Supply Chain Management

Certified Supply Chain Analyst

Study Session - 3
 Supply Chain Drivers and Metrics
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2
 Session # 3 Outline
• Drivers of supply chain performance
• A framework for structuring drivers
• Facilities
• Inventory
• Transportation
• Information
• Sourcing
• Pricing
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• Obstacles to achieving fit

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 Supply Chain Drivers

• To understand 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.
– Logistical Drivers are –
• Facilities
• Inventory
• Transportation
– Cross functional Drivers are –
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• Information
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• Sourcing
• Pricing
 Supply Chain Drivers

• Facilities
– places where inventory is stored, assembled, or
fabricated
– production sites and storage sites
• Inventory
– raw materials, WIP, finished goods within a supply
chain
– inventory policies
• Transportation
– moving inventory from point to point in a supply
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chain
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– combinations of transportation modes and routes

 Supply Chain Drivers

• Information
– data and analysis regarding inventory,
transportation, facilities throughout the supply chain
– potentially the biggest driver of supply chain
performance
• Sourcing
– functions a firm performs and functions that are
outsourced
• Pricing
– Price associated with goods and services provided
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by a firm to the supply chain

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 A Framework for Structuring Drivers

Competitive Strategy

Supply Chain
Strategy

Efficiency Supply Chain Structure Responsiveness

Logistical Drivers

Facilities Inventory Transportation

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Information Sourcing Pricing

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Cross Functional Drivers

 Framework for Structuring Drivers
 The goal of a supply chain strategy is to strike the balance between
responsiveness and efficiency that fits with the competitive strategy.
 To reach this goal, a company must structure the right combination of
the three logistical and three cross functional drivers.
 For each of the individual drivers, supply chain managers must make a
trade-off between efficiency and responsiveness based on interaction
with the other drivers.
 The combined impact of these drivers then determines the
responsiveness and the profits of the entire supply chain.
 Most companies begin with a competitive strategy and then decide what
their supply chain strategy ought to be.
 The supply chain strategy determines how the supply chain should
perform with respect to efficiency and responsiveness.
 The supply chain must then use the three logistical and three cross-
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functional drivers to reach the performance level the supply chain

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strategy dictates and maximize the supply chain profits.

 Supply Chain Drivers – “Facilities”

 Facilities are the actual physical locations in the supply chain network
where product is stored, assembled, or fabricated (example – 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.
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 Components of Facilities Decisions

 Location
 centralization (efficiency) vs. decentralization (responsiveness)
 other factors to consider (e.g., proximity to customers)
 Capacity (flexibility versus efficiency)
 Manufacturing methodology (product focused versus process
focused)
 Warehousing methodology (SKU storage, job lot storage, cross-
docking)
 Overall trade-off: Responsiveness versus efficiency
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 FACILITIES continued

Role in the Supply Chain

 Facilities are the locations to or from which inventory is
transported.
 Within a facility, inventory is either transformed into
another state (manufacturing) or it is stored
(warehousing)
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 FACILITIES continued

 Role in the Competitive Strategy

 Facilities are a key driver of supply chain performance in
terms of responsiveness and efficiency.
 Companies can gain economies of scale when a product is
manufactured or stored in only one locations; this
centralization increases efficiency.
 The cost reduction may come at the expense of
responsiveness
 Locating facilities close to customers increases the
number of facilities needed and consequently reduces
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efficiency.
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 This facility decision helps meet the company’s

competitive strategy goals.
 FACILITIES continued

Role in the Competitive Strategy

– Example - Toyota and Honda

• Both Toyota and Honda use facilities decisions to be more

responsive to their customers. These companies have an
end goal of opening manufacturing facilities in every
major market that they enter. While there are other
benefits to opening local facilities, such as protection from
currency fluctuation and trade barriers, the increase in
responsiveness plays a large role in Toyota and Honda’s
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decision to place facilities in their local markets.

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 Metrics
Capacity: measures the maximum amount a facility can
process.

Utilization: measures the fraction of capacity that is

currently being used in the facility. Utilization affects
both the unit cost of processing and the associated
delays. Unit costs tend to decline and delays increase
with increasing
 Metrics
Theoretical flow/cycle time of production measures the
time required to process a unit if there are absolutely no
delays at any stage.

