Advanced Supply Chain Management

Advanced Supply Chain Management
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COURSE DESIGN COMMITTEE
TOC Reviewer Content Reviewer

Mr. Rajagopal Mukundan Mr. Rajagopal Mukundan
Visiting Faculty, NMIMS Global Access - Visiting Faculty, NMIMS Global Access -
School for Continuing Education School for Continuing Education
Specialization: Operations & SCM Specialization: Operations & SCM
Chief Academic Officer

Dr. Sanjeev Chaturvedi
NMIMS Global Access – School for Continuing Education
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Author: Shesadev Nayak
Reviewed By: Mr. Rajagopal Mukundan
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Copyright:
2015 Publisher
ISBN:
978-93-5119-864-2
Address:
4435/7, Ansari Road, Daryaganj, New Delhi–110002
Only for
NMIMS Global Access - School for Continuing Education School Address
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NMIMS Global Access - School for Continuing Education

C O NTENT S
CHAPTER NO. CHAPTER NAME PAGE NO.
Role of Supply Chain in Economy and

1 1
Organisation
2 Aggregate Planning in Supply Chain 27
3 Sourcing in Supply Chain Management 51
4 Inventory Management in Supply Chain 73
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Designing and Planning Transportation Networks 99
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Designing Distribution Networks and Application to
6 123
E-Business
7 Pricing and Revenue Management 147

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8 Demand Forecasting in Supply Chain 165

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9 Information Technology in Supply Chain Management 187
10 Supply Chain Integration 201
11 Supply Chain Restructuring 221
12 Metrics and Drivers of Supply Chain 239
13 Supply Chain Strategies and Performance Measures 261
14 Case Studies 281

iv
A dva n c e d Su pply C hain

Man ag e m e n t
c u rr i c u l u m
The Role of Supply Chain in Economy & Organization: Introduction; What is Supply Chain/its
Objectives & Importance; Evolution of Supply Chain Management; Key Concepts in Supply Chain;
Enablers of Supply Chain; Supply Chain Strategies; Supply Chain Performance in India
Aggregate Planning in Supply Chain: Role of Aggregate Planning in Supply Chain; Strategies &
Problems; Implementing Aggregate Planning in Practice; Aggregate Strategies
Sourcing in Supply Chain Management: Role of Sourcing in Supply Chain; Make vs. Buy: Strate-
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gic Approach; Sourcing Strategy; Sourcing Planning & Analysis; Supplier Selection/Procurement
Process; Risk Management in Sourcing; Impact of IT on Sourcing Strategy; Third Party & Fourth
Party Service Providers
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Inventory Management in Supply Chain: Introduction; Types of Inventory; Inventory-related
Costs; Managing Economies of Supply Channels in Supply Chain; Role of Cycle Stock/Seasonal
Stock in Supply Chain; Impact of Supply Chain Redesigning on Inventory Policy; Managing Uncer-
tainty in a Supply Chain: Safety Stock; Managing Inventory for Short Life Cycle Products; Multiple
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Item, Multiple Location Inventory Management; Inventory Models
Designing & Planning Transportation Networks: Role of Transportation in a Supply Chain; Driv-
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ers of Transportation Decision; Modes of Transportation & Their Performance Measures; Devising
Strategy for Transportation; Transportation Infrastructure & Policies; Tailored Transportation;
Transportation Costs; Design Options for Transport Network
Designing Distribution Networks & Application to e-Business: Role of Distribution in Supply

Chain; Factors Influencing Distribution Network Design; Network Operations Planning; Network
Design Problems; Incorporating Uncertainty in Network Design; Data for Network Design; the
Role of IT in Network Design
Pricing & Revenue Management: Introduction; Role of Pricing & Revenue Management in Sup-
ply Chain; Revenue Management for Multiple Customer Segments; Pricing under Capacity Con-
straints; Revenue Management under Uncertain Demand & Limited Capacity Situations; Revenue
Management for Inventory Assets; Innovative Pricing

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Demand Forecasting in Supply Chain: Demand Forecasting; Role of Forecasting in Supply Chain;
Qualitative & Quantitative/Time Series Forecasting Methods; Errors in Forecasting; Role of IT in Fore-
casting; Risk Management in Forecasting
Information Technology in Supply Chain: Introduction; Role of IT in a Supply Chain; Enabling Sup-
ply Chain through IT; Strategic Management Framework for IT Adoption in Supply Chain; Supply
Chain Application at Marketplace; Future Trends
Supply Chain Integration: Introduction; Supply Chain Integration; Model for Integrating Inbound and
Outbound Networks; Global Supply Chain Design; Internal & External Integration; Building Partner-
ship & Trust in a Supply Chain, Vendor-managed Inventory; Collaborative Planning, Forecasting and
Replenishment (CPFR)
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Supply Chain Restructuring: Supply Chain Mapping; Supply Chain Process Restructuring; Postpon-
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ing the Point of Differentiation; Re-engineering Improvement in SCM
Metrics and Drivers of Supply Chain: Framework for Supply Chain Drivers; Facilities/Inventory/
Transportation/Information/Sourcing/Pricing; Managing Performance with Metrics; Supply Chain Op-
erations Reference Model (SCOR)
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Supply Chain Strategies & Performance Measures: Customer Service & Cost Trade-off; Drivers of
Supply Chain: Internal & External Performance Measures; Linking Supply Chain & Business Perfor-
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mance; Enhancing Supply Chain Performance

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C h a
1 p t e r
ROLE OF SUPPLY CHAIN IN ECONOMY AND

ORGANISATION
CONTENTS
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1.1 Introduction
1.2 Concept of Supply Chain
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Self Assessment Questions
Activity
1.3 Meaning of Supply Chain Management
1.3.1 Objectives of Supply Chain Management
1.3.2 Importance of Supply Chain Management
1.3.3 Evolution of Supply Chain Management
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Activity
1.4 Key Concepts in Supply Chain Management
1.4.1 Decision Phases of Supply Chain Management
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Activity
1.5 Enablers of Supply Chain Performance
1.5.1 Advancement in Communication and IT
1.5.2 Entry of Third-party Logistics Providers
1.5.3 Enhanced Interorganisational Coordination Capabilities
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1.6 Supply Chain Performance of Organisations in the Indian Context
Activity
1.7 Competitive and Supply Chain Strategies
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1.8 Achieving Strategic Fit
Activity

2 Advanced Supply Chain Management
CONTENTS
1.9 Summary
1.10 Descriptive Questions
1.11 Answers and Hints
1.12 Suggested Readings for Reference
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ROLE OF SUPPLY CHAIN IN ECONOMY AND ORGANISATION 3
Introductory Caselet
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SUPPLY CHAIN AT WHIRLPOOL
Whirlpool is one of the leading American multinational organi-

sations engaged in the manufacturing of home appliances. It is
a Fortune 500 organisation that generates annual revenue of ap-
proximately $19 billion. The organisation has around 70 manufac-
turing and technology research centres around the world. Howev-
er, in 2000, the delivery performance of Whirlpool was falling from
its regular standards. The main cause behind the unsatisfactory
delivery was the failure of the existing supply chain to meet ex-
pectations. There were many inconsistencies in inventory levels
and quality that embittered retail partners and customers alike.
The top management of Whirlpool felt the need to fix the ongoing
supply chain issues.
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The main cause behind supply chain problems was the integra-
tion of different systems and procedures at its geographically
dispersed locations due to business expansion. All these issues
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brought down the organisation’s overall availability rate (a mea-
sure to know how often a product is in the right place at the right
time) to 83 per cent. In comparison to industry standards, this was
proved to be a dismal failure for Whirlpool.
In order to solve these problems, Whirlpool supply chain man-

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agement and IT teams initiated the task of replacing their myriad

production scheduling and distribution systems with a stream-
lined, standardised solution. In the new system, there was a cen-
tral platform for all supply chain functions, such as master sched-
uling, inventory planning and deployment planning. Moreover,
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the system also provided collaborative tools for forecasting and

replenishment. As a result, the organisation was able to achieve
greater efficiencies and cost savings across the board. Within a
short span of implementation of the new system, Whirlpool was
able to bring down forecasting errors by 50 per cent and reduce
inventory levels by more than 20 per cent. Moreover, its overall
availability rate increased from 83 per cent to 93 per cent, and
reached 97 per cent within five years of implementation. All these
accomplishments demonstrate that an efficient supply chain
management along with skilled personnel can have a deep impact
on the organisation’s system-wide performance and profitability.

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learning objectives
After studying this chapter, you will be able to:

>> Describe the concept of supply chain
>> Explain the meaning of supply chain management
>> Discuss the key concepts in supply chain management
>> Describe the enablers in supply chain performance
>> Explain the supply chain performance of organisations in
Indian context
>> Discuss competitive and supply chain strategies
>> Explain the concept of achieving strategic fit
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1.1 Introduction
These days stiff competition in global markets, the introduction of
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products with shorter life cycles, and high customer expectations
have impelled organisations to focus more on their supply chains. A
supply chain is a series of activities involved in moving products from
the raw materials stage to the final delivery to end-users. Continuous
advancement in communication technologies has motivated organi-
sations to introduce new methods of managing their supply chain ac-
tivities.
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Supply chain management is the integration of various functions,

such as manufacturing, operations, purchasing, transportation and
physical distribution. The main aim of supply chain management is
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to make on-time delivery of products to customers through a coordi-

nated flow of physical goods and associated information. Supply chain
management leads to the profitable growth of organisations by timely
processing of customer orders and supporting aftersales services.
Apart from this, the most commonly observed benefits of supply chain
management are reduced costs in various areas, such as inventory
management, transportation, warehousing, and packaging, which
directly leads to an increase in revenues. Supply chain management
also improves a relationship between various parties involved in the
value chain of an organisation, such as suppliers, retailers, wholesal-
ers and customers.
This chapter discusses the concept of supply chain and the meaning
of supply chain management. It also explores the enablers of supply
chain performance, the supply chain performance of organisations in
the Indian context and competitive supply chain strategies. Towards
the end the, chapter focusses on the ways in which organisations
achieve strategic fit.

