SCM CHAPTER 1.pdf

CHAPTER 1: UNDERSTANDING SUPPLY CHAIN directions of this chain. The term supply chain may also imply that only one player is involved at each stage. In reality, a 1.1 Supply Chain Management (SC...

CHAPTER 1: UNDERSTANDING SUPPLY CHAIN directions of this chain. The term supply chain may also imply that only one player is involved at each stage. In reality, a 1.1 Supply Chain Management (SCM) Definition manufacturer may receive material from several suppliers and then supply several distributors. Thus, most supply chains are Supply Chain: the sequence of organizations — their facilities, actually networks. It may be more accurate to use the term functions, and activities — that are involved in producing and supply network or supply web to describe the structure of delivering a product or service. The sequence begins with basic most supply chains, as shown in Figure 1-2. suppliers of raw materials and extends all the way to the final customer. Facilities include warehouses, factories, processing centers, distribution centers, retail outlets, and offices. Functions and activities include forecasting, purchasing, inventory management, information management, quality assurance, scheduling, production, distribution, delivery, and customer service. Consider a customer walking into a Wal-Mart store to purchase detergent. The supply chain begins with the customer and his or her need for detergent. The next stage of this supply chain is the Wal-Mart retail store that the customer visits. Wal-Mart stocks its shelves using inventory that may have been supplied from a finished-goods warehouse or a distributor using trucks supplied by a third party. The distributor in turn is stocked by the manufacturer (say, Proctor & Gamble [P&G] in this case). The The Objective of a Supply Chain P&G manufacturing plant receives raw material from a variety of suppliers, who may themselves have been supplied by lower- The objective of every supply chain should be to maximize the tier suppliers. For example, packaging material may come from overall value generated. The value a supply chain generates Tenneco packaging, while Tenneco receives raw materials to is the difference between what the final product is worth to the manufacture the packaging from other suppliers. This supply customer and the costs the supply chain incurs in filling the chain is illustrated in Figure 1-1, with the arrows corresponding customer's request. For most commercial supply chains, value to the direction of physical product flow. will be strongly correlated with supply chain profitability (also known as supply chain surplus), the difference between the revenue generated from the customer and the overall cost across the supply chain. For example, a customer purchasing a wireless router from Best Buy pays $60, which represents the revenue the supply chain receives. Best Buy and other stages of the supply chain incur costs to convey information, produce components, store them, transport them, transfer funds, and so on. The difference between the $60 that the customer paid and the sum of all costs incurred by the supply chain to produce and distribute the router represents the supply chain profitability or surplus. Supply chain profitability or surplus is the total profit to be shared across all supply chain stages and intermediaries. The higher the supply chain profitability, the more successful is the supply chain. Supply chain success should be measured in A supply chain is dynamic and involves the constant flow of terms of supply chain profitability and not in terms of the profits information, product, and funds between different stages. In our at an individual stage. (In subsequent chapters we see that a example, Wal-Mart provides the product, as well as pricing and focus on profitability at individual stages may lead to a reduction availability information, to the customer. The customer transfers in overall supply chain profits.) funds to Wal-Mart. Wal-Mart conveys point-of-sales data as well as replenishment orders to the warehouse or distributor, who Having defined the success of a supply chain in terms of supply transfers the replenishment order via trucks back to the store. chain profitability, the next logical step is to look for sources of Wal-Mart transfers funds to the distributor after the revenue and cost. For any supply chain, there is only one source replenishment. The distributor also provides pricing information of revenue: the customer. At Wal-Mart, a customer purchasing and sends delivery schedules to Wal-Mart. Wal-Mart may send detergent is the only one providing positive cash flow for the back packaging material to be recycled. Similar information, supply chain. All other cash flows are simply fund exchanges material, and fund flows take place across the entire supply that occur within the supply chain, given that different stages chain. have different owners. When Wal-Mart pays its supplier, it is taking a portion of the funds the customer provides and passing This example illustrate that the customer is an integral part of that money on to the supplier. All flows of information, product, the supply chain. In fact, the primary purpose of any supply or funds generate costs within the supply chain. Thus, the chain is to satisfy customer needs and, in the process, generate appropriate management of these flows is a key to supply chain profit for itself. The term supply chain conjures up images of success. Effective supply chain management involves the product or supply moving from suppliers to manufacturers to management of supply chain assets and product, information, distributors to retailers to customers along a chain. This is and fund flows to maximize total supply chain profitability. certainly part of the supply chain, but it is also important to visualize information, funds, and product flows along both aj villamino Supply Chain Management: the strategic coordination of Supply chains are