Actual average flow/cycle time measures the average

actual time taken for all units processed over a specified
duration such as a week or month.

The actual flow/cycle time includes the theoretical time

and any delays.
 Metrics
Flow time efficiency is the ratio of the theoretical flow
time to the actual average flow time.

Product variety measures the number of

products/product families processed in a facility.

Processing costs and flow times are likely to increase

with product variety.
 Metrics
Processing/setup/down/idle time measure the
fraction of time that the facility was processing units,
being set up to process units, unavailable because it
was down, or idle because it had no units to process.

Average production batch size measures the average

amount produced in each production batch.

Large batch sizes will decrease production cost but

increase inventories in the supply chain.
 Metrics
Production service level measures the fraction
of production orders completed on time and in
full.
 Supply Chain Drivers – “Inventory”

Inventory encompasses all raw materials, work in

process, and finished goods within a supply chain

Changing inventory policies can dramatically alter

the supply chain’s efficiency and responsiveness
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 Supply Chain Drivers – “Inventory”

Role in the Competitive Strategy

 If responsiveness is a strategic competitive priority,

a firm can locate larger amounts of inventory closer
to customers
 If cost is more important, inventory can be reduced
to make the firm more efficient
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 Trade-off
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 Supply Chain Drivers – “Inventory”
Components of Inventory Decisions

 Cycle inventory
– Average amount of inventory used to satisfy demand between
shipments
– Depends on lot size
 Safety inventory
– inventory held in case demand exceeds expectations
– costs of carrying too much inventory versus cost of losing sales
 Seasonal inventory
– inventory built up to counter predictable variability in demand
– cost of carrying additional inventory versus cost of flexible
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production
 Overall trade-off: Responsiveness versus efficiency
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– more inventory: greater responsiveness but greater cost

– less inventory: lower cost but lower responsiveness
 Metrics
Average inventory measures the average amount of
inventory carried.

Average inventory should be measured in units, days

of demand, and financial value.

Products with more than a specified number of days

of inventory identifies the products for which the firm
is carrying a high level of inventory.
 Metrics
This metric can be used to identify products that are in oversupply
or identify reasons that justify the high inventory, such as price
discounts, or being a very slow mover.

Average replenishment batch size measures the average

amount in each replenishment order.
The batch size should be measured by SKU in terms of
both units and days of demand.

SKU means (Stock-Keeping-Unit) - number or code used to identify each unique

product or item for sale in a store or other business. It is a unique identifier for
each distinct product and service that can be purchased.
 Metrics
Average safety inventory measures the average
amount of inventory on hand when a replenishment
order arrives.

Average safety inventory should be measured by SKU

in both units and days of demand.

Seasonal inventory measures the amount of both cycle

and safety inventory that is purchased solely due to
seasonal changes in demand.
 Metrics
Fill rate measures the fraction of orders/demand that
were met on time from inventory.

Fraction of time out of stock measures the fraction of

time that a particular SKU had zero inventory.

This fraction can be used to estimate the demand

during the stock out period.
 Supply Chain Drivers – “Transportation”

Transportation entails moving inventory from point

to point in the supply chain.
Transportation can take the form of many
combinations of modes and routes.
Transportation choices have a large impact on
supply chain responsiveness and efficiency.
Faster transportation allows greater
responsiveness but lower efficiency
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Also affects inventory and facilities

 Supply Chain Drivers – “Transportation”

Role in the Competitive Strategy

 If responsiveness is a strategic competitive priority,
then faster transportation modes can provide
greater responsiveness to customers who are willing
to pay for it
 Can also use slower transportation modes for
customers whose priority is price (cost)
 Can also consider both inventory and transportation
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to find the right balance

 Supply Chain Drivers – “Transportation”

Components of Transportation Decision

 Mode of transportation:
 air, truck, rail, ship, pipeline, electronic transportation
 vary in cost, speed, size of shipment, flexibility
 Route and network selection
route: path along which a product is shipped
network: collection of locations and routes
 In-house or outsource
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 Overall trade-off: Responsiveness versus efficiency

 Metrics
Average inbound transportation cost typically measures the
cost of bringing product into a facility as a percentage of sales
or cost of goods sold (COGS).
Average incoming shipment size measures the average
number of units or dollars in each incoming shipment at a
facility.
Average inbound transportation cost per shipment measures
the average transportation cost of each incoming delivery.

this metric identifies opportunities for greater economies of

scale in inbound transportation.
 Metrics
Average outbound transportation cost measures the cost
of sending product out of a facility to the customer.
Average outbound shipment size measures the average
number of units or dollars on each outbound shipment at a
facility.
Average outbound transportation cost per shipment
measures the average transportation cost of each outgoing
delivery.
 Metrics
Fraction transported by mode measures the fraction of
transportation (in units or dollars) using each mode of
transportation.