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1.2 Concept of Supply Chain

The aim of every organisation is to satisfy its customers in the best
possible manner. For that, an organisation needs to ensure that prod-
ucts and services are produced and supplied in the market without
any disruptions. This requires effective coordination with various
parties, such as suppliers and distributors so that a smooth flow of
products and services can be maintained. For this, organisations need
to design a supply chain, wherein resources, raw materials, and com-
ponents are gathered and organised for producing finished products
to be delivered to end-customers on time. Now, let us understand the
concept of supply chain in detail.
According to the American Production and Inventory Control So-

ciety (APICS), the term supply chain can be defined in two ways.
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Firstly, supply chain can be defined as processes from the initial raw
materials to the ultimate consumption of the finished product linking
across supplier-user companies. Secondly, supply chain can be stated
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as the functions within and outside a company that enable value chain
to make products and provide services to the customers. Here, value
chain comprises a series of activities performed in an organisation to
add value to the end-products. Apart from this, the following are some
popular definitions of supply chain:
According to Stock and Lambert, supply chain integrates the key busi-
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ness processes of an organisation from end-user through original suppli-

ers that provides products, services and information that add value for
customers and other stakeholders.
In the words of Mohanty and Deshmukh, a supply chain is a network

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of facilities and distribution options that performs the functions of pro-

curement of materials, transformation of these materials into intermedi-
ate and finished products and the distribution of these finished products
to customers.
From the above definitions, it can be said that supply chain is a dy-
namic process, wherein various parties (employees, suppliers, distrib-
utors, etc.) are involved to deliver products and services as per the
customers’ requirements. In the absence of an effective supply chain,
there can be disruption in the flow of product delivery, which, in turn,
may lead to customer loss. Thus, an organisation needs to effectively
manage its supply chain network.
self assessment Questions
1. Supply chain is a dynamic process, wherein various parties

(employees, suppliers, distributors, etc.) are involved to deliver
products and services as per the customers’ requirements.
(True/False)

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Activity
Depict a supply chain network in a leading Indian logistics firm.
Meaning of Supply Chain

1.3
Management
Supply Chain Management (SCM) can be defined as an integrated
process of administering the flow of information, material and services
through various stages of production with the aim of effective product
delivery in the market. According to Thomas and Griffin (1996), SCM
is the management of material and information flows both in and be-
tween facilities, such as vendors, manufacturing and assembly plants,
and distribution centres. It includes various activities like inbound and
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outbound transportation, warehousing, inventory control, etc.
Figure 1.1 shows an example of the supply chain management process

of an apparel manufacturer:
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Weaving factory Apparel distribution centre Retailer

Reference: Reference:
Reference: Product code
Product code Product Color
Color code Color Size
Size, etc. Size, etc. Cloth
Materials, etc
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Reading via RFID tag reader Reading via RFID tag reader Reading via RFID tag reader
RFID tags
Inspections of incoming/ Inspections of incoming
outgoing shipments, shipments, stocktaking
Shipping inspection
stocktaking
Figure 1.1: Supply Chain Management at an Apparel Organisation

(Source: http://www.fibre2fashion.com/industry-article/21/2031/enhanced-apparel-chain-config-
urations-for-enhancing-profits1.asp)
1.3.1 Objectives of Supply Chain Management
The SCM approach is adopted in organisations to build cordial rela-

tionships among all the involved parties in the supply chain network.
The main objective for any SCM is to ensure a smooth flow of prod-

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ucts to maximise customer satisfaction. Figure 1.2 lists some of the

important objectives of SCM:
Creating Value for Customers
Increasing Organisational Responsiveness

towards Change
Reducing Business Risks
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Enhancing Cost Efficiencies
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Figure 1.2: Objectives of SCM
Let us now study these objectives in detail.

Creating value for customers: Customer satisfaction is the prima-
ry goal of any organisation for its overall success. SCM aims to add
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customer value by establishing a market-driven customer service

strategy based on customer requirements. This results in repeti-
tive business for the organisation.
Increasing organisational responsiveness towards change: Or-
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ganisations need to adapt to many changes on a frequent basis

with respect to the changes in the business environment, such as
the advent of new technologies and changes in government poli-
cies. Effective SCM helps the organisation to quickly respond to
such changes.
Reducing business risks: Quite often, organisations encounter
various disruptions in the entire business network, such as natu-
ral disasters, cataclysmic weather, labour strikes and supplier fail-
ures. These sudden disruptions affect the smooth flow of products
and services in the market, which may lead to major consequences
for the organisations. An effective SCM network enables the or-
ganisations to reduce such risks by establishing backup plans.
Enhancing cost efficiencies: The major objectives of SCM are
to reduce inventory-carrying costs, minimise labour expenses,
cut expenditures on freight spend, and so on, thereby achieving
cost efficiencies. For this, organisations adopt various measures in
SCM, such as using contracts or a bid/proposal to obtain economic
resources at the lowest cost possible.

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1.3.2 Importance of Supply Chain Management
SCM plays a pivotal role in an organisation’s success by enhancing its

operational efficiency and maximising customer satisfaction. More-
over, SCM provides a competitive edge to the organisation by ensur-
ing a smooth flow of products and services in the market. The follow-
ing points explain the importance of SCM:
SCM helps an organisation in bringing down inventory costs by
proper inventory management.
Through SCM, information is disseminated effectively between
various partners in the network.
SCM also helps the organisation in enhancing customer satisfac-
tion by making on-time delivery.
SCM helps in building trust between various partners as they
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work together.
It also improves profits of the organisation by increasing the effi-
ciency of operations.
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SCM also offers various tools and techniques to identify and diagnose
disruptions and solve them in time.
1.3.3 Evolution of Supply Chain Management

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Evolution is a process of gradual changes over successive time peri-

ods. There has also been significant evolution in the field of SCM in
the last century. This can be better understood through three major
phases of evolution in the context of the broader economic and tech-
nological developments. A startling fact is that a firm like Ford Motors
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had a well-integrated supply chain in place, almost a century ago, that

allowed it to maximise asset productivity and minimise cost. Yet mod-
ern-day supply chain managers are currently concerned about how
to continuously maximise the role of supply chain in organisational
development and economic growth. To answer this question, let us
have a look at how SCM has evolved in the last hundred years or so.
THE FIRST PHASE (1910s to 1950s)
This phase was characterised by firms that were highly integrated

and the bulk of manufacturing was done in-house. For example, in the
1910s, Ford Motors, a US-based automobile company, had managed
to build a robust integrated supply chain in which the entire process
from the iron-ore stage to the finished automobile stage was complet-
ed in just 81 hours. Although Ford Motors was only offering black-co-
loured ‘T’ Model cars, due to lack of competition, its productivity pros-
pered. However, it was unable to handle product variety, and, hence,
was not sustainable in the long-term. Towards the end of this phase,
General Motors (GM) and some other progressive companies realised

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that customers want a wider product variety in terms of colours and

models and the supply chain should be flexible to accommodate these
varieties efficiently.
THE SECOND PHASE (1960s to EARLY 1990s)
The second phase is characterised by firms offering product varieties

(automobile companies offering different car models) to the custom-
ers. Thus, the supply chains needed to be more flexible and efficient
without holding too much inventory. The Toyota Motor Company ef-
fectively addressed these concerns, thus becoming the leading auto-
mobile company in the 1960s.
The Toyota Motor Company came up with the idea that only manu-
facturing of the key components and the final assembly needed to be
done in-house and bulk of the components could be obtained from
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a large number of suppliers. This thought led to the introduction of
the keiretsu system, that is, a number of companies with interlock-
ing business relationships and shareholding. Toyota had a long-term
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relationship with all its suppliers and its partner firms were situated
in close proximity to the Toyota plant. This arrangement reduced the
set-up time from a couple of hours to a couple of minutes. Long-term
relationship with the suppliers and low set-up time were the key fea-
tures of the second phase. This principle was known as lean produc-
tion system. It was a radical deviation from the tightly integrated sup-
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ply chain pioneered by Ford.
However, the lean production system was successful only when the
ancillary units (the large number of component suppliers) were lo-
cated in close proximity to the principal company (the final assem-
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bler). When Toyota and other Japanese firms set up their assembly
plants in other global locations, the lean production system, involving
tight linkages, faced issues. Moreover, some companies in the keiretsu
system were no longer cost-competitive due to complacency, which
occurred as a result of an assured market for their products. This be-
came a liability over a period of time. These issues led to the advent
of the third phase. Manufacturers were of the opinion that by using
the Electronic Data Interchange (EDI), it is possible to integrate with
the suppliers, whose plants need not be located close to the assembly
plants of the manufacturers.
Dell Computers, with its loosely held supplier network, pioneered the
third phase, wherein customers were offered the benefits of customi-
sation.
THE THIRD PHASE (MID-1990s ONWARDS)
This phase was characterised by firms adapting to technological

changes and offering customised products to customers. For example,
Dell Computers applied Information Technology to allow its custom-

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ers to configure their own PCs. While customers were able to cus-
tomise their computers, Dell was tracking the same in its production
and distribution systems. Dell was working with world-class suppli-
ers who maintained their technological superiority and offered cost
leadership. In contrast to Toyota, which maintained long-term rela-
tionship with its suppliers, Dell preferred to maintain medium-term
relationship with its suppliers. Thus, if a supplier failed to offer the
technological superiority or cost leadership, Dell would swiftly source
from another supplier that offered these advantages. Moreover, Dell’s
inventory levels were minimal, as the inventory levels were not on the
basis of forecasts but were based on actual orders placed by custom-
ers. Using the advancements in Information Technology, Dell could
integrate with its suppliers effectively, even if they had a medium-term
relationship with Dell. Further, since the inventories were based on
the actual orders and not on forecasts, it was able to respond to any
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changes in the marketplace swiftly.
Dell made most of the advancements in the field of Information Tech-

nology as it achieved operational integration with suppliers located
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in distant countries. Dell allowed firms to move from a single product
to multiple products at the component level, thereby offering the cus-
tomer a wide variety of customisation options. Thus, the third phase
was characterised by the advances in the field of Information Tech-
nology.
Thus, these three phases were triggered by the changing market and
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economic dynamics. While rapid economic growth has spurred devel-

opment and expansion of the supply chain function as a whole, the im-
plementation of SCM strategies has been aided by the advancement of
Information Technology.
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2. __________ can be defined as an integrated process of

administering the flow of information, material and services
through various stages of production with the aim of effective
product delivery in the market.
Activity
List the activities performed in the supply chain management of an

Indian organisation of your choice.
Key Concepts in Supply Chain

1.4
Management
SCM encompasses various business processes, activities and goals. It
is important to clarify the meaning and relevance of some of the key
SCM concepts for a better understanding, which are detailed below.

