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OPER3208-001 Supply Chain Management Fall 2006 Instructor: Prof. Setzler
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Page 1: Simchi-Levi Ch05

OPER3208-001Supply Chain Management

Fall 2006Instructor: Prof. Setzler

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Simchi-Levi, Chapters 5

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Introduction– The challenge in SC integration is to coordinate activities across

the SC so that the enterprise can improve performance• Reduce cost• Increase service level• Reduce the bullwhip effect• Better utilize resources• Effectively respond to changes in the marketplace

– These challenges are only met by coordination of • Production• Transportation• Inventory decisions• Integrating the front-end of the SC (i.e., customer demand), and the

back-end of the SC (i.e., production and manufacturing)

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Push-Based Supply Chain– Production and distribution decisions are based on long-term

forecasts• Demand forecast for manufacturer is based on orders received from

the retailer’s warehouse– As discussed in Ch 4, the variability of orders received from retailers

and warehouses is much larger than the variability of customer demand—Bullwhip Effect

– Increases in variability leads to» Excessive inventories (safety stock)» Larger and more variable production batches» Unacceptable service levels» Product obsolescence

• It takes longer for a push-based SC to react to changes in the marketplace, which can lead to

– The inability to meet changing demand patterns– The obsolescence of SC inventory

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Push-Based Supply Chain– Due to the need for emergency production

changeovers, we often find increased transportation costs, high inventory levels, and/or high manufacturing costs

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Pull-Based Supply Chain– Production and distribution are demand driven so that they are

coordinated with true customer demand rather than forecast demand

– In a pure pull system, the firm does not hold any inventory and only responds to specific orders

– Pull systems are attractive since they lead to• A decrease in lead times through the ability to better anticipate

incoming orders from the retailers• A decrease in inventory at the retailers since inventory levels at

these facilities increase with lead times• A decrease in variability in the system and variability faced by

manufacturers due to lead-time reduction• Decreased inventory at the manufacturer due to the reduction in

variability

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Pull-Based Supply Chain– These systems typically have

• A significant reduction in system inventory level• Enhanced ability to manage resources• A reduction in system costs (when compared to an equivalent

push-based system)

– Pull systems are difficult to implement when lead times are too long

• Unable to react to demand– Pull systems are more difficult to take advantage of

economies of scale in manufacturing and transportation since systems are not planned far ahead in time

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Push-Pull Supply Chain– A new SC strategy that takes advantage of the best of

the push strategy and the pull strategy– Some stages of the SC (usually the initial stages)

operate as a push-based system, the remaining stages operate as a pull-based system

– The interface (boundary) between the push-based stages and the pull-based stages is called the push-pull boundary

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Push-Pull Supply Chain

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Push-Pull Supply Chain– Example 1: Dell Computers uses the push-pull

strategy• Manufacturer builds to order• Component inventory is managed based on forecast (push)

– Demand for component is an aggregation of demand for all finished goods that use that component

– Since aggregate forecasts are more accurate, uncertainty in component demand is much smaller than uncertainty in finished goods

» This leads to a reduction in safety stock• Final assembly is in response to specific orders (pull)• The push-pull boundary is at the beginning of the assembly

process

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Push-Pull Supply Chain– Example 2: Postponement, or delayed differentiation

• The firm designs the product and the manufacturing process so that decision can be delayed as long as possible

• The manufacturing process starts by producing a generic or family product

• The portion of the SC prior to product differentiation is usually operated using a push-based strategy

• Since demand for the generic product is an aggregation of demand for all its corresponding end-products, forecasts are more accurate and inventory levels are reduced

– The portion of the SC starting from the time of differentiation is pull-based

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Identifying the Appropriate Supply Chain Strategy– Figure 5.2 provides a framework for matching

SC strategies with products and industries

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Identifying the Appropriate Supply Chain Strategy– Everything else being equal, higher demand uncertainty leads to

a preference for managing the SC based on realized demand: a pull strategy

– Smaller demand uncertainty leads to an interest in managing the SC based on a long-term forecast: a push strategy

– Everything else being equal, the higher the importance of economies of scale in reducing cost, the greater the value of aggregating demand, and the greater the importance of managing the SC based on long-term forecast, a push-based strategy

– If economies of scale are not important aggregation does not reduce cost, so a pull-based strategy makes more sense