This metric can be used to estimate if certain modes

are overused or underutilized.
 Supply Chain Drivers – “Information”

 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 the management with the

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opportunity to make supply chains more responsive and

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more efficient.
 Supply Chain Drivers – “Information”
Components of Information Decisions
 Push (MRP) versus pull (demand information transmitted
quickly throughout the supply chain)
 Coordination and information sharing
 Forecasting and planning
 Enabling technologies
 EDI
 Internet
 ERP systems
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 Supply Chain Management software

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 Overall trade-off: Responsiveness versus efficiency

 Metrics
Forecast horizon identifies how far in advance of the actual
event a forecast is made.

The forecast horizon must equal the lead time of the

decision that is driven by the forecast.

Frequency of update identifies how frequently each

forecast is updated.

The forecast should be updated somewhat more

frequently than a decision will be revisited, so that large
changes can be flagged and corrective action taken.
 Metrics
Forecast error measures the difference between the
forecast and actual demand.

The forecast error is a measure of uncertainty and drives

all responses to uncertainty such as safety inventory or
excess capacity.

Seasonal factors measure the extent to which the average

demand in a season is above or below the average in the
year.
 Metrics
Variance from plan identifies the difference between the
planned production/inventories and the actual values.

These variances can be used to raise flags that identify

shortages and surpluses.

Ratio of demand variability to order variability measures

the standard deviation of incoming demand and supply
orders placed.

A ratio less than one potentially indicates the existence of

the bullwhip effect.
 Bullwhip Effect

Fluctuations in orders increase as they move up the supply

chain from retailers to wholesalers to manufacturers to
suppliers.

Distorts demand information within the supply chain,

where different stages have very different estimates of
what demand looks like

Results in a loss of supply chain coordination

 Bullwhip Effect Results
 Manufacturing cost (increases)
 Inventory cost (increases)
 Replenishment lead time (increases)
 Transportation cost (increases)
 Labor cost for shipping and receiving (increases)
 Level of product availability (decreases)
 Relationships across the supply chain (worsens)
 Profitability (decreases)

The bullwhip effect reduces supply chain profitability by

making it more expensive to provide a given level of product
availability
 Supply Chain Drivers – “Sourcing”

 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 out
sources.

 Sourcing decisions affect both the responsiveness and

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efficiency of a supply chain.

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 Supply Chain Drivers – “Sourcing”

Components of Sourcing Decisions

 In-house versus outsource decisions

 Supplier evaluation and selection
 Procurement process
 Overall trade-off: Increase the supply chain profits
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 Metrics
Days payable outstanding measures the number of days between
when a supplier performed a supply chain task and when it was
paid.
Average purchase price measures the average price at which a
good or service was purchased during the year.
The average price should be weighted by the quantity purchased
at each price.
Range of purchase price measures the fluctuation in purchase
price during a specified period.
The goal is to identify if the quantity purchased correlated with
the price.
 Metrics
Average purchase quantity measures the average amount
purchased per order.
The goal is to identify whether a sufficient level of aggregation
is occurring across locations when placing an order.
Fraction on-time deliveries measures the fraction of deliveries
from the supplier that were on time.
Supply quality measures the quality of product supplied.
Supply lead time measures the average time between when an
order is placed and the product arrives
 Supply Chain Drivers – “Pricing”

• Pricing determines how much a firm will charge for

goods and services that it makes available in the
supply chain.