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LOGISTICS MANAGEMENT
Logistics is a fundamental set of supply chain processes that aid ful-

filment of demand. The objective is to supply the right product or ser-
vice at the right place at the right time. According to the Council of
Supply Chain Management, logistics management is defined as the
part of supply chain management that plans, implements and controls
the efficient, effective forward and reverse flow and storage of goods,
services and related information between the point of origin and the
point of consumption in order to meet customers’ requirements. Wheth-
er offered in-house, by a supplier, by the customer, or by an external
logistics service provider, these capabilities are important in attaining
supply chain success.
SUPPLY MANAGEMENT
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According to the Institute for Supply Management, 2010, supply
management focusses on the identification, acquisition, access, position-
ing, management of resources and related capabilities the organisation
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needs or potentially needs in the attainment of its strategic objectives.
It is observed that logistics controls the distribution of products in
most organisations and the supply management controls the strategic
sourcing of direct materials, finished goods, capital equipment, ser-
vices and indirect materials. Both logistics and supply management
are required to ensure optimal supply chain performance.
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VALUE CHAIN
The value chain concept focusses on competitive analysis and strat-

egy. As per Porter, 1985, the value chain comprises the activities as
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shown in Figure 1.3 below:
Value Chain
Primary Activities Secondary Activities
Figure 1.3: Value Chain

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Let us study these activities in detail.

Primary activities: These include inbound logistics, operations,
outbound logistics, marketing and sales and service.
Secondary activities: These include infrastructure, human re-
source management, technology and development and procure-
ment.
These activities together offer value to customers and generate profits

for the organisation.
According to Ramsey, 2005, a value chain and a supply chain are com-
plementary views of an extended enterprise, with integrated supply
chain processes enabling the flow of products and services in one di-
rection, and the value chain generating demand and cash flows from
customers.
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DISTRIBUTION CHANNEL
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According to the Council of Supply Chain Management Profession-
als, 2010, distribution channels support the flow of goods and services
from the manufacturer to the final user or consumer. An organisation
can either set up direct channels to consumers or depend on tradi-
tional intermediaries like wholesalers and retailers to aid transactions
with end-users. The Internet is used by organisations as a vital selling
base. This has enabled manufacturers and retailers to design innova-
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tive and flexible ‘omnichannel’ supply chain capabilities to meet cus-

tomer demand from stores, production and distribution centres.
REVERSE LOGISTICS
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Another concept that must be understood as an essential part of an

effective SCM is the reverse flow of material from the customer to
the manufacturer/retailer to the supplier, in case of deficient/defec-
tive products and excess supplies. This aspect is known as reverse
logistics. Organisations are increasingly becoming liberal to product
recalls if there are issues with product quality. For example, Toyota
has recently recalled a number of its ‘hybrid’ cars to fix issues. Some-
times, the product disposal issues warrant the supplier to take back
any unused/excess supplies, especially when the supplied materials
are toxic or hazardous.
1.4.1 Decision Phases of Supply Chain Management
In order to maintain an effective supply chain network, an organisa-

tion needs to make key decisions related to the flow of information
and products and services. The decisions of SCM are made in three
phases, which are shown in Figure 1.4:

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Design
Plan
Operation
Figure 1.4: Decision Phases of SCM
Let us now study these phases in detail.

1. Design: In this phase, an organisation makes decisions related
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to the structure of the supply chain network for the present as
well as the future. These are usually long-term decisions as they
cannot be altered easily in short periods. These decisions can be
choosing the mode of supply chain (internal or external), selecting
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the location of a plant and warehousing facilities, determining
products to be stored at different locations, defining processes
to be performed at each stage of the supply chain, identifying
the modes of transportation and the information system to be
utilised, and so on.
2. Plan: This phase involves planning for a quarter to a year. The
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aim behind planning is to generate maximum supply chain

surplus over a period based on the constraints identified during
the design phase. The planning of supply chain begins with the
forecast of demand for products in the market in the coming year.
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The planning phase involves deciding markets to be supplied,

the subcontractors to be used for manufacturing, the inventory
policies to be followed, marketing and promotional strategies to
be adopted, etc. During the planning phase, there are a number
of factors to be considered, such as change in demand and level
of competition.
3. Operation: In this phase, supply chain configuration is fixed
and planning policies are established. These decisions are made
either on a daily or weekly basis. Operational decisions are
mainly customer-oriented and include:
Deciding on allocation of inventory or production to individ-
ual orders
Setting the date for customer order fulfilment
Generating pick lists at a warehouse
Allocating the order to a shipment
Defining delivery schedules of trucks
Placing replenishment orders

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3. List the three key decision phases of SCM.
Activity
List three key concepts in SCM and explain them in detail (apart
from those detailed in the text).
Enablers of Supply Chain

1.5
Performance
Enablers make things happen and are considered vital for a supply
chain to perform efficiently. According to Marien, 2000, based on a
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survey of supply chain managers, there are four enablers which in-
fluence the supply chain performance. These are shown in Figure 1.5
below:
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Organisational Infrastructure
Technology
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Alliances
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Human Resources
Figure 1.5: Enablers of Supply Chain Performance
Let us now study about these enablers in detail.

Organisational infrastructure: The key issue that one needs to
consider here is whether supply chain management activities are
internal to the firm, throughout various firms in the supply chain,
organised in vertical orientation or greater decentralisation. More-
over, intra-firm SCM processes need to be in place and operate
effectively to enable successful inter-firm collaboration on SCM
activities.
Technology: There are mainly two types of technology which in-
fluence supply chain performance: information technology and
manufacturing technology. Several software providers and consul-
tants focus on information technology as a key enabler in supply
chain performance. However, manufacturing technology (product

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design) can have significant impact on whether supply chain effi-

ciencies can ultimately be achieved.
Alliances: The effectiveness of alliances is especially vital in de-
centralised supply chains, wherein suppliers are given more au-
thority. In certain cases, suppliers can act as outsourcing partners
who take on key roles in product design and manufacturing.
Human resources: There are two classes of employees who play
vital role as enablers in the supply chain performance. They are
technical employees and managerial employees. Technical em-
ployees play crucial role in designing networks which reduce costs,
while at the same time, attaining high levels of customer service
performance. These employees need to have a clear understand-
ing of the various mathematical models and tools in the supply
chain process. Managerial employees need to understand the key
issues addressed by application of such models and tools and anal-
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yse how this will help the firm in attaining its strategic goals.
Apart from these, there are other important enablers, which influence
the supply chain performance, like Enterprise Resource Planning
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(ERP), various information systems, third-party logistics providers,
etc. Let us study about these in the subsequent sections.
1.5.1 Advancement in Communication and IT
The last couple of decades have seen vast advancements in the field of
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information and communication technologies. The cost of computing

has decreased gradually, the speed of communication has increased
and the cost of communication has reduced. As a result, the co-or-
dination of global supply chains has become very cost-effective and
efficient at the same time. Advances in Enterprise Resource Planning
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(ERP) have changed the nature of information flow across the various
departments of an organisation. It has become possible to integrate
suppliers into the fold of the ERP, wherein the suppliers can access
the production plan of the manufacturer, the material requirement
to meet the planned production, the inventory level of each of the
material supplied by a vendor, etc. enabling the vendors to replenish
the inventory supplied by them on time as per the requirement at the
manufacturing facility. This has resulted not only in the elimination of
stock-out situations in the entire manufacturing process, but has also
helped to reduce the holding costs drastically. Both of these factors
have contributed towards the bottom-line of a firm. Moreover, since
the vendors need to supply only as per the production plan of the
manufacturer, there is very little scope for accumulation of obsolete
or excess inventory, which has further contributed positively to the
overall supply chain surplus.
In the beginning, firms were sceptical about the cost-effectiveness of

the investments made in the field of IT. However, for many firms, the
cost savings made as a result of implementation of IT systems well ex-
ceeded the investments made within the first year itself. In addition,

n o t e s
the implementation of IT systems made other organisational systems

more productive and responsive towards customer needs. IT-enabled
systems helped firms to offer a wide variety of products to their custom-
ers and expand their markets, because of the capability of these sys-
tems to manage large number of inventories. Real-time data helped the
companies to offer products in sync with customers’ changing needs.
The manufacturing and distribution systems also helped to fulfill the
changing needs of the marketplace in record time. Information systems
made it possible for managers to track a moving vehicle to its exact geo-
graphical location. This increased the customer value in a more cost-ef-
fective manner. IT systems have virtually eliminated the instances of
thefts and pilferages, thereby further reducing the supply chain costs
and boosting the productivity and performance of these firms.
1.5.2 Entry of Third-party Logistics Providers
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Quite often, organisations do not have the necessary resources and
time to carry out the appropriate supply chain activities. In such cas-
es, they need a third-party logistics (3PLs) service provider to man-
IM
age their supply chain activities in a cost-effective manner. Currently,
3PLs handle more than 90 per cent of the supply chain activities on
behalf of manufacturing firms. In developed economies, the 3PL com-
panies have gone beyond their traditional role and have served as a
fourth-party logistics (4PLs) service provider that integrate the capa-
bilities, resources and technology so as to offer comprehensive supply
chain solutions to its customers.
M
In India, the 3PL industry is still in its infancy stage. This is because
not many companies in India have employed the services of 3PL pro-
viders. However, with the growth of the Indian economy, many new
N
MNCs and forward-looking Indian companies have started using the

services of 3PL providers. Over a period of time, it is likely that the
3PL providers will increase their scale of operation and develop their
competence, as more and more companies would outsource their
logistics activities to these service providers and like the developed
economies, the 3PL providers will account for the logistics require-
ment of the bulk of the industry.
1.5.3 Enhanced Inter-organisational
Coordination Capabilities
The advancement in the Information and Communication Technol-

ogies (ICT) and 3PL providers has made it essential for firms to co-
ordinate with a network of companies towards achievement of their
respective organisational objectives. They have started viewing their
role strategically. Companies like Dell Computers have successfully
managed complex networks, played their part as a strategic centre
and have emerged as role models for other companies. This is because
a firm should focus on its core competency to offer significant value to
the customers over a long period of time. The other non-core activities

n o t e s
can be outsourced to professional companies. Investing in the appro-

priate information system will ensure that all the activities of the firms
are handled effectively and efficiently. Therefore, the firm just needs
to concentrate on activities pertaining to its core competency and per-
form its role as a strategic control centre that coordinates the activi-
ties of a network of companies. This will, in turn, provide competitive
advantage to the firm.
4. List the various enablers of supply chain performance.
Activity
Find out the benefits and limitations of ERP. Prepare a report on
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your findings.
Supply Chain Performance of