sometimes referred to as value chains, a business functions within a business organization and term that reflects the concept that value is added as goods and throughout its supply chain for the purpose of integrating supply services progress through the chain. Supply or value chains and demand management. Supply chain managers are people typically comprise separate business organizations, rather than at various levels of the organization who are responsible for just a single organization. Moreover, the supply or value chain managing supply and demand both within and across business has two components for each organization: a supply organizations. They are involved with planning and coordinating component and a demand component. The supply component activities that include sourcing and procurement of materials and starts at the beginning of the chain and ends with the internal services, transformation activities, and logistics. Logistics is the operations of the organization. The demand component of the part of a supply chain involved with the forward and reverse flow chain starts at the point where the organization’s output is of goods, services, cash, and information. Logistics delivered to its immediate customer and ends with the final management includes management of inbound and outbound customer in the chain. The demand chain is the sales and transportation, material handling, warehousing, inventory, order distribution portion of the value chain. The length of each fulfillment and distribution, third-party logistics, and reverse component depends on where a particular organization is in the logistics (the return of goods from customers). Every business chain; the closer the organization is to the final customer, the organization is part of at least one supply chain, and many are shorter its demand component and the longer its supply part of multiple supply chains. Often the number and type of component. organizations in a supply chain are determined by whether the supply chain is manufacturing or service oriented. Figure 1-3 Supply chains are the lifeblood of any business illustrates several perspectives of supply chains. Figure 1-4 organization. They connect suppliers, producers, and final shows a more detailed version of the farm-to-market supply customers in a network that is essential to the creation and chain with key suppliers at each stage included. delivery of goods and services. Managing the supply chain is the process of planning, implementing, and controlling supply chain operations. The basic components are strategy, procurement, supply management, demand management, and logistics. The goal of supply chain management is to match supply to demand as effectively and efficiently as possible. Key issues relate to: 1. Determining the appropriate level of outsourcing. 2. Managing procurement. 3. Managing suppliers. 4. Managing customer relationships. 5. Being able to quickly identify problems and respond to them. An important aspect of supply chain management is flow management. The three types of flow that need to be managed are product and service flow, information flow, and financial flow. Product and service flow involves the movement of goods or services from suppliers to customers as well as handling customer service needs and product returns. Information flow involves sharing forecast and sales data, transmitting orders, tracking shipments, and updating order status. Financial flow involves credit terms, payments, and consignment and title ownership arrangements. Technological advances have greatly enhanced the ability to effectively manage these flows. A dramatic decrease in the cost of transmitting and receiving information and the increased ease and speed of communication have facilitated the ability to coordinate supply chain activities and make timely decisions. In effect, a supply chain is a complex supply network. 1.2 PORTER’S VALUE CHAIN The value chain was designed by Michael Porter in 1985 as a systematic way to examine how competitive advantage develops and to identify where value is added in an organization (see Figure 1-5). According to Porter, a value chain consists of primary activities and support activities, all of which add value to the products or services offered by the business. The primary activities focus on taking the inputs, converting them into outputs, and delivering the output to the customer. The support activities play an auxiliary role in primary activities. When a company is efficient in combining these activities to provide a aj villamino superior product or service, then the customer is willing to pay 1. Facilities are the actual physical locations in the supply more for the product than the cost to make and deliver the chain network where product is stored, assembled, or product which results in a higher profit margin. 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 The primary activities are: belonging to a firm is reported under assets. Changing 1. Inbound Logistics - involve relationships with suppliers inventory policies can dramatically alter the supply chain’s and include all the activities required to receive, store, and efficiency and responsiveness. For example, W.W. disseminate inputs. Grainger makes itself responsive by stocking large amounts 2. Operations - are all the activities required to transform of inventory and satisfying customer demand from stock inputs into outputs (products and services). even though the high inventory levels reduce efficiency. 