• Pricing affects the behavior of the buyer of the goods

or service, thus affecting supply chain performance.
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 Supply Chain Drivers – “Pricing”

Components of Pricing Decisions

 Pricing and economies of scale

 Everyday low pricing versus high-low pricing
 Fixed price versus menu pricing
 Overall trade-off: Increase the firm profits
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 Metrics
Days sales outstanding measures the average time between
when a sale is made and when the cash is collected.
Incremental fixed cost per order measures the incremental
costs that are independent of the size of the order.
These include changeover costs at a manufacturing plant or
order processing or transportation costs that are incurred
independent of shipment size at a mail-order firm.
Incremental variable cost per unit measures the incremental
costs that vary with the size of the order.
These include picking costs at a mail-order firm or variable
production costs at a manufacturing plant.
 Metrics
Average sale price measures the average price at which a
supply chain activity was performed in a given period.
The average should be obtained by weighting the price
with the quantity sold at that price.
Average order size measures the average quantity per order.
The average sale price, order size, incremental fixed cost
per order, and incremental variable cost per unit help
estimate the contribution from performing the supply chain
activity.
 Metrics
Range of sale price measures the maximum and the
minimum of sale price per unit over a specified time horizon.

Range of periodic sales measures the maximum and

minimum of the quantity sold per period (day/week/month)
during a specified time horizon.

The goal is to understand any correlation between sales and

price and any potential opportunity to shift sales by
changing price over time.
 Obstacles to Achieving Strategic Fit

 Increasing variety of products

 Decreasing product life cycles

 Increasingly demanding customers

 Fragmentation of supply chain ownership

 Globalization
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 Difficulty executing new strategies

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Case
 Case
Wal-Mart’s competitive strategy is to be a reliable, low-cost
retailer for a wide variety of mass-consumption goods.

 Wal-Mart aims to provide high availability of a variety of

products of reasonable quality at low prices

 This strategy dictates that the ideal supply chain will

emphasize efficiency but also maintain an adequate level of
responsiveness. Wal-Mart uses the three logistical and three
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cross-functional drivers effectively to achieve this type of

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supply chain performance.

 Case
With the inventory driver, Wal-Mart maintains an
efficient supply chain by keeping low levels of inventory.

For instance, Wal-Mart pioneered cross-docking, a

system in which inventory is not stocked in a
warehouse but rather is shipped to stores from the
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manufacturer.
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 Case
These shipments make only brief stops at distribution
centers (DCs), where they are transferred to trucks that
make deliveries to stores. This significantly lowers
inventory because products are stocked only at stores,
not at both stores and warehouses. With respect to
inventory, Wal-Mart favors efficiency over
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responsiveness.
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 Case
On the transportation front, Wal-Mart runs its own
fleet, to keep responsiveness high. This increases
transportation cost, but the benefits in terms of reduced
inventory and improved product availability justify this
cost in Wal-Mart’s case.
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 Case
In the case of facilities, Wal-Mart uses centrally located
DCs within its network of stores to decrease the number
of facilities and increase efficiency at each DC. Wal-Mart
builds retail stores only where the demand is sufficient
to justify having several of them supported by a DC,
thereby increasing efficiency of its transportation assets.
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 Case
To utilize information in the supply chain, Wal-Mart has
invested significantly more than its competitors in
information technology. As a result, Wal-Mart is a leader
in its use of the information driver to improve
responsiveness and decrease inventory investment.
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 Case

Wal-Mart feeds demand information across the supply

chain to suppliers who manufacture only what is being
demanded. The supply chain’s ability to share demand
information has required large investments, but the
result is an improved supply chain in terms of both
responsiveness and efficiency.
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 Case

With regard to the sourcing driver, Wal-Mart identifies

efficient sources for each product it sells. Wal-Mart
feeds them large orders, allowing them to be efficient by
exploiting economies of scale.
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 Case

Finally, for the pricing driver, Wal-Mart practices “every

day low pricing” (EDLP) for its products. This ensures
that customer demand stays steady and does not
fluctuate with price variations. The entire supply chain
then focuses on meeting this demand in an efficient
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manner.
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 Case

Wal-Mart uses all the supply chain drivers to achieve the

right balance between responsiveness and efficiency so
that its competitive strategy and supply chain strategy
are in harmony.
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 Summary of Learning Objective

What are the major drivers of supply chain

performance?
What is the role of each driver in creating strategic fit
between supply chain strategy and competitive
strategy?
What are the major obstacles to achieving strategic
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fit?
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 Any Question?
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