1.6
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Organisations in THE Indian Context
There are several dimensions of measuring supply chain performance
of organisations. The main measures are logistics costs at the econom-
ic level and the inventory turnover ratio at the organisational level.
Logistics costs comprise of inventory-carrying costs, and transporta-
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tion and administration costs.
Figure 1.6 gives the ratio of logistics costs as a percentage of GDP of

the nation:
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Mexico
Japan
India
Asia
Europe
China
US
0 2 4 6 8 10 12 14 16 18
Percentage of GDP
Figure 1.6: Logistics Cost as a Percentage of GDP

(Source: 2013 State of Logistics Report from CSCMP, http://www.scdigest.com/ASSETS/
NEWSVIEWS/13-06-20-2.PHP?CID=7168)
As can be observed from the above figure, US has the lowest logistics
costs as a percentage of GDP at 8.2 per cent, followed by Japan at 10.4
per cent. India’s logistics costs as a percentage of GDP is at 12.5 per

n o t e s
cent, much higher than US and Japan. Infrastructure development is

one factor responsible for this higher ratio in the Indian context. The
other factor in favour of US and Japan’s lower logistics cost is the size
of the economy in terms of GDP. However, the performance of India is
still fair. It is comparable to Europe and is lower as compared to China
at 14.4 per cent and the Asian average at 16.4 per cent.
Let us now analyse the inventory turnover ratio as the measure of
performance of supply chain in India. The detailed analysis of data by
the Centre for Monitoring Indian Economy (CMIE) over the last 25
years reveals that there was an improvement in the inventory turn-
over ratio from 1990 till 2001, from an average inventory turnover ra-
tio of 3.5 in 1990 to 5.5 in 2001. Since 2001, the Indian organisations
have been able to maintain it at that level and there has not been any
further improvement on the same.
Therefore, in order to compete globally, the Indian organisations need
S
to improve on both the measures of performance, that is, in managing
their inventory and lowering the logistics cost. However, the Indian
organisations need to address the following challenges which are af-
IM
fecting their supply chain performance:
The complex Indian taxation structure: In India, various tax-
es are imposed on the movement of goods within and across the
states. To promote industrialisation, some states offer incentives to
industries to set-up manufacturing plants in certain areas within
their states. For example, there are several pharmaceutical compa-
M
nies that have their manufacturing facilities in Baddi in Himachal

Pradesh to take advantage of the tax relaxation offered by the Hi-
machal Pradesh government. Special Economic Zones (SEZs) of-
fer taxation benefits and many organisations decide their locations
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after analysing these benefits.

Poor state of logistics infrastructure: In India, the poor state of
the roads and other infrastructures, like ports (both seaports and
airports), railways, etc. limits the flow of materials from one place
to another. India has a network of national and state highways, but
the conditions are not very encouraging. The creation and main-
tenance of the national highways has been entrusted to a sepa-
rate entity, the National Highways Authority of India (NHAI). The
Government of India is trying to improve the condition through
schemes like the Golden Quadrilateral connecting the four metro-
politan cities of India, the Delhi-Mumbai freight corridor, etc.
5. Name the two main measures of supply chain performance.
Activity
List some other issues that affect the supply chain performance of
the Indian organisations (apart from those mentioned in the text).

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Competitive and Supply chain

1.7
strategies
An organisation’s competitive strategy is formulated depending on
the customer needs that it seeks to satisfy through its products and
services, relative to its competitors. For example, Big Bazaar’s com-
petitive strategy is to make available a wide variety of products to
its customers at a reasonable price. Most products sold at a Big Ba-
zaar outlet are common products (from grocery to home appliances
to clothing) that are available almost anywhere. However, what Big
Bazaar provides is low price. The competitive strategy of Page Indus-
tries, the manufacturer of Jockey brand of clothing, is to offer the most
comfortable undergarments and clothing. The company’s punch-line
is ‘Jockey, or nothing’. It uses the best quality of cotton available to spin
its yarn and uses the latest hosiery-knitting technology to produce the
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best-quality product. Its products offer a premium as high as 100 per
cent in comparison to its competitors. Dell has focussed on customis-
ation as its competitive strategy. It allows customers to configure their
IM
own PCs. Although it takes almost a week for the customised PC to
arrive at the customer’s place, it is still worth it as the PC exactly suits
the customer’s requirement. On the other hand, Apple’s competitive
strategy includes selling its products at premium price. Steve Jobs’
strategy for Apple had four pillars: (i) offering a minimum number of
products, (ii) focussing on the high-end customers, (iii) giving priority
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to profits over market share, and (iv) creating a halo effect that makes
people crave immensely for new Apple products.
Thus, an organisation’s competitive strategy is formulated based on

its customer’s priority. An organisation targets one or more customer
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segments and aims to offer products or services that meet its custom-
ers’ needs.
The relationship between an organisation’s competitive strategy and

supply chain strategy can best be shown by the value chain, as depict-
ed in Figure 1.7:
{
Firm Infrastructure: General Management, Planning Management, Legal, Finance,
Accounting
Support Human Resource Management: Recruitment, Retention, Training, R&D
Processes
Technology Development: Continuous improvement in printing & finishing assets
{
Procurement of Resources: Purchasing paper, printing consumables and other finishing Competitive
consumables Advantage
Inbound Logistic Operations Outbound Logistics Marketing and Service
Primary • Reception •Printing •Warehousing Sales •Customer
Business • Storage •Finishing •Order fulfilment •Partnership support
Processes • Inventory control •Transportation •Advertising
• Transportation •Distribution •Promotion
planning
Figure 1.7: The Value Chain

n o t e s
Thus, in order to create an organisation’s competitive strategy, all

these functions mentioned in the value chain play an important role.
A product development strategy specifies the number of new products

an organisation will launch within a specific period of time. A market-
ing and sales strategy specifies how the segmentation, targeting and
positioning will be done and what integrated marketing communi-
cation strategies will be adopted to reach the target group. A supply
chain strategy will determine the nature of procurement, transporta-
tion of material to and from the manufacturing plant, manufacturing
and warehousing and distribution of the products and services to the
marketplace. The supply chain strategy not only covers the activities
carried out within the organisation but also covers all the outside en-
tities involved in the supply chain function.
The value chain emphasises the role supply chain plays in creating a
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competitive advantage for an organisation and establishes its relation-
ship with other functional strategies of the firm. Thus, these functions
are integrated with each other.
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6. A __________ will determine the nature of procurement,

transportation of material to and from the manufacturing
plant, manufacturing and warehousing and distribution of the
products and services to the marketplace.
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Activity
Compare the competitive strategies of two global manufacturing

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firms. Prepare a report on your comparison.
1.8 Achieving Strategic Fit

Strategic fit means the integration of the supply chain strategy along
with the other functional strategies, so that all the strategies are
aligned with each other resulting in operational synergies for deliv-
ering significant value to the customers and achieving optimal perfor-
mance by the organisation.
If all the processes and functions of the organisation, including the

supply chain activities, are aligned with the competitive strategies of
the firm, the organisation would be able to satisfy the needs of the
target market better than its competitors. This will enable the organ-
isation to expand its market share in the target market and have sig-
nificant economies of scale, which, in turn, can contribute towards
higher profitability growth. The three key points to the success of an
organisation are as follows:

n o t e s
1. The alignment of the competitive strategy with all other functional

strategies, so that they support each other in generating customer
value.
2. Each of these functions must structure its processes and resources
in such a way as to execute these strategies successfully.
3. The effective design, planning and operation of the supply chain
so that it provides the necessary capabilities to support the
desired strategic fit.
If there is no strategic fit between the supply chain strategies and the
other competitive strategies or if the supply chain design, process-
es and resources do not provide the organisation with the capabili-
ty to support the desired strategic fit, the organisation will fail in all
likelihood.
S
According to Chopra and Meindl (2006), there is a direct relation be-
tween the competitive strategy and supply chain strategy in achieving
the strategically fit, that is, whenever the competitive strategy targets
IM
market segments with higher uncertainties, the supply chain strategy
needs to be shifted towards responsiveness. Figure 1.8 shows this di-
rect relationship:
Fully Uncertain
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Competitive
ne
Strategy
N St
eg
at
r
al
ic
ly
Fi
Zo
t
Fully Certain
Efficient Supply Chain Strategy Responsive
Figure 1.8: Strategically Fit Zone