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Identifying the Appropriate Supply Chain Strategy– Box 1 represents industries (i.e., products) such as

computer industry (e.g., Dell uses the pull-based strategy)

– Box 3 represents product in the grocery industry such as beer, pasta, and soup (a push-based retail strategy is appropriate)

• Demand is stable– Boxes 1 & 3 represent situations in

which it is relatively easy to identify an efficient SC strategy

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Identifying the Appropriate Supply Chain Strategy– Boxes 2 & 4: There is a mismatch between the

strategies suggested by the two attributes• Uncertainty “pulls” the SC towards one strategy, while

economies of scale “push” the SC in a different direction• Box 4 represents products such as high-volume/fast-moving

books and CDs.– Both traditional push strategies and

innovative push-pull strategies may be appropriate

» Depends on specific costs and uncertainties

» Discussed further in Section 5.4

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Identifying the Appropriate Supply Chain Strategy– Boxes 2 & 4: There is a mismatch between the strategies

suggested by the two attributes• Box 2 represents products and industries such as the furniture

industry– Offers a large number of similar products distinguished by shape, color,

fabric, etc– Need to distinguish between the production and the distribution

strategies– Production strategy has to follow a pull-based strategy since it is

impossible to make production decisions based on long-term forecasts– On the other hand, the distribution strategy

needs to take advantage of economies of scale in order to reduce transportation cost

– The SC strategy followed by furniture manufacturers is a pull-push strategy

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Implementing a Push-Pull Strategy– There are many ways to implement a push-

pull strategy, depending on the location of the push-pull boundary

• Dell locates the push-pull boundary at the assembly point

• Furniture manufacturers locate the boundary at the production point

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Implementing a Push-Pull Strategy– Push strategy

• Demand uncertainty is relatively small and managing this portion based on long-term forecast is appropriate

– Service level is not an issue, so the focus can be on cost minimization– Low demand uncertainty and economies of scale in production and/or

transportation– Long lead times and complex SC structures, including product assembly at

various levels– Cost minimization is achieved by better utilizing resources such as production

and distribution capacity while minimizing inventory, transportation, and production costs

– Pull strategy• Uncertainty is high, and it is important to manage this portion based on

realized demand– High uncertainty, and a short cycle time– Focus is on service level– High service level is achieved by deploying a flexible and responsive SC

» A SC that can adapt quickly to changes in customer demand

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Implementing a Push-Pull Strategy– Different processes need to be used in

different portions of the SC• The focus in the pull part of the SC is on service

level, order fulfillment processes are typically applied

• The focus of the push part of the SC is on cost and resource utilization, SC planning processes are used to develop effective strategies for a given planning horizon (e.g., a few weeks, or months)

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Implementing a Push-Pull Strategy– Table 5-1 summarizes the characteristics of

the push and pull portions of the SC

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Implementing a Push-Pull Strategy– Notice that the push portion and the pull portion of the SC

interact only at the push-pull boundary• This is the point along the SC time line where there is a need to

coordinate the two SC strategies– Typically through buffer inventory

» This inventory takes a different role in each portion» In the push portion, buffer inventory at the boundary is part of the

output generated by the tactical planning process» In the pull portion, buffer inventory represents the input to the

fulfillment process• The interface between the push portion and the pull portion of the

SC is forecast demand– Forecast demand is based on historical data obtained from the pull

portion– Forecast is used to drive the SC planning process and determines the

buffer inventory

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Demand-Driven Strategies– Need to integrate demand information into the

SC planning process• Information is generated by applying 2 different

processes– Demand Forecast: Historical demand data is used to

develop long-term estimates of expected demand– Demand Shaping: The firm determines the impact of

various marketing plans such as promotion, pricing discounts, rebates, new product introduction, and product withdrawal on demand forecasts

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Demand-Driven Strategies– The forecast is not completely accurate

• An important output from the demand-forecast and demand-shaping processes is an estimate of the accuracy of the forecast

– Forecast error– Measured according to its standard deviation

– High demand forecast error has a detrimental impact on SC performance

• Resulting in lost sales, obsolete inventory, and inefficient utilization of resources

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Demand-Driven Strategies– Can the firm employ SC strategies to increase forecast accuracy

and decrease forecast error?• Select the push-pull boundary so that demand is aggregated over

one or more of the following dimensions– Demand aggregated across products– Demand aggregated across geography– Demand aggregated across time