3. Outbound Logistics - include all the activities required to Such a practice makes sense for Grainger because its collect, store, and distribute the output. products hold their value for a long time. A strategy using 4. Marketing and Sales - activities inform buyers about high inventory levels can be dangerous in the fashion products and services, induce buyers to purchase them, apparel business where inventory loses value relatively and facilitate their purchase. quickly with changing seasons and trends. Rather than hold 5. Service - includes all the activities required to keep the high levels of inventory, Spanish apparel retailer Zara has product or service working effectively for the buyer after it is worked hard to shorten new product and replenishment sold and delivered. lead times. As a result, the company is very responsive but carries low levels of inventory. Zara thus provides Secondary activities are: responsiveness at low cost. 3. Transportation entails moving inventory from point to point 1. Procurement - is the acquisition of inputs, or resources, for in the supply chain. Transportation can take the form of the firm. many combinations of modes and routes, each with its own 2. Human Resource management - consists of all activities performance characteristics. Transportation choices have a involved in recruiting, hiring, training, developing, large impact on supply chain responsiveness and efficiency. compensating and (if necessary) dismissing or laying off For example, a mail-order catalog company can use a personnel. faster mode of transportation such as FedEx to ship 3. Technological Development - pertains to the equipment, products, thus making its supply chain more responsive, but hardware, software, procedures, and technical knowledge also less efficient given the high costs associated with using brought to bear in the firm's transformation of inputs into FedEx. McMaster-Carr and W.W. Grainger, however, have outputs. structured their supply chain to provide next-day service to 4. Infrastructure - serves the company's needs and ties its most of their customers using ground transportation. They various parts together, it consists of functions or are providing a high level of responsiveness at lower cost. departments such as accounting, legal, finance, planning, Outbound transportation costs of shipping to the public affairs, government relations, quality assurance and customer are typically included in selling, general, and general management. administrative expense, while inbound transportation costs are typically included in the cost of goods sold. 1.3 DRIVERS OF SUPPLY CHAIN PERFORMANCE 4. Information consists of data and analysis concerning To understand how a company can improve supply chain facilities, inventory, transportation, costs, prices, and performance in terms of responsiveness and efficiency, we must customers throughout the supply chain. Information is examine the logistical and cross–functional drivers of supply potentially the biggest driver of performance in the supply chain performance: facilities, inventory, transportation, chain because it directly affects each of the other drivers. It information, sourcing, and pricing. These drivers interact to presents management with the opportunity to make supply determine the supply chain’s performance in terms of chains more responsive and more efficient. For example, responsiveness and efficiency. The goal is to structure the Seven-Eleven Japan has used information to better match drivers to achieve the desired level of responsiveness at the supply and demand while achieving production and lowest possible cost, thus improving the supply chain distribution economies. The result is a high level of surplus and the firm’s financial performance. First, we define responsiveness to customer demand while production and each driver and discuss its impact on the performance of the replenishment costs are lowered. Information technology– supply chain. related expenses are typically included under either operating expense (typically under selling, general, and administrative expense) or assets. For example, in 2009, aj villamino  Amazon included $1.24 billion in technology expense under have chosen to focus on providing variety. Given the high variety operating expense and another $551 million under fixed and high prices, keeping inventory of all variants at a retailer assets to be depreciated. would be very expensive. In this case, the supply chain has been 5. Sourcing is the choice of who will perform a particular designed so that the retailer carries little inventory. Customers supply chain activity such as production, storage, place their orders with the retailer by seeing one variant of the transportation, or the management of information. At the furniture and selecting among the various options. The supply strategic level, these decisions determine what functions a chain is made responsive by using information technology to firm performs and what functions the firm outsources. convey order information effectively, structuring flexible Sourcing decisions affect both the responsiveness and manufacturing facilities to be able to produce in small lots, and efficiency of a supply chain. After Motorola outsourced using responsive transportation to deliver the furniture to the much of its production to contract manufacturers in China, customer. In this instance, responsive facilities, transportation, it saw its efficiency improve but its responsiveness suffers and information are used to lower inventory costs. The key to because of the long distances. To make up for the drop in achieving strategic fit and strong financial performance across responsiveness, Motorola started flying in some of its cell the supply chain is to structure the supply chain drivers phones from China even though this choice increased appropriately to provide the desired level of responsiveness at transportation cost. Flextronics, an electronics contract the lowest possible cost. manufacturer, is hoping to offer both responsive and efficient sourcing options to its customers. It is trying to Framework for Structuring Drivers make its production facilities in high-cost locations very The goal of a supply chain strategy is to strike the balance responsive while keeping its facilities in low-cost countries between responsiveness and efficiency that fits with the efficient. Flextronics hopes to become an effective source competitive strategy. To reach this goal, a company must for all customers using this combination of facilities. structure the right combination of the three logistical and three Sourcing costs show up in the cost of goods sold, and cross-functional drivers. The combined impact of these drivers monies owed to suppliers are recorded under accounts then determines the responsiveness and the profits of the entire payable. supply chain. 