(Source: http://cdn.intechopen.com/pdfs-wm/15543.pdf)
As depicted in Figure 1.8, when uncertainties increase, the supply

chain strategy also needs to increase its responsiveness to prevent
major issues of high uncertainty on the customer service level. If the
supply chain needs to emphasise on efficiency in a highly turbulent
business environment, then the organisations will lose customers as
a result of low service level, inadequate product availability, greater
lead times and low responsiveness. In such uncertain market uncer-

n o t e s
tainties, customers tend to move away from that particular organisa-

tion towards its more responsive competitors. On the other hand, if
the responsiveness level of a supply chain is not damaged and can be
fixed at a reasonable level, competitors can offer customers with the
expected level of responsiveness. Hence, the challenge is to provide
them with low prices.
Let us take the example of Dell Computers.
The competitive strategy of Dell Computers is to offer a range of cus-

tomisable products at a reasonable price. The supply chain strategy
of a company can be greatly varied, that is, the company can have an
efficient supply chain with an emphasis on the ability to manufacture
low-cost PCs by limiting variety and exploiting economics of scale. On
the other hand, the company can have a highly flexible and responsive
supply chain which is efficient in manufacturing a wide range of prod-
S
ucts but with high costs. However, both do not fit with the competitive
strategy of Dell Computers. A supply chain strategy that focusses on
flexibility and responsiveness has a better strategic fit with the com-
IM
petitive strategy of Dell Computers, which has to offer a wide range of
customisable products.
HOW TO ACHIEVE THE STRATEGIC FIT?
We have discussed the importance of the strategic fit in the success or

failure of a business organisation. Now the bigger question to answer
M
is how to achieve the strategic fit. A competitive strategy will specify a

customer segment whose needs the organisation aims to satisfy. Now,
in order to achieve the strategic fit, the organisation needs to ensure
that its supply chain capabilities support its endeavour to satisfy the
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targeted customer segments. The following three steps will help the
firm achieve the strategic fit:
1. Understanding the customers’ needs in the targeted market
segment and the uncertainties associated with the supply chain
function.
2. Understanding the capabilities of the supply chain.
3. Matching the supply chain’s capability to satisfy the needs of the
targeted market.
7. Strategic fit means the integration of the supply chain strategy

along with the other functional strategies, so that all the
strategies are aligned with each other, resulting in operational
synergies for delivering significant value to the customers
and achieving optimal performance by the organisation.
(True/False)

n o t e s
Activity
Select an Indian retail organisation of your choice. Find out how it

achieves strategic fit. Write a brief note on your findings.
1.9 Summary
Supply chain is a dynamic process wherein various parties (em-
ployees, suppliers, distributors, etc.) are involved to deliver prod-
ucts and services as per the customers’ requirements.
Supply Chain Management (SCM) can be defined as an integrated
process of administering the flow of information, material and ser-
vices through various stages of production with the aim of effective
product delivery in the market.
S
Design, plan and operation are the three key decision phases of
SCM.
Organisational infrastructure, technology, alliances and human
IM
resources are the various enablers of supply chain performance.
The two main measures of supply chain performance are logistics
costs at the economic level and the inventory turnover ratio at the
organisational level.
A supply chain strategy will determine the nature of procurement,
M
transportation of material to and from the manufacturing plant,

manufacturing and warehousing and distribution of the products
and services to the marketplace.
Strategic fit means integration of the supply chain strategy along
N
with the other functional strategies, so that all the strategies are
aligned with each other, resulting in operational synergies for de-
livering significant value to the customers and achieving optimal
performance by the organisation.
key words
Competitive strategy: An organisation’s competitive strategy

is the set of customer needs that it seeks to satisfy through its
products and services, relative to its competitors.
Keiretsu: It is a system originated by Toyota Motors, wherein
bulk of the materials could be sourced from a large number of
suppliers with interlocking business relationships and share-
holding.
Strategic fit: It means integration of the supply chain strat-
egy along with the other functional strategies, so that all the
strategies are aligned with each other, resulting in operational
synergies for delivering significant value to the customers and
achieving optimal performance by the organisation.

n o t e s
Supply chain profitability/surplus: It is the difference between

the revenue generated from the customer and the total cost in-
curred throughout the supply chain.
Third Party Logistics (3PL) service providers: They have ex-
pertise in managing logistics of an organisation efficiently at a
lower cost.

1. Explain the concept of supply chain.
2. What are the three key decision phases of SCM? Describe each
of them in detail.
3. What are the various enablers of supply chain performance?
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Discuss each of them in detail.

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answers for SELF ASSESSMENT QUESTIONS
Topic Q. No. Answer

Concept of Supply Chain 1. True
Meaning of Supply Chain 2. Supply Chain Management
M
Management (SCM)
Key Concepts in Supply Chain 3. Design, Plan and Operation
Management
Enablers of Supply Chain 4. Organisational infrastructure,
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Performance technology, alliances and human

resources
Supply Chain Performance of 5. Logistics costs at the economic
Organisations in the Indian level and the inventory turnover
Context ratio at the organisational level
Competitive and Supply Chain 6. Supply chain strategy
Strategies
Achieving Strategic Fit 7. True
HINTS FOR DESCRIPTIVE QUESTIONS

1. Supply chain is a dynamic process, wherein various parties
(employees, suppliers, distributors, etc.) are involved to deliver
products and services as per the customers’ requirements. Refer
to Section 1.2 Concept of Supply Chain.
2. Design, plan and operation are the three key decision phases
of SCM. Refer to Section 1.4 Key Concepts in Supply Chain
Management.

n o t e s
3. Organisational infrastructure, technology, alliances and human

resources are the various enablers of supply chain performance.
Refer to Section 1.5 Enablers of Supply Chain Performance.
Suggested Readings for

1.12
Reference
SUGGESTED READINGS
Ayers,J. (2001). Handbook of supply chain management. (1st ed.).
Boca Raton: St. Lucie Press.
Chopra, S., and Meindl, P. (2014). Supply chain management.
(1st ed.). Hallbergmoos: Pearson.
Fredendall, L., and Hill, E. (2001). Basics of supply chain manage-
S
ment. (1 ed.). Boca Raton: St. Lucie Press.
st
Wisner,
J., Leong, G., and Tan, K. (2005). Principles of supply chain
management. (1st ed.). Mason, Ohio: Thomson/South-Western.
IM
E-References
Ecrasia.com. (2015). The basic concepts of supply chain manage-
ment. Retrieved 07 December 2015, from http://www.ecrasia.com/
the-basic-concepts-of-supply-chain-management/
M
Fibre2fashion.com. (2015). Overview of supply chain management,

supply chain process, supply chain information system. Retrieved 07
December 2015, from http://www.fibre2fashion.com/industry-arti-
cle/29/2893/an-overview-of-supply-chain-management1.asp
N
Scm.ncsu.edu. (2015). What is supply chain management?– SCM

| Supply Chain Resource Cooperative (SCRC) | North Carolina
State University. Retrieved 07 December 2015, from http://scm.
ncsu.edu/scm-articles/article/what-is-supply-chain-management

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S
C h a
2 p t e r
AGGREGATE PLANNING IN SUPPLY CHAIN
CONTENTS
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2.1 Introduction
2.2 Meaning of Aggregate Planning
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2.2.1 Role of Aggregate Planning in Supply Chain
Activity
2.3 Aggregate Planning Strategies
2.3.1 Aggregate Planning Using Linear Programming
2.3.2 Aggregate Planning in Excel
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Activity
2.4 Problems Related to Aggregate Planning
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Activity
2.5 Implementing Aggregate Planning in Practice
Activity
2.6 Summary

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ZARA’S AGGREGATE PLANNING
(Source: birminghameastside.com)
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Zara, Spain’s largest apparel manufacturer and retailer, based
in Arteixo, Galicia, is a chain of fashion stores. It has more than
2,200 retail outlets in 56 countries. Zara belongs to Inditex, which
IM
is one of the largest distribution groups in the world. Though the
fashion industry is very fickle, Zara’s strategy of being highly re-
sponsive to the changing trends with affordable pricing has con-
tributed to its tremendous growth. Zara has been able to match
customers’ preferences with its product displays better than its
competitors. It introduces new designs every week and changes
more than three-fourths of its merchandise display every three to
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four weeks. Zara is able to achieve this because it manufactures

its apparel using a combination of flexible and quick sources in
Portugal and Spain and low-cost sources in Asia, whereas major
apparel manufacturers have shifted their manufacturing base to
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Asia. In addition, of the total capacity, about 40% of the manufac-

turing capacity is owned by Inditex, while the rest is outsourced.
Zara has a strong aggregate plan in place. It outsources the manu-

facture of apparels with a more predictable demand to Asian man-
ufacturers, while sourcing products with uncertain demand from
its own manufacturing facilities within Europe. This arrangement
allows it to be more responsive to customers’ changing trends.
This effective planning has helped Zara to reduce inventories,

as the forecasting errors are significantly reduced. Zara has also
made heavy investment in information systems to ensure the
availability of real-time sales data that drives the replenishment
and production decisions. It has also centralised its European dis-
tribution through a single distribution centre in Spain since 2002.
This allows the equilibrium between the demand and supply of
inventory.
Zara is a perfect example of how aggregate planning helps in

achieving average profitability in an unpredictable industry.

AGGREGATE PLANNING IN SUPPLY CHAIN 29
n o t e s
learning objectives

>> Explain the concept of aggregate planning
>> Explain the aggregate planning strategies
>> Discuss the problems regarding aggregate planning
>> Discuss implementing aggregate planning in practice
2.1 INTRODUCTION
In the previous chapter, you studied the concept of the supply chain
and its role in the economy and organisations. However, to achieve an
effective supply chain, organisations must plan production schedules
S
in advance by assessing and combining different available resources
and current capacity to make on-time delivery of products. This could
be done effectively with the help of aggregate planning.
IM
Aggregate planning is defined as a process that assists an organisation
in performing production smoothly and synchronising the flow across
its supply chain.
As an approach, it maintains the balance between the products’ de-

mand and supply. Its main objective is to create a production plan
M
that ensures the optimal use of organisational resources to fulfill the

expected demand, which ultimately helps the organisations in main-
taining an effective supply chain.
Aggregate planning concentrates on maintaining a suitable level of

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workforce and a stable output rate, using a combination of decision

variables and matching demand from one period to another. It is a
comprehensive planning tactic in which the planners avoid concen-
trating on individual products/services and focus on the overall pro-
duction capacity of an organisation.
Organisations can apply mathematical tools, such as linear program-

ming for effective aggregate planning. In addition, information technol-
ogy offers substantial benefits for aggregate planning in an organisation.
In this chapter, you will study the concept of aggregate planning and
its importance in detail. You will also study about the aggregate plan-
ning strategies and different problems associated with it. Towards the
end, you will study how to implement aggregate planning in practice.
2.2 MEANING OF AGGREGATE PLANNING