• Use market analysis and demographic and economic trends to improve forecast accuracy

• Determine the optimal assortment of products by store so as to reduce the number of SKUs competing in the same market

• Incorporate collaborative planning and forecasting processes with your customers so as to achieve a better understanding of market demand, impact of promotions, pricing events, and advertising

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Demand-Driven Strategies– At the end of the demand planning process, the firm

has a demand forecast by SKU by location– The next step is to analyze the SC to see if it can

support these forecasts• This process is called supply and demand management• It involves matching supply and demand by identifying a

strategy that minimizes total production, transportation, and inventory costs, or a strategy that maximizes profits

• The firm also needs to determine the best way to handle volatility and risks in the SC

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• The Impact of the Internet on Supply Chain Strategies– The direct-business model employed by industry

giants such as Dell Computers and Amazon.com enables customers to order products over the Internet

• Allows companies to sell their products without relying on third-party distributors

• Business-to-business e-commerce promises convenience and cost reductions

– e-commerce is predicted to skyrocket from $43 billion in 1998 to $1.3 trillion in 2003

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• The Impact of the Internet on Supply Chain Strategies– The Internet and the emerging e-business models

have produced expectations that many SC problems will be resolved merely by using these new technology and business models

• e-business strategies were supposed to reduce cost, increase service level, and increase flexibility and profits

• In reality, these expectations have frequently gone unmet, as many new e-businesses have not been successful

– The downfall of some of the highest-profile Internet businesses has been attributed to their logistics strategies

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• The Impact of the Internet on Supply Chain Strategies

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• The Impact of the Internet on Supply Chain Strategies

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• The Impact of the Internet on Supply Chain Strategies

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• The Impact of the Internet on Supply Chain Strategies

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• What is E-Business– E-business

• A collection of business models and processes motivated by Internet technology and focusing on improvement of extended enterprise performance

– E-commerce• The ability to perform major commerce

transactions electronically

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• What is E-Business– E-commerce is only part of e-business– Internet technology is the force behind the business

change– The focus in e-business is on the extended

enterprise, intra-organizational, business-to-consumer (B2C), and business-to-business (B2B) transactions

– Many companies recognize that the Internet can have a huge impact on SC performance

• The Internet can help move away from traditional push strategies

• Initially the move was toward a pull strategy, but eventually many companies ended up with a push-pull SC

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• The Grocery Industry– A typical supermarket employs a push-based strategy where inventory

at the warehouses and stores is based on a forecast– Peapod

• On-line grocer • Founded 11 years ago• Idea: establish a pure pull strategy with no inventory and no facilities

– Customers ordered groceries, Peapod would pick the products at a nearby supermarket

– There were significant service problems since stockout rates were very high (about 8 to 10%)

• Peapod changed its business model to a push-pull strategy by setting up a number of warehouses; stockout rates are now less than 2%

– The push part is the portion of the Peapod SC prior to satisfying customer demand and the pull part starts from a customer order

– Since Peapod warehouse covers a large geographical area, clearly larger than the one covered by an individual supermarket, demand is aggregated over may customers and locations, resulting in better forecasts and inventory reduction

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• The Grocery Industry– Most on-line grocery stores have failed

• No current on-line grocers have the density of customers that will allow them to control transportation costs

• Response time is very short, typically within 12 hours in a tight delivery window

• On-line groceries– Low level of demand uncertainty for many products– High economies of scale in transportation cost– A Push-based strategy is more appropriate

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• The Book Industry– Barnes and Noble had a typical push supply chain

• When Amazon.com was established about 6 years ago– SC was a pure pull system with no warehouses and no stock– Ingram Book Group supplied most of Amazon’s customer demand

» Ingram Book can aggregate across many customers and suppliers and take advantage of economies of scale

– As volume and demand increased, two issues are clear» Amazon.com’s service level was affected by Ingram Book’s

distribution capacity, which was shared by many booksellers» During peak holiday demand, Amazon.lcom could not meet its

service level goals» Using Ingram Book allowed Amazon.com to avoid inventory costs

but significantly reduced profit margins» As demand increased, Amazon.com’s ability to aggregate across

large geographical areas allowed the company to reduce uncertainties and inventory costs by itself, without using a distributor

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• The Book Industry– Barnes and Noble had a typical push supply

chain– Amazon.com changed its Barnes and Noble’s philosophy

» Has several warehouses around the country where most of the titles are stocked

» Inventory at the warehouses is managed based on a push strategy

» Demand is satisfied based on individual requests, a pull strategy

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• The Retail Industry– The retail industry was late to respond to competition

from virtual stores and to recognize the opportunities provided by the Internet

– As many brick-and-mortar companies are adding an Internet shopping component to their offering

– Click-and-mortar giants Wal-Mart, Kmart, Target, and Barnes and Noble, etc.