6. Pricing determines how much a firm will charge for the goods and services that it makes available in the supply We provide a visual framework for supply chain decision making chain. Pricing affects the behavior of the buyer of the good in Figure 1-6. Most companies begin with a competitive strategy or service, thus affecting supply chain performance. For and then decide what their supply chain strategy ought to be. example, if a transportation company varies its charges The supply chain strategy determines how the supply chain based on the lead time provided by the customers, it is likely should perform with respect to efficiency and responsiveness. that customers who value efficiency will order early and The supply chain must then use the three logistical and three customers who value responsiveness will be willing to wait cross-functional drivers to reach the performance level the and order just before they need a product transported. supply chain strategy dictates and maximize the supply chain Differential pricing provides responsiveness to customers profits. Although this framework is generally viewed from the top that value it and low cost to customers that do not value down, in many instances, a study of the six drivers may indicate responsiveness as much. Any change in pricing impacts the need to change the supply chain strategy and potentially revenues directly but could also affect costs based on the even the competitive strategy. impact of this change on the other drivers. Consider this framework using Wal-Mart as an example. Wal- Our definitions of these drivers attempt to delineate logistics and Mart’s competitive strategy is to be a reliable, low-cost retailer supply chain management. Supply chain management includes for a wide variety of mass-consumption goods. This strategy the use of logistical and cross-functional drivers to increase the dictates that the ideal supply chain will emphasize efficiency but supply chain surplus. Cross-functional drivers have become also maintain an adequate level of responsiveness in terms of increasingly important in raising the supply chain surplus in product availability. Wal-Mart uses the three logistical and three recent years. While logistics remains a major part, supply chain cross-functional drivers effectively to achieve this type of supply management is increasingly becoming focused on the three chain performance. With the inventory driver, Wal-Mart cross-functional drivers. maintains an efficient supply chain by keeping low levels of inventory. For instance, Wal-Mart pioneered cross-docking, a It is important to realize that these drivers do not act system in which inventory is not stocked in a warehouse but independently but interact to determine the overall supply chain rather is shipped to stores from the manufacturer with a brief performance. Good supply chain design and operation stop at a distribution center (DCs), where product is transferred recognize this interaction and make the appropriate trade-offs to from inbound trucks from the supplier to outbound trucks to the deliver the desired level of responsiveness. Consider, for retail store. This significantly lowers inventory because products example, the furniture industry in the United States. Low-cost are stocked only at stores, not at both stores and warehouses. furniture sourced from Asia is available at many discount With respect to inventory, Wal-Mart favors efficiency over retailers. The primary goal of this supply chain is to deliver a low responsiveness. On the transportation front, Wal-Mart runs its price and acceptable quality. Variety is typically low and retailers own fleet, to keep responsiveness high. This increases such as Wal-Mart stock inventory of finished goods. The low transportation cost, but the benefits in terms of reduced variety and stable replenishment orders allow furniture inventory and improved product availability justify this cost in manufacturers in Asia to focus on efficiency. Given the available Wal-Mart’s case. In the case of facilities, Wal-Mart uses centrally inventory, low-cost modes of transportation from Asia are used. located DCs within its network of stores to decrease the number In this instance, relatively low-cost inventory at the retailer allows of facilities and increase efficiency at each DC. Wal-Mart builds the supply chain to become efficient by lowering transportation retail stores only where the demand is sufficient to justify having and production costs. In contrast, some U.S. furniture makers aj villamino several of them supported by a DC, thereby increasing efficiency located far from the production facility. The opposite is also true. of its transportation assets. Wal-Mart has invested significantly Locating facilities close to customers increases the number of more than its competitors in information technology, allowing the facilities needed and consequently reduces efficiency. If the company to feed demand information across the supply chain to customer demands and is willing to pay for the responsiveness suppliers who manufacture only what is being demanded. As a that having numerous facilities adds, however, then this facilities result, Wal-Mart is a leader in its use of the information driver to decision helps meet the company’s competitive strategy goals. improve responsiveness and decrease inventory investment. With regard to the sourcing driver, Wal-Mart identifies efficient Example: Toyota and Honda sources for each product it