Aggregate planning aims at matching the demand and supply of prod-
ucts/services by calculating the correct quantities of inputs and out-

n o t e s
puts and the right time for their conversion. In other words, aggregate
planning is a process of determining the ideal levels of production,
capacity, inventory, sub-contracting, stockouts and pricing for a spe-
cific time period. With the use of aggregate planning, an organisation
targets at solving the problems that need aggregated decisions while
carrying out supply chain activities. For instance, an organisation can
find out a suitable production level that needs to be maintained to ful-
fill the customers’ needs successfully.
Aggregate planning assists in establishing an organisation-wide stra-

tegic plan for allocating resources, minimising the total production
costs, reducing investment in inventories and improving customer
service. Besides, some other objectives of aggregate planning are to:
Minimise alterations in production rates
Maintain an appropriate production level
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Ensure effective utilisation of the available resources
Let us consider an example to understand the concept of aggregate

IM
planning. ABC is a paper mill that experiences seasonal demand for
premium paper needed to make company reports and brochures.
Meeting such demand can be costly because of high prices of special
coatings and additives needed for manufacturing premium paper.
Therefore, for dealing with these constraints, ABC must perform ag-
gregate planning for determining the correct levels of inventory and
M
production to maintain an efficient supply chain.
Aggregate planning is made on the basis of the demand forecast. Once

the plans are prepared, organisations can do backward working from
the final sales volume to production planning to raw materials re-
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quired. These annual plans are again broken down into quarterly and
monthly plans and further into labour, raw material, working capital
requirements, etc. In this way, the overall process of determining the
production requirements is called aggregate planning.
2.2.1 ROLE OF AGGREGATE PLANNING IN SUPPLY CHAIN
Aggregate planning aids an organisation in creating production

schedules that utilise scarce resources in the best possible manner,
which increases the efficiency of a supply chain. The role of aggregate
planning in a supply chain is explained as follows:
Aggregate planning aids planners in taking decisions with respect
to factors like employment levels, output rates and appropriate
inventory levels. These factors are important for an efficient and
responsive supply chain.
With the use of aggregate planning, an organisation facilitates the
arrangement of resources needed for production and on-time de-
livery of products.

n o t e s
In case of a change in demand, aggregate planning assists in tak-

ing decisions with respect to operations and marketing to match
the demand with the supply of products.
Aggregate planning also lays the foundation for preparing an ini-
tial budget for the supply chain of an organisation.
1. ____________ is defined as a process that assists an organisation

in performing production smoothly and synchronising the
flow across its supply chain.
2. Aggregate planning aids planners in taking decisions with
respect to factors like employment levels. (True/False)
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Activity
Using the Internet, identify examples of aggregate planning in the

Indian manufacturing industry.
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2.3 AGGREGATE PLANNING STRATEGIES
In order to build an effective aggregate planning strategy, the aggre-
gate planner has to make trade-offs among variables like capacity, in-
ventory and backlog costs. This is because an increase in one of these
M
costs typically results in reduction of the other two. For example, if

the aggregate planner attempts to reduce the backlog cost, then the
inventory cost will have to increase. Similarly, to lower the inventory
cost, a planner has to increase capacity cost or delay delivery to the
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customer. Thus, the planner trades one cost for others. Selecting the
most profitable combination of trade-offs is the objective of aggregate
planning. As demand changes over time, the planner uses one of these
three costs as the key lever to minimise the overall costs, thereby en-
suring maximum profits. For example, if the cost of changing capacity
is low, there is no need for a firm either to hold inventory or to carry
backlogs. However, if the cost of changing capacity is high, the firm
may compensate by building some inventory during the lean periods
of demand to the peak period or carry some backlogs of the peak peri-
od to the next lean demand periods.
The principal trade-offs faced by an aggregate planner are as follows:

Inventory
Backlog/lost sales because of delay

Capacity (including sub-contracting)
An aggregate planner attempts to use a combination of these three

costs to meet the demand in a cost-effective way.

n o t e s
Essentially, there are three types of distinct aggregate planning strat-

egies available to a planner to find a balance among these costs. These
three strategies are discussed in the following sections:
1. Chase strategy: In this strategy, capacity is used as a lever. The
production rate is synchronised with the demand rate by changing
(increasing during peak demand periods and decreasing during
off-peak demand periods) the plant capacity or manpower
(hiring during peak demand periods and laying off during off-
peak demand periods). In reality, achieving this flexibility is
very problematic because of the practical difficulty in varying
the capacity and workforce on short notice. This strategy may
prove to be expensive. It can also cause a serious negative impact
on the morale of the workforce. Using this strategy lowers the
inventory-levels in the supply chain and involves a high level of
change in capacity and workforce. It is generally used when the
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inventory carrying cost is very high, the cost of varying capacity
is low and increasing/decreasing the workforce is easy.
2. Capacity strategy or time flexibility from workforce: In this
IM
strategy, utilisation is used as the lever. This strategy is ideally
suitable when there is excess machine capacity (i.e. machines are
not used 24*7). In this case, the workforce (number of workers)
is kept stable, but the number of hours of work is changed. For
example, if, at present, the plan is working only one shift and it
is not possible to meet the demand with one shift, the aggregate
planner decides to start a second shift. To work in this shift, the
M
planner may use variable amount of overtime or flexi-schedule

to synchronise the capacity with the rising demand. This strategy
also requires the workforce to be flexible. However, it eliminates
some of the problems linked to chase strategy, notably changing
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the size of the workforce. This strategy leads to a lower level

of inventory but with lower average machine utilisation. The
strategy is ideal when the cost of carrying inventory is very high
and that of machine capacity is relatively less.
3. Level strategy: This strategy uses inventory as the lever. In
this strategy, the machine capacity and size of the workforce is
kept unchanged, maintaining a stable output rate. In this case,
production is not varied to match the demand. Rather, the stable
production rate will result in excess inventory during off-peak
demand periods, which is carried forward to meet the demand
during the peak demand periods. If the excess inventory is not
sufficient to meet the peak demand periods, then this would result
in a backlog, which will be fulfilled with the excess inventory
during the next off-peak demand period. In this strategy, the cost
of changing capacity is low but the inventory capacity is high. One
of the disadvantages of this strategy is that huge inventory levels
may get accumulated and, if the customer order gets delayed,
the cost of carrying the inventory may be very high. Another risk
is that some of the accumulated inventory may result in dead
inventory, if there is a change in the preference of the customers.

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2.3.1 AGGREGATE PLANNING USING LINEAR

PROGRAMMING
In the last section, we discussed that the objective of aggregate plan-

ning is to maximise profit while meeting the demand. Each firm, in
its endeavour to meet its customer demand, faces certain constraints
related to the manufacturing capacity or the supplier’s ability to de-
liver a component. Given these constraints, the firm tries to maximise
profits or minimise costs by using linear programming. Linear pro-
gramming is a very effective method to find a solution that creates the
maximum profit while incorporating all the given constraints.
Let us illustrate the linear programming techniques used by Laxmi

Pumps, a small manufacturer of electric pumps with manufacturing
facility at Mancheswar Industrial Area, Bhubaneswar. The organisa-
tion’s products are sold through retailers in India. Laxmi Pumps’ op-
S
eration consists of the assembly of purchased parts into a water pump
used for irrigation purpose in households, gardens, lawns, farmlands,
etc. Due to limited equipment and space required for assembly, Laxmi
IM
Pumps’ capacity is determined primarily by its size of the workforce.
For developing the aggregate plan, we will consider a six-month time

period, which is long enough to illustrate the important points.
Demand for Laxmi Pumps from customers is highly seasonal, peak-

ing in the spring season as people plant their gardens/commence
M
their Rabi crops. This seasonal demand comes from the retailers to
Laxmi Pumps. Laxmi Pumps has decided to use linear programming
to tackle the seasonal nature of consumer demand and to maximise
profits. Alternative tools the organisation has are building inventory
during the off-peak periods, adding workers during the peak periods
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and sub-contracting out some work during peak periods. To find out
how to use these three options through an aggregate plan, the General
Manager of Laxmi Pumps focusses his attention in preparing a de-
mand forecast in consultation with the retailers. The demand forecast
is given below:
Table 2.1 : Demand Forecast for Laxmi Pumps

Month Demand Forecast (in numbers)
January 1,600
February 3,200
March 3,600
April 3,800
May 2,600
June 2,400
TOTAL 17,200
Laxmi Pumps sells each pump to the retailers for ` 4,000. At the be-
ginning of January, the opening inventory is 1,100 pumps. The firm

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has a manpower of 80 workers. There are 25 working days available

each month. Each worker earns ` 40 per hour during regular hours.
Each employee works for 8 hours a day, which constitutes the regular
work time. Working for more than 8 hours constitutes overtime. The
number of labour hours spent, and not the machine capacity, primar-
ily determines the capacity of the production function. A worker can
work for a maximum of 10 hours per month. The various costs are
presented in Table 2.2 below:
Table 2.2 : Costs for Laxmi Pumps

Item Cost
Material cost ` 2,000/unit
Inventory-holding cost ` 200/unit/month
Cost of stockout/backlog ` 500/unit/month
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Hiring and training costs ` 8,000/worker
Lay-off cost ` 12000/worker
Regular time cost ` 40/hour
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Overtime cost ` 60/hour
Cost of sub-contracting ` 2,800/unit
Laxmi Pumps has no limits on inventories, sub-contracting and stock-

out/backlog. All stockouts can be supplied from the production of the
next month. Inventory costs are incurred on the closing inventory lev-
els in the month. The aggregate planner’s goal is to produce the opti-
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mal aggregate planning that allows Laxmi Pumps to have a closing in-
ventory of 500 units at the end of June after taking care of all backlogs.
All demands are to be met, although at a later date. The optimal ag-
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gregate plan is the one that results in maximum profit over the plan-
ning period of six months from January to June. The revenue earned
for this period is fixed at ` 6,88,00,000 (` 4,000 per unit ×17,200 units
sales). Therefore, minimising cost is the same as maximising profit.
The following steps need to be carried out in developing the aggregate plan.
Step 1: Identifying the Decision Variables
In the process of developing an aggregate plan, the first step is to iden-

tify the set of decision variables whose values are to be obtained. For
Laxmi Tools, the following decision variables are defined for the ag-
gregate planning model:
Wt = Workforce size for month t, t = 1, 2, ... 6
Ht = No. of employees hired at the beginning of the month t,
t = 1, 2, ... 6
Lt = No. of employees laid off at the beginning of the month t,
t = 1, 2, ... 6

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Pt = No. of units produced in month t, t = 1, 2, ... 6

It = Inventory at the end of the month t, t = 1, 2, ... 6
St = No. of units stocked out/backlogged at the end of the
month t, t = 1, 2, …6
Ct = No. of units sub-contracted for month t, t = 1, 2, ... 6
Ot = No. of overtime hours worked in month t, t = 1, 2, ... 6
Step 2: Defining the Objective Function
The demand in month t is denoted by Dt. The values of Dt are given in

Table 2.1. The objective function is to minimise the total cost incurred
during the planning horizon. The various components of the cost in-
curred are as follows:
Material cost
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Regular time labour cost
Overtime labour cost
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Cost of hiring and layoffs
Cost of holding inventory
Cost of stocking out
Cost of sub-contracting
M
Let us evaluate each of these costs separately.