• These retailers recognize the advantage they have over pure Internet companies

• They already have the distribution and warehousing infrastructure in place

– They have established virtual retail stores, serviced by their existing warehousing and distribution structures

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• The Retail Industry– Click-and-mortar firms have changed their approach

to stocking inventory• High-volume, fast-moving products, whose demand can be

accurately matched with supply based on long-term forecasts, are stocked in stores

• Low-volume, slow-moving products are stocked centrally for on-line purchasing

– The low-volume products have highly uncertain demand levels, and therefore require high levels of safety stock

– Centralized stocking reduces uncertainties by aggregating demand across geographical locations, and therefore reduce inventory levels

– **These retailers use a push strategy for high volume, fast-moving products and a push-pull strategy for low volume, slow-moving products

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• The Retail Industry– The move from brick-and-mortar to click-and-

mortar is not an easy one, and may require skills that the brick-and-mortar companies don’t have

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Impact on Transportation and Fulfillment– The Internet and the associated new SC

paradigms introduce a shift in fulfillment strategies: from cases and bulk shipments to single items and smaller-size shipments, and from shipping to a small number of stores to serving highly geographically dispersed customers

– This shift has also increased the importance and the complexity of reverse logistics

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Impact on Transportation and Fulfillment– Table 5-2 summarizes the impact of the

Internet on fulfillment strategies

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Impact on Transportation and Fulfillment– New developments in SC strategies are good news

for the parcel and LTL industries• Both push-pull systems rely on individual (e.g., parcel)

shipments rather than bulk shipments• Especially true in the business-to-customer area (a.k.a. B2C

e-fulfillment)• Another impact of e-fulfillment on the transportation industry

is the significant increase in reverse logistics– In the B2C arena, e-fulfillment means that the supplier needs to

handle many returns, each of which consists of a small shipment

» On-line retailers need to build customer trust through generous return terms

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Impact on Transportation and Fulfillment– E-fulfillment logistics requires short lead time, the

ability to serve globally dispersed customers, and the ability to reverse the flow easily from B2C and C2B

• Only parcel shipping can do all that• One important advantage of the parcel industry is the

existence of an excellent information infrastructure that enables real-time tracking

• The future looks promising for the parcel shipping industry and for those carriers and consolidators who work to modify their own systems in order to integrate it with their customers’ SC

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Distribution Strategies– Typically, three distinct outbound distribution

strategies are utilized:1. Direct shipment

• Items are shipped directly from the supplier to the retail stores without going through distribution centers

2. Warehousing• Classic strategy in which warehouses keep stock and provide

customers with items as required3. Cross-docking

• Items are distributed continuously from suppliers through warehouses to customers

• Warehouses rarely keep the items more than 10 to 15 hours

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Direct shipment– Bypass warehouses and distribution centers– Employing direct shipment, the manufacturer

or supplier delivers goods directly to retail stores

– The advantages• The retailer avoids the expenses of operating a

distribution center• Lead times are reduced

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Direct shipment– Disadvantages:

• Risk-pooling effects are negated because there is no central warehouse

• The manufacturer and distributor transportation costs increase because it must send smaller trucks to more locations

– Direct shipment is common when the retail store requires fully loaded trucks, which implies that the warehouse does not help in reducing transportation cost

• Sometimes, the manufacturer is reluctant to be involved with direct shipping but may have no choice in order to keep the business

• Also prevalent in the grocery industry, where lead times are critical because of perishable goods

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Cross-Docking– A strategy that Wal-Mart made famous– Warehouses function as inventory coordination points

rather than as inventory storage points– Goods arrive at warehouses from the manufacturer,

are transferred to vehicles serving the retailers, and are delivered to the retailers as rapidly as possible

– This system limits inventory cost and decreases lead time by decreasing storage time

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Distribution Strategies– Few major retailers utilize one of these

strategies exclusively• Different approaches are used for different

products, making it necessary to analyze the SC and determine the appropriate approach to use for a particular product or product family