sells. Wal-Mart feeds them large Both Toyota and Honda use facilities decisions to be more orders, allowing them to be efficient by exploiting economies of responsive to their customers. These companies have an end scale. Finally, for the pricing driver, Wal-Mart practices goal of opening manufacturing facilities in every major market “everyday low pricing” (EDLP) for its products. This ensures that that they enter. While there are other benefits to opening local customer demand stays steady and does not fluctuate with price facilities, such as protection from currency fluctuation and trade variations. The entire supply chain then focuses on meeting this barriers, the increase in responsiveness plays a large role in demand in an efficient manner. Wal-Mart uses all the supply Toyota’s and Honda’s decision to place facilities in their local chain drivers to achieve the right balance between markets. The flexibility of Honda facilities to assemble both responsiveness and efficiency so that its competitive strategy SUVs and cars in the same plant allowed the company to keep and supply chain strategy are in harmony. costs down in the downturn of 2008. While competitors’ SUV production facilities were idle, Honda facilities maintained a high level of utilization. OVERALL TRADE-OFF: RESPONSIVENESS VERSUS EFFICIENCY. The fundamental trade-off that managers face when making facilities decisions is between the cost of the number, location, capacity, and type of facilities (efficiency) and the level of responsiveness that these facilities. INVENTORY In this section, we discuss the role that inventory plays in the supply chain and how managers use inventory to drive supply chain performance. Role in the Supply Chain Inventory exists in the supply chain because of a mismatch between supply and demand. This mismatch is intentional at a steel manufacturer, where it is economical to manufacture in large lots that are then stored for future sales. The mismatch is also intentional at a retail store where inventory is held in anticipation of future demand. An important role that inventory plays in the supply chain is to increase the amount of demand that can be satisfied by having the product ready and available when the customer wants it. Another significant role FACILITIES that inventory plays is to reduce cost by exploiting economies of scale that may exist during production and In this section, we discuss the role that facilities play in the distribution. Inventory impacts the assets held, the costs supply chain and critical facility-related decisions that supply incurred, and responsiveness provided in the supply chain. High chain managers need to make. levels of inventory in an apparel supply chain improve Role in the Supply Chain responsiveness but also leave the supply chain vulnerable to the need for markdowns, lowering profit margins. Low levels of If we think of inventory as what is being passed along the supply inventory improve inventory turns but may result in lost sales if chain and transportation as how it is passed along, then facilities customers are unable to find products they are ready to buy. are the where of the supply chain. They are the locations to or from which the inventory is transported. Within a facility, Inventory also has a significant impact on the material flow inventory is either transformed into another state time in a supply chain. Material flow time is the time that (manufacturing) or it is stored (warehousing). elapses between the point at which material enters the supply chain to the point at which it exits. For a supply chain, Role in the Competitive Strategy throughput is the rate at which sales occur. If inventory is represented by I, flow time by T, and throughput by D, the three Facilities are a key driver of supply chain performance in terms can be related using Little’s law as follows: of responsiveness and efficiency. For example, companies can gain economies of scale when a product is manufactured or I = DT stored in only one location; this centralization increases efficiency. The cost reduction, however, comes at the expense For example, if the flow time of an auto assembly process is 10 of responsiveness, as many of a company’s customers may be hours and the throughput is 60 units an hour, Little’s law tells us aj villamino that the inventory is 60 x 10 = 600 units. If we were able to Role in the Competitive Strategy reduce inventory to 300 units while holding throughput constant, we would reduce our flow time to 5 hours (300/60). We note that Transportation allows a firm to adjust the location of its in this relationship, inventory and throughput must have facilities and inventory to find the right balance between consistent units. responsiveness and efficiency. A firm selling high-value items such as pacemakers may use rapid transportation to be The logical conclusion here is that inventory and flow time are responsive while centralizing its facilities and inventory to lower synonymous in a supply chain because throughput is often cost. In contrast, a firm selling low-value, high-demand items like determined by customer demand. Managers should use light bulbs may carry a fair amount of inventory close to the actions that lower the amount of inventory needed without customer but then use low-cost transportation like sea, rail, and increasing cost or reducing responsiveness, because reduced full trucks to replenish this inventory from plants located in low- flow time can be a significant advantage in a supply chain. cost countries. Role in the Competitive Strategy Example: Blue Nile The form, location, and quantity of inventory allow a supply chain Blue Nile is an online retailer of diamonds that has used to range from being very low cost to very responsive. Large responsive transportation with FedEx to ship diamonds to amounts of finished goods inventory close to customers allow a customers in the United States, Canada, and several countries supply