • How much inventory to stock and what control policies to use? • Make or Buy? That is, shall we produce a component or service in-house or purchase it from an outside source? • What type of relationship should be established among members in the same supply chain? • …

7. Bullwhip Effect • Local Optimization • Members of the chain are inclined to focus on maximizing local profit or minimizing immediate cost based on their limited knowledge. • Prisoner’s dilemma can be a good example of the sub-optimal result of local optimization. • The result is that the fluctuation in orders increases as orders move through the supply chain, which is called Bullwhip effect.

8. Bullwhip Effect (Cont.) • Why called Bullwhip effect? Suppliers (Upstream) End Customer (Downstream)

9. Behavioral causes of Bull-whip effect • Failure to understand the impact of individual decisions on the supply chain as a whole is one cause of the bullwhip effect. • Risk-averse attitudes of decision makers

10. Major Non-behavioral Causes • Demand Forecast update • Explanation: • When a downstream player places an order, the upstream manager take it as a signal about future demand. • Many of the forecasting methods place substantial weight on recently observed demand, leading to distortion when there is a sudden peak or drop in orders. • Remedies: • In-time demand sharing among members. • Some companies convinced their suppliers to locate their production faculties nearby.

11. Examples of Remedies - Demand Forecast • JC Penny and Levi Strauss are linked with an EDI that allows Levi Strauss to obtain sales data. These data allow Levi Strauss to better plan the production process as well as better control inventory and delivery. The savings leads to a reduction in costs and prices, benefitting both JC Penny and Levi Strauss. • McKesson developed a close relationship with Johnson & Johnson, one of its major suppliers. Both firms receive data on inventory, POS, and customer information through a joint information system. This enables Johnson & Johnson to provide better services to McKesson, which in turn improves the level of service that McKesson is able to provide to its customers.

12. Major Causes of Bullwhip Effect • Order Batching • Explanation: Companies may want to accumulate demand before issuing an order to take advantage of the economies of scale in order placing or transportation. • Remedies: • Use Electronic purchasing to reduce ordering costs • One solution to discourage shipment consolidation can be to outsource the transportation activities.

13. Major Causes of Bullwhip Effect • Price Fluctuation • Explanation: Companies may buy supplies well in advance of demand as a result of special trade deals and consumer promotions, such as discounts and rebates. • Remedies: • Every-Day-Low-Price can be one solution; • Adopt Continuous Replenishment Program (CRP), that is, products are replenished only for the sold amount.

14. Major Causes of Bullwhip Effect • Rationing and Shortage Gaming • Explanation: • When product demand exceeds product supply, manufacturers tend to ration their products to customers by allocating in proportion to the amount ordered. • Remedies: • One possible way is to allocate products in proportion to past sales. • Impose high order cancellation fee.

15. Achieving SC Coordination in Practice Steps to follow: • Quantify the bullwhip effect • Get top management commitment for coordination • Devote resources to coordination • Focus on communication with other stages • Try to achieve coordination in the entire supply chain network • Use technology to improve connectivity in the supply chain • Share the benefits of coordination equitably The slides on “Achieving SC Coordination” are written based on the relevant chapter from “Supply Chain Management” by Chopra and Meindl.

16. How to evaluate Supply Chain performance • The evaluation of Supply Chain with focuses on procurement and inventory tends to answer two questions: • How well the supply chain is performing; and • How well assets are utilized. • Benchmarkingis used to answer the 1stquestion. • To answer the 2nd question, three measures can be of help. • Percent of assets invested in inventory • Inventory Turnover • Weeks-of-Supply

17. Benchmarking • Benchmarking is the process of comparing one’s own business processes to the industry bests or the best practices in other industries.

18. How well assets are utilized • Percent of assets invested in inventory Example: Home Depot had $11.4 billion invested in inventory and total assets of $44.4 billion in 2006. Then, its Percent of assets invested in inventory = (11.4/44.4)* 100% = 25.7%

19. Inventory Turnover • Inventory turnover (computed on an annual basis) Inventory turnover = Cost of goods sold / Inventory Investment Cost of goods soldis the cost to produce the goods or services sold for a given period. The inventory investmentcan be: • The sum of the beginning and the ending inventory values divided by 2; OR • The sum of the values of different types of inventories being held in the system.

20. Example: Inventory Turnover • PepsiCo. Inc provides the following in its 2005 annual report (in $ billion). Determine its inventory turnover.

21. Weeks-of-Supply • Weeks-of-supply indicates for how long the average amount of on-hand inventory may last based on the current demand. Weeks-of-supply = Inventory Investment / (cost of goods sold / 52 weeks) For weeks-of-supply, it is usually the lower the better.

22. Supplement: Demand Forecasting Methods • There are two general approaches to forecasting: • Qualitative, which incorporate factors such as decision maker’s intuition, emotions, personal experience, and so on. • Quantitative, which uses a variety of models that rely on historical data to forecast demand.

23. Common types of Qualitative Methods • Jury of execution opinion: The opinions of a group of high-level experts or mangers are pooled together to arrive at a group estimate of demand. • Delphi method: Surveys and questionnaires are distributed to a group of selected respondents. Then a group of 5-10 experts make the decision based on the responses. • The state of Alaska used Delphi method to develop its long-range economic forecast.

24. Common types of Qualitative Methods • Sales force composite: Combine each sales person’s estimate of future demand. • Lexus dealers meet every quarter to talk about the sales, such as what is selling, in what colors, so the manufacturer has an idea what to build. • Consumer market survey: Collect information from current or potential customers about future purchasing plan.

25. Common Quantitative Methods • Time series models predict on the assumption that the future is a function of the past. • Naïve approach • Moving averages • Exponential smoothing • Associative Models incorporate variables that might influence the quantity being forecast. • For example, an associative model for lawn mowers sales might use factors such as new housing starts, advertising budget and so on.

26. Naïve Approach • Assume that demand in the next period will be equal to the most recent period. • Bull-whip effect will be maximized under this forecasting method.

27. Moving averages • A moving-average forecast uses a number of historical actual data values to generate a forecast. • It is useful if we can assume that market demands will stay fairly steady over time. • An n-period moving-average model: Moving average forecast for demand in period (n+1) Usually the n is 3, 6, 9 months.

28. Example: 3-/6-month moving average forecast

29. Weighted moving averages • Weights can be used to place more emphasis on recent values or older values. • A weighted n-period moving average: Forecast for the demand in period (n+1) is the weight attached to the actual demand in period i is the actual demand in period i

30. Example: Weighted moving average • The following table summarizes the actual demands for a product in the past 6 weeks. What is the forecast for Week 4 if the company wants to use the 3-period weighted moving average method with the weight of 0.6 for the most recent demand, 0.3 for the 2nd most recent demand, and 0.1 for the oldest actual demand.

31. Limitations of moving averages • Increasing the size of n makes the method less sensitive to real changes in the data; • Moving averages cannot predict changes to either higher or lower levels in time. They lag the actual values. • Moving averages require extensive records of past data.

32. Exponential smoothing • Exponential smoothing is a sophisticated weighted-moving-average method. • Call a smoothing constant, valued between 0 an 1. Usually from 0.05 to 0.50 for business application. • New forecast =

33. Example: Exponential smoothing • Suppose the actual demand for year 2012 was 250 and the forecast for the demand was 230. Set the smoothing constant α = 0.1. • What is the exponential smoothing forecast for year 2013?

34. Next Week • Design for Supply Chain efficiency • Supply Chain Coordination • Buy Back contract • Quantity Discount • More Supply Chain contracts • Cycle inventory