1. Material and sub-contracting costs: The material cost is
` 2,000/- per unit and the sub-contracting cost is ` 3,000/- per
unit. Pt represents the quantity produced and Ct represents the
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quantity sub-contracted in period t. Thus, the material and sub-

contracting cost is given as follows:
6 6
Costs of material and sub-contracting = ∑ 2000Pt + ∑ 3000Ct
t=1 t=1
2. Regular time labour cost: The workers are paid a regular time
wage of ` 8,000 per month (` 40/hour × 8 hours/day × 25 days/
month). For Wt workers in period t, the regular time labour cost
over the planning horizon is given by:
6
Regular time labour cost = ∑ 8000 Wt
t=1
3. Overtime labour cost: Workers are paid an over time wage of

` 60/hour. For Ot hours worked in period t, the over time labour
cost over the planning horizon is given by:

n o t e s
6
Over time labour cost = 60 ∑ Ot
t=1
4. Cost of hiring and layoff: The cost of hiring a worker is `3,000

and the cost of laying off a worker is ` 5,000. Ht and Lt represent
the number of workers hired land laid off, respectively, in period
t. Thus, the cost of hiring and layoff is given by:
6 6
Cost of hiring and layoff = ∑ 3000Ht + ∑ 5000Lt
t=1 t=1
5. Cost of inventory and stockout: The cost of carrying inventory

is ` 200 per unit per month, and that of stocking out is ` 500 per
unit per month. It and St represent the units in inventory and the
S
units stocked out, respectively, in period t. The cost of inventory
and stockout is given by:
6 6
IM
Cost of inventory and stockout = ∑ 200It + ∑ 500St
t=1 t=1
The total cost incurred during the planning horizon is the sum of
all these five costs and is given by:
TOTAL COST =
M
6 6 6 6
∑ 2000Pt + ∑ 3000Ct + ∑ 8000Wt + ∑ 60Ot
t=1 t=1 t=1 t=1
6 6 6 6
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+ ∑ 3000Ht + ∑ 5000Lt + ∑ 200It + ∑ 500St

t=1 t=1 t=1 t=1

Equation 2.1
The objective of Laxmi Tools was to develop an aggregate plan
that minimised the total cost incurred during the planning
horizon.
The values of the decision variables in the objective function are sub-
ject to a variety of constraints and, hence, cannot be set arbitrarily. In
the next section, we will clearly define these constraints linking the
decision variables.
Step 3: Defining the Constraints
Laxmi Pumps’ General Manager must now specify the constraints

that the decision variables must meet. These are as follows:

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1. Workforce, hiring and layoff constraints: The workforce size

Wt in period t is obtained by adding the number hired Ht to the
workforce size Wt-1 in Period t-1, and subtracting the number laid
off Lt in Period t as follows:
Wt = Wt-1 + Ht – Lt for t = 1,2....,6 Equation 2.2
The initial workforce is given by W0 = 80
2. Capacity constraint: In each period, the quantity produced
cannot exceed the available capacity. Total production is
restricted by the total internal capacity, based on the available
labour hours (both regular and overtime). We will consider that
the capacity constraint is limited to the plant only and not to sub-
contracted production. Each worker can produce 40 units per
month (four hours per unit as mentioned in Table 2.1) and one
unit for every four hours of overtime.
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Pt = 40Wt + Ot/4 for t = 1...,6 Equation 2.3
3. Inventory balance constraints: These constraints balances
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inventory at the end of each time period. Net demand for period t
equals the sum total of the current demand (Dt) and the previous
backlog (St-1). This demand is filled from current in-house
production (Pt) or sub-contracted production (Ct) and previous
inventory (It-1) or part of it is backlogged (St). This is expressed by
the following equation:
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It-1 + Pt + Ct = Dt + St-1 + It – St for t = 1, 2,....,6 Equation 2.4

As shown in Table 2.1, the initial inventory is given by I0=1000
units, there are no backlogs initially and the ending inventory by
the end of June must be 500 units.
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4. Overtime limit constraints: The final constraint is that a worker

cannot work more than 10 hours overtime in each month. This
can be expressed by the following equation:
Ot ≤ 10Wt for t = 1,2,....,6 Equation 2.5
Moreover, each of the variables must be non-negative and there must

be no backlog at the end of period 6 (i.e. S6 = 0)
When implementing the model in Microsoft Excel, the task would be-
come easier if all the constraints are written so that the right-hand
side for each constraint is 0. For example, we can write the overtime
constraint as Ot–10Wt ≤ 0 for t = 1,2,...,6
The aggregate planner can easily add other constraints that limit the
maximum number of employees to be hired or the quantities pur-
chased from sub-contractors each month. Any other constraints limit-
ing inventories or backlog can also be easily accommodated.

n o t e s
By optimising the above objective function (minimising the cost in

equation 2.1 subject to the four constraints as, the General Manager
obtains the aggregate plan shown below:
Table 2.3 : Aggregate Plan for Laxmi Pumps

Period Ht Lt Wt Ot It St Ct Pt Dt
No. No. No. of Over- Inventory Stocks Sub-con- Pro- De-
hired laid off work- time out tract duction mand
force
0 0 0 80 0 1000 0 0
1 0 0 80 0 0 0 0 600 1600
2 0 0 80 0 0 0 0 3200 3200
3 10 0 90 0 0 0 0 3600 3600
4 0 0 90 0 0 200 0 3600 3800
5 0 17 72 0 0 0 0 2800 2600
S
6 0 0 72 0 500 0 0 2900 2400
For this aggregate plan, we have the following:

IM
The total cost over the planning horizon = ` 3,77,69,999
Laxmi Pumps hires 10 workers in the month of March to increase

capacity to meet the peak demand for March and April and lays off
18 workers in May as the peak demand decreases. They do not use the
outsourcing option during the entire planning horizon. There was a
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backlog of 200 units in the month of April, which was filled in from the
production in the month of May. At the end of the planning horizon,
there was a closing inventory of 500 units.
Revenue over the planning horizon = ` 17800 × 4000 = ` 7,12,00,000

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If the seasonal fluctuations increase, synchronising supply with fluc-

tuating demand becomes difficult and often results in increase of ei-
ther inventory or backlog. These increases transform into an increase
in the cost of the supply chain, thereby reducing the supply chain
profitability/surplus.
What happens if the demand forecast or the values of decision vari-

ables are changed? We can feed the revised value into the aggregate
planning worksheet and re-run the aggregate plan. We will get a re-
vised aggregate plan. For example, if the demand forecast has more
seasonal fluctuation as shown in Table 2.4 below, then the revised ag-
gregate plan would be changed to the one given in Table 2.5.
Table 2.4 : Revised Demand Forecast for Laxmi Pumps

January 1200
February 3400
March 3800

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April 4800
May 2700
June 1900
TOTAL 17800
Table 2.5 : Optimal Aggregate Plan for Revised

Demand Forecast
Pe- Ht Lt Wt Ot It St Ct Pt
riod
No. No. No. of Over- Inven- Stock- Sub-con- Pro- De-
hired laid work- time tory out tract duc- mand
off force tion
0 0 0 80 0 1000 0 0
S
1 0 0 80 0 200 0 0 400 1200
2 0 0 80 0 0 0 0 3200 3400
3 27 0 107 0 500 0 0 4300 3800
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4 0 0 107 0 0 0 0 4300 4800
5 0 40 67 0 0 0 0 2700 2700
6 0 0 67 0 500 0 0 2400 1900
Similarly, the aggregate plan will change when the cost of one or more
decision variables change.
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The aggregate planning methodology we have used does not take into
account any forecast error. However, in reality, this is not the case. A
forecast is a forecast and there are bound to be errors. Therefore, fore-
cast errors should be taken into account to make aggregate planning
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more accurate. One way of dealing with forecast errors is to use safety
stock, defined as inventory held to satisfy the demand in excess of the
forecasted demand, or safety capacity, defined as capacity used to sat-
isfy the excess demand. Safety stock can be created by building and
carrying extra inventory. Safety capacity can be created by:
Using overtime
Carrying extra workforce permanently
Using sub-contractors
Purchase capacity or product from an open market
The actions a firm takes depend on the relative cost of the choices.
2.3.2 AGGREGATE PLANNING IN EXCEL
In this section, we will discuss how to generate an aggregate plan for

Laxmi Pumps in Excel. To access Excel’s linear programming capabil-
ities, use Solver (Tools Solver).

n o t e s
To begin with, we must create a table, which we illustrate in

Figure 2.1, containing the following decision variables:
Wt = Workforce size for month t, t = 1,2, ...,6
Ht = No. of employees hired at the beginning of the month t, t =
1,2, ...,6
Lt = No. of employees laid off at the beginning of the month t, t
=1,2, ...,6
Pt = No. of units produced in month t, t = 1,2, ...,6
It = Inventory at the end of the month t, t = 1,2, ...,6
St = No. of units stocked out / backlogged at the end of the month
t, t = 1,2, ...,6
Ct = No. of units sub-contracted for month t, t = 1,2, ...,6
S
Ot = No. of overtime hours worked in month t, t = 1,2, ...,6
The first step is to prepare a table containing all the decision vari-
IM
ables. Figure 2.1 illustrates what this table should look like. The cells
B5 to I10 contain the decision variables with each cell corresponding
to a decision variable. For example, cell F8 corresponds to the inven-
tory in time period 4. Column J contains the values of demand forecast
from period 1 to period 6 of the planning horizon. This information is
required to calculate the aggregate plan. We begin by setting all the
decision variables in cells B5 to I10 to 0, as we want the aggregate
M
planning process to fill-in the optimal values of these variables taking

into account the costs of each of these decision variables and subject
to the constraints. Figure 2.1 illustrates the spreadsheet area for the
constraints and Figure 2.2 illustrates the spreadsheet area for cost cal-
N
culations.
Figure 2.1: Spreadsheet Area for Decision Variables
The next step is to build a table for the constraints as given in equa-
tions 2.2 to 2.5.