chain to be responsive but at a high cost. Centralized in Europe and Asia. Given the high value of diamonds, Blue Nile inventory in raw material form allows a supply chain to lower cost offers free shipping for the overnight delivery. Responsive but at the expense of responsiveness. The goal of good supply shipping, however, allows Blue Nile to centralize its inventory of chain design is to find the right form, location, and quantity of diamonds and also eliminate the need for expensive storefronts. inventory that provides the right level of responsiveness at the In spite of the high transportation costs, Blue Nile has very low lowest possible cost. costs compared to bricks-and mortar retailers because of the low facility and inventory expenses. Blue Nile is thus able to offer Example: Amazon.com significantly lower prices than its bricks-and-mortar competition. Amazon attempts to provide a wide variety of books (among OVERALL TRADE-OFF: RESPONSIVENESS VERSUS other products) to its customers. Best-selling books are stocked EFFICIENCY. The fundamental trade-off for transportation is in many regional warehouses close to customers for high between the cost of transporting a given product (efficiency) and responsiveness. Slower moving books are stocked at fewer the speed with which that product is transported warehouses to lower the cost of inventory at the expense of (responsiveness). Using fast modes of transport raises some responsiveness. Some of the slowest moving books are responsiveness and transportation cost but lowers the inventory not held in inventory but are obtained from the holding cost. publisher/distributor or printed on demand when requested by a customer. Amazon changes the form, location, and quantity of INFORMATION inventory it holds by the level of sales of a book to provide the right balance of responsiveness and efficiency. In this section, we discuss the role that information plays in the supply chain, as well as key information related decisions that OVERALL TRADE-OFF: RESPONSIVENESS VERSUS supply chain managers must make. EFFICIENCY. The fundamental trade-off that managers face when making inventory decisions is between responsiveness Role in the Supply Chain and efficiency. Increasing inventory generally makes the supply Good information can help improve the utilization of supply chain more responsive to the customer. A higher level of chain assets and the coordination of supply chain flows to inventory also facilitates a reduction in production and increase responsiveness and reduce costs. Seven-Eleven transportation costs because of improved economies of scale in Japan uses information to improve product availability while both functions. This choice, however, increases inventory decreasing inventories. Wal-Mart uses information on holding cost. shipments from suppliers to facilitate cross-docking and lower Transportation inventory and transportation expense. Li & Fung, a global trading group supplying time-sensitive consumer goods such as In this section, we discuss the role that transportation plays in apparel, uses information on its third-party manufacturers to the supply chain and key transportation related decisions that source each order from the most appropriate supplier. Airlines supply chain managers must make. routinely use information to offer the right number of seats at a discount price, leaving sufficient seats for business customers Role in the Supply Chain making reservations at the last minute and willing to pay a higher price. Each of these examples illustrates the importance of Transportation moves product between different stages in a information as a key driver that can be used to provide higher supply chain and impacts both responsiveness and efficiency. responsiveness while simultaneously improving efficiency. Faster transportation allows a supply chain to be more responsive but reduces its efficiency. The type of transportation Role in the Competitive Strategy a company uses also affects the inventory and facility locations in the supply chain. Dell, for example, flies some components The right information can help a supply chain better meet from Asia because doing so allows the company to lower the customer needs at lower cost. The appropriate investment in level of inventory it holds. Clearly, such a practice also increases information technology improves visibility of transactions and responsiveness but decreases transportation efficiency coordination of decisions across the supply chain. Coordination because it is more costly than transporting parts by ship. is essential if all stages of the supply chain are to work together aj villamino toward a common goal. The goal in general should be to share Role in the Competitive Strategy the minimum amount of information required to achieve coordination because, beyond a certain point, the marginal Sourcing decisions are crucial because they affect the level cost of handling additional information increases, whereas the of efficiency and responsiveness the supply chain can marginal benefit from the additional information decreases. The achieve. In some instance, firms outsource to responsive third following examples illustrate how information can be used to parties if it is too expensive for them to develop this provide customized products and improve supply chain responsiveness on their own. An example is the outsourcing of performance. next-day package delivery by all firms to a few package carriers because it is too expensive for a firm to develop next-day Example: Andersen Windows delivery capability on its own. In other instances, firms have kept the responsive process in-house to maintain control. An Andersen Windows, a major manufacturer of residential wood example is Zara, which keeps responsive capacity in-house so windows located in Bayport, Minnesota, has invested in an it can respond quickly to orders as they arrive. Firms also information system that enables the company