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Distribution Strategies– What are the factors that influence distribution

strategies?• Customer demand and location • Service level• Transportation costs• inventory costs

– Both transportation and inventory costs depend on shipment size, but in opposite ways

• Increasing lot sizes reduces delivery frequency and enables the shipper to take advantage of price breaks in shipping volume, which reduces transportation costs

• Large lost sizes increase inventory cost per item because items remain in inventory for a longer period of time

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Distribution Strategies– Demand variability also has an impact on the distribution

strategy• Demand variability has a huge impact on cost

– The larger the variability, the more safety stock needed– Stock held at the warehouses provides protection against demand

variability and uncertainty, and due to risk pooling, the more warehouses a distributor has, the more safety stock is needed

– If warehouses are not used for inventory storage, as in the cross-docking strategy, or if there are no warehouses at all, as in direct shipping, more safety stock is required in the distribution system» This is true because in both cases each store needs to keep

enough safety stock» This effect is mitigated by distribution strategies that enable

better demand forecasts and smaller safety stocks, and transshipment strategies

» Any assessment of different strategies must also consider lead time and volume requirements

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Distribution Strategies– Table 5-3 summarizes and compares the

three distribution strategies

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Transshipment– An important option to consider when selecting SC

strategies• Transshipment: The shipment of items between different

facilities at the same level in the SC to meet some immediate need

• Transshipment is considered at the retail level• Transshipment capability allows the retailer to meet customer

demand from the inventory of other retailers– The retailer must know what other retailers have in inventory

and must have a rapid way to ship the items either to the store where the customer originally tried to make the purchase or to the customer’s home

– Requirements can only be met with advanced information systems, which allow a retailer to see what other retailers have in stock and facilitate rapid shipping between retailers

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Centralized versus Decentralized Control– Centralized Control

• Decisions are made at a central location for the entire supply network

• Objective: to minimize the total cost of the system while maintaining some stated service-level requirement

• True when the network is owned by one entity• True when the network includes many different organizations

– Savings, or profits, need to be allocated across the network using some contractual mechanism

• Leads to global optimization

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Centralized versus Decentralized Control– Decentralized Control

• Each facility identifies its most effective strategy without considering the impact on the other facilities in the SC

• Leads to local optimization

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Centralized versus Decentralized Control– Centralized distribution network will be at least as

effective as a decentralized one– With advances in IT, all facilities in a centralized

system can have access to the same data• Single point of contract

– Information can be accessed from anywhere in the SC and is the same no matter what mode of inquiry is used or who is seeking the information

– Allows for sharing of information– Utilization of this information in ways that reduce the bullwhip

effect and improve forecasts– Allow for the use of coordinated strategies across the entire SC

» Strategies that reduce systemwide costs and improve service levels

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Centralized versus Local Facilities– Important considerations

• Safety stock– Consolidating warehouses allows the vendor to take

advantage of risk pooling– The more centralized an operation is, the lower the

safety stock levels

• Overhead– Economies of scale suggest that operating a few large

central warehouses leads to lower total overhead cost relative to operating many smaller warehouses

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Centralized versus Local Facilities– Important considerations

• Economies of scale– Economies of scale can be realized if manufacturing is

consolidated– Often much more expensive to operate many small

manufacturing facilities than to operate a few large facilities with the same total capacity

• Lead time– Lead time to market can often be reduced if a large

number of warehouses are located closer to the market areas

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Centralized versus Local Facilities– Important considerations

• Service– Depends on how service is defined– Centralized warehousing enables the utilization of risk pooling, which

means that more orders can be met with a lower total inventory level» Shipping time from the warehouse to the retailer will be longer

• Transportation costs– Directly related to the number of warehouses used– As the number of warehouses increases, transportation costs between

the production facilities and the warehouses also increases because total distance traveled is greater, and quantity discounts are less likely to apply

– Transportation costs from the warehouses to the retailers are likely to fall because the warehouses tend to be much closer to the market area

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Chapter 5: Supply Chain Integration (Simchi-Levi)

• Centralized versus Local Facilities– It is possible

• That in an effective distribution strategy, some products will be stored in a central facility while others will be kept in various local warehouses

– e.g., very expensive products with low customer demand may be stocked at a central warehouse while low-cost products facing high customer demand may be stocked at many local warehouses