to bring outsource for efficiency if the third party can achieve significant customized products to the market rapidly. This system, called economies of scale or has a lower underlying cost structure for “Window of Knowledge,” allows distributors and customers to other reasons. The following example illustrates how Cisco has design windows to custom-fit their needs. Users can select from sourced appropriately to be efficient for low-end products and a library of more than 50,000 components that can be combined responsive for high-end products. in any number of ways. The system immediately gives the customer price quotes and automatically sends the order to the Example: Cisco factory if the customer decides to buy. This information investment not only gives the customer a much wider variety of Cisco has outsourced almost all of its manufacturing. It does, products, it also allows Andersen to be much more responsive however, have a sourcing strategy that varies by product type. to the customer, as it gets the customer’s order to the factory as For low-end products such as routers for home networks, Cisco soon as the order is placed. aims for efficiency. These routers are produced and packed in China and shipped in bulk for sale in the United States. Cisco OVERALL TRADE-OFF: COMPLEXITY VERSUS VALUE. aims for the lowest cost manufacturing location and economies Good information clearly helps a firm improve both its efficiency of scale in transportation because the targeted market segment and responsiveness. There is a danger, however, in the values low cost. For high-end products, in contrast, Cisco assumption that more information is always better. As more outsources to contract manufacturers in the United States. information is shared across a supply chain, the complexity and These manufacturers are not low cost, but they are responsive cost of both the required infrastructure and the follow-up and can serve the rapidly evolving needs of the high-end market. analysis grow exponentially. The marginal value provided by the information shared, however, diminishes as more and more OVERALL TRADE-OFF: INCREASE THE SUPPLY CHAIN information is available. It is thus important to evaluate the SURPLUS. Sourcing decisions should be made to increase the minimum information required to accomplish the desired size of the total surplus to be shared across the supply chain. objectives. For example, it may often be enough if aggregate The total surplus is affected by the impact of sourcing on sales, sales are shared between a retailer and a manufacturer instead service, production costs, inventory costs, transportation costs, of detailed point-of-sale data. Aggregate information is cheaper and information costs. Outsourcing to a third party is meaningful to share and provides most of the value with regard to better if the third party raises the supply chain surplus more than the production planning. The trade-off between complexity and firm can on its own. In contrast, a firm should keep a supply value is important to consider when setting up the information chain function in-house if the third party cannot increase the infrastructure. supply chain surplus or if the risk associated with outsourcing is significant. SOURCING PRICING In this section, we discuss the role that sourcing plays in the supply chain and key sourcing-related decisions that managers In this section, we discuss the role that pricing plays in the need to make. supply chain. Role in the Supply Chain Role in the Supply Chain Sourcing is the set of business processes required to Pricing is the process by which a firm decides how much to purchase goods and services. Managers must first decide charge customers for its goods and services. Pricing affects whether each task will be performed by a responsive or efficient the customer segments that choose to buy the product, as well source and then whether the source will be internal to the as the customer’s expectations. This directly affects the supply company or a third party. Sourcing from low-cost countries chain in terms of the level of responsiveness required as well as allows a company like IKEA to provide the basic modules for the the demand profile that the supply chain attempts to serve. furniture it sells at low cost. Sourcing some of its PCs sold at Pricing is also a lever that can be used to match supply and Wal-Mart from China has allowed Dell to lower their cost. demand especially when the supply chain is not very flexible. Meanwhile, Dell continues to produce in-house those machines Short-term discounts can be used to eliminate supply surpluses for which responsiveness is required. As supply chains have or decrease seasonal demand spikes by moving some of the globalized, many more sourcing options now offer both demand forward. In short, pricing is one of the most significant considerable opportunity and potential risks. Thus, sourcing factors that affect the level and type of demand that the supply decisions have a significant impact on supply chain chain will face. performance. aj villamino Role in the Competitive Strategy Efficiency also requires one more thing — stability. You need to know that demand and prices will remain relatively stable for Pricing is a significant attribute through which a firm some number of years (5 or 10 years or more). Because then executes its competitive strategy. For example, Costco, a you can build factories and stores and transportation membership-based wholesaler in the United States, has a policy infrastructure to enable your efficient operating model. Efficiency that prices are kept steady but low. Customers expect low prices is best when producing relatively simple commodity products but are comfortable with a lower level of product availability. The and services that sell in more predictable and stable markets. steady prices also ensure that demand stays relatively stable. Costco serves a well-defined segment, and it can thus design Responsiveness is better — In the 21st century, an appropriate supply chain. The Costco supply chain aims to responsiveness drives the economy. Responsiveness is what be efficient, at the expense of some responsiveness. In contrast, drives continuous innovation in products and technology and some manufacturing and transportation firms use pricing that continuous change in the ways we organize businesses and varies with the response time desired by the customer. Through serve customers. The big companies of the 20th century were their pricing, these firms are targeting a broader set of efficient manufacturing companies (Ford, GM, US Steel, Kodak, customers, some of whom need responsiveness while others Whirlpool etc.), but the big companies of the 21st century are need efficiency. In this case, it becomes important for these firms responsive service and technology companies (Alibaba, to structure a supply chain that can meet the two divergent Amazon, Apple, Facebook, Google, Starbucks, Tencent, etc.). needs. Amazon uses a menu of shipping options and prices to All these 21st century companies certainly need to be efficient, identify customers who value responsiveness and those who but their success is based mostly on their ability to sense and value low cost. This identification allows the company to serve respond quickly to changing markets and evolving customer both effectively, as shown in the following example. desires. Lowest price is not always the deciding factor in purchasing decisions. People want products and services that Example: Amazon respond quickly and meet their changing needs and desires. Amazon offers its customers a large menu of prices for products Apple and Starbucks do not sell the lowest priced laptops or that are purchased from the company. For example, in July cups of coffee, nor does Porsche or Tesla make the lowest 2008, a person purchasing two books worth $30 could use priced automobiles, but as long as people value the quality and standard shipping (ships in 3–5 business days) at a cost of innovation offered by those companies and others like them, $4.98, two-day shipping (ships in 2 business days) at a cost of they will pay more for their products. Home delivery of $13.97, one day shipping (ships in 1 business day) at a cost of everything from clothes to groceries costs a bit more, but people $22.97 or use free shipping (ships in 7–14 business days). The value and pay for the responsiveness and convenience of those pricing menu allows Amazon to attract customers with varying services. Responsiveness is best when providing complex or levels of desired responsiveness. Whereas customers paying unique products and services that sell in continuously changing for one-day shipping impose a high degree of uncertainty on markets driven by evolving technology and new customer needs Amazon, customers opting for free shipping can be used to level and desires. out the workload at the warehouse over time. Amazon can thus use its pricing to provide responsiveness to those who value it The Right Mix of Efficiency and Responsiveness while using customers who want a low price to help it improve its efficiency. Even within supply chains that emphasize responsiveness, there are segments of those supply chains that should focus on OVERALL TRADE-OFF: INCREASE FIRM PROFITS. All pricing efficiency. Efficiency is critical wherever there are high volumes decisions should be made with the objective of increasing firm of predictable products moving between facilities. For example, profits. This requires an understanding of the cost structure of segments of supply chains that connect factories with performing a supply chain activity and the value this activity warehouses or distribution centers should be as efficient as brings to the supply chain. Strategies such as everyday low possible. They should use the most efficient transportation pricing may foster stable demand that allows for efficiency in the modes and delivery schedules, and those facilities should supply chain. Other pricing strategies may lower supply chain automate their operations as much as possible. costs, defend market share, or even steal market share. Differential pricing may be used to attract customers with varying However, segments of supply chains that connect distribution needs, as long as this strategy helps either increase revenues centers to end use customers usually focus on or shrink costs, preferably both. responsiveness. These segments are known as “last mile” deliveries. They use transportation modes and delivery When to Be Efficient and When to Be Responsive schedules that emphasize responsiveness because customers have come to expect fast delivery of products. In every supply Efficiency is good — In the 20th century, efficiency drove chain some operations will need to focus on efficiency, and economic growth. The push for efficiency increased productivity others on responsiveness. That mix continues to shift over time and lowered the prices of products from automobiles to home as customer preferences, market conditions, and technologies appliances thus making them available to a wide segment of the change. population. Yet efficiency requires two things that are becoming much harder to find. The first thing is New technologies such as robots, drones, artificial intelligence, predictability. To efficiently plan and manage production and and 3D printing are making big impacts on how supply chains distribution of products you need to know what the demand will operate. And yet after all is said and done, these new be for those products, and you need to know what the cost of technologies can be employed to do one of two things: increase raw materials will be and what the selling prices will be for the efficiency; or increase responsiveness (or some blend of the products. Then you can optimize your operations to produce the two). right amounts at the right prices and maximize profits. aj villamino