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This constraint table may be built as shown in Figure 2.2 below:
Figure 2.2: Spreadsheet Area for Constraints
S
The operations of the cell are shown in Table 2.6:
Table 2.6: Cell Operations

Cell Cell Formula Equation Copied to
IM
M5 =D5–D4–B5+C5 2.2 M6:M10
N5 =40*D5 + E5/4–I5 2.3 N6:N10
O5 =F4–G4+I5+H5–J5–F5+G5 2.4 O6:O10
P5 =–E5+10*D5 2.5 P6:P10
Column M contains the workforce constraints as given in equation 2.2,

M
column N contains the capacity constraints as given in equation 2.3,

column O contains the inventory constraints as given in equation 2.4
and column P contains the overtime constraints as given in equation
2.5. These constraints are applied to each of the six time periods. Each
N
constraint needs to be written in Solver as:
Cell value { ≤, = or ≥ } 0
For our constraints,
M5 = 0,
N5 ≥ 0,
O5 = 0 and
P5 ≥ 0
The third step is to create a cell that will contain the objective func-
tion, on the basis of which the solution will be obtained. This cell is to
be written as a formula using cells with intermediate cost calculation.
All cost calculations for Laxmi Pumps are shown in Figure 2.3. For
example, cell B15 contains the hiring costs incurred in period 1 and is

n o t e s
the product of cell B5 and the cell containing the hiring cost per work-
er, which is obtained from Table 2.2. Other cells are filled in a similar
manner. Cell C22 will have the total cost and is the sum of all the costs
contained in cells from B15 to I20.
S
Figure 2.3: Aggregate Plan Cost Calculations
The fourth step is to invoke solver using Tools | Solver. Enter the fol-
IM
lowing information within the Solver Parameter dialogue box to rep-
resent the linear programming model.
Set Target to Cell: C22
Equal to: Select Min
By Changing Cells: B5:I10
M
Subject to the constraints:

B5:I10 ≥ 0 {Each of the decision variables is non-negative}
F10 ≥ 500 {Inventory at the end of the planning horizon is 500}
N
G10 = 0 {Stockout at the end of the planning horizon is 0}

M5:M10 = 0 {Wt–Wt-1–Ht + Lt = 0 for t = 1,2....,6}
N5:N10 ≥ 0 {40 Wt + Ot/4 – Pt ≥ 0 for t = 1,2...,6)
O5:O10 = 0 {It-1 – St-1 + Pt + Ct – Dt – It + St = 0 for t = 1, 2,....,6}
P5:P10 ≥ 0 {10 Wt – Ot ≥ 0 for t=1,2...,6
The Solver Parameter dialogue box is shown in Figure 2.4.
Figure 2.4: Solver Parameter Dialogue Box

n o t e s
Within the Solver Parameter dialogue box, tick the Assume Linear
Model. Doing this allows the Solver to recognise a linear program-
ming problem that speeds up the solution significantly. Return to the
Solver Parameters dialogue box and click on Solve. The optimal solu-
tions will be returned as shown in Figure 2.5. It is worth mention-
ing here that the optimal solution (the total minimum cost figure of
` 3,77,69,999) we obtained using Excel is exactly the same that we have
got using Linear Programming in the previous section.
S
IM
M
Figure 2.5: Optimal Aggregate Plan

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3. _____ strategy uses capacity as the lever.

4. Level strategy uses _______________ as the lever.
Activity
Visit a nearby manufacturing organisation and find out whether

they use the linear programming model or Excel to find the opti-
mum solution for their production requirement to maximise profits.
PROBLEMS RELATED TO AGGREGATE

2.4
PLANNING
As discussed, aggregate planning focusses on matching the demand
and supply for a product or service by estimating the right quantities
of inputs and outputs and the right timing for their transformation.

n o t e s
It fulfills the demand in a way that maximises profits for the busi-
ness firm. A poor aggregate plan results in lost sales and lost profits, if
the available inventory and capacity are unable to meet the demand.
Moreover, it leads to large amount of excess inventory and capacity,
thereby raising costs. Organisations suffer various problems while
considering aggregate planning. Some of them are as follows:
Smoothing costs: These costs are associated with hiring and firing
in the organisations. This cost is incurred by the organisation for
changing production and workforce levels from one time period to
the next.
Bottleneck problems: It is the supply chain system’s problem to
face the sudden changes in demand that occur due to capacity re-
strictions. For example, a sudden increase in demand may act as a
bottleneck for the organisation in case the organisation has insuf-
S
ficient capacity to meet the demand.
Planning horizon: Organisations plan in advance for the number
of periods for the demand, workforce levels and inventory levels.
IM
Sometimes, inaccurate forecasts lead to extremely long planning
horizon. For example, for minimising the inventory-holding costs,
an aggregate planning may suggest keeping zero inventory at the
end of the horizon. This is considered as a poor strategy if the plan
fails or if the demand for inventory increases due to unforeseen
circumstances. The solution to the problem is to use rolling sched-
ules. These schedules should be used for periods more than the
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planning horizon. This ensures stability in the production and

workforce over a long time.
Demand variations: In aggregate planning, it is assumed that
demand is known with certainty, which is a weakness as well as
N
strength of this approach. However, this planning ignores the pos-

sibility of forecast errors. It ignores uncertainty, such as seasonal
variations in demand.
5. __________________ costs are associated with hiring and firing

in the organisations.
6. Rolling schedules should be used for periods more than the
planning horizon. (True/False)
Activity
Visit a nearby manufacturing organisation and find out what kind

of problems it faces in the aggregate planning.

n o t e s
IMPLEMENTING AGGREGATE
2.5
PLANNING IN PRACTICE
By now, you have studied the basic concepts of aggregate planning.
Let us now discuss how aggregate planning is implemented in practice
and how it impacts the production schedules of organisations. Imple-
mentation of aggregate planning involves the following four elements:
Expand the resource-based view of the firm to include external
supply chain entities: In general, companies include all the com-
pany-specific factors while performing the aggregate planning.
However, it must be remembered that there are many critical fac-
tors outside the organisation in its supply chain which can affect
the aggregate planning. A company, therefore, must keep in mind
these factors as well. Ideally, the company should work with the
S
downstream supply chain partners to generate forecasts and must
work with the upstream supply chain partners to determine the
various bottlenecks in the supply chain. This helps in improving
the quality of inputs that go into the aggregate plan. This implies
IM
that the company must communicate and integrate other supply
chain entities, such as suppliers, transporters, third-party logistics
partners, warehouses and customers with the information system
of the firm. The final form of an aggregate plan depends on the
quality of inputs that goes in making it. Therefore, if there is im-
provement in the quality of the inputs, the quality of the aggregate
M
plan is bound to improve. Moreover, the aggregate plan must be

shared with all the supply chain partners.
Develop flexible aggregate plans: Aggregate plans are prepared
on the basis of demand forecasts; and the demand forecasts are
N
never 100% accurate, which means that there remains a certain

degree of error in demand forecasts. Therefore, it is essential that
the aggregate plans must have some built-in flexibility in order to
accommodate any changes such as change in the demands or costs.
To build flexibility in an aggregate plan, the concerned managers
of the company should perform sensitivity analysis on the inputs
that will be used in aggregate planning. Sensitivity analysis on the
inputs results in a number of scenarios which display the impact of
change in input on the aggregate plan. Concerned managers can
then analyse these scenarios and take a decision accordingly. For
example, assume that a manager prepares an aggregate demand
plan; the plan suggests that the capacity of the company should
be increased. Now, if expanding the capacity of the company is an
expensive affair and the demand is uncertain, then new aggregate
plans must be examined at higher than expected and lower than
expected levels of demand. Next, the results of such examinations
must be analysed.

n o t e s
Assume that examinations suggest that capacity expansion will

lead to little savings in the case of higher than expected demand
and will lead to enormous costs in case of lower than expected de-
mand. In such a case, it is recommended that capacity expansion
should not be undertaken.
Re-run aggregate plans: As mentioned earlier, an aggregate plan
is generally made for a period of 3 to 18 months. However, this
does not mean that the firm must wait for 3 to 18 months before
preparing a new aggregate plan. The managers and the compa-
ny continuously receive updated data such as demand forecasts,
sales forecasts, etc. through their information systems. As various
inputs of the aggregate plans change, the manager should keep
revising the aggregate plans using the latest available data.
Use aggregate planning as capacity utilisation increases: In
S
practice, many firms do not use aggregate plans to prepare their
production schedules. Instead, they rely on orders from their dis-
tributors or warehouses. The distributors and warehouses provide
the demand data based on actual demand or on inventory manage-
IM
ment algorithms. A company can continue using this method for
production scheduling if it is able to fulfil the demands. However,
when capacity utilisation rises, relying solely on orders will create
capacity problems. Instead, depending on aggregate planning will
enable efficient capacity utilisation.
M
7. Since the aggregate plan provides a map for the next 3 to

18 months, the firm should run aggregate plans only every 3 to
18 months. (True / False).
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Activity
Visit a nearby manufacturing plant and find out what they do when
there are changes in demand forecasts.
2.6 SUMMARY
Aggregate planning is defined as a process that assists an organi-
sation in performing production smoothly and synchronising the
flow across its supply chain.
Aggregate planning aids planners in taking decisions with respect
to factors, like employment levels, output rates and appropriate
inventory levels.
In order to build an effective aggregate planning strategy, the ag-
gregate planner has to make trade-offs among the variables like
capacity, inventory and backlog costs.

n o t e s
The principal trade-offs faced by for an aggregate planner are the

following:
Inventory
Backlog/lost sales because of delay

Capacity (including sub-contracting)
The three main aggregate planning strategies adopted by organi-
sations include:
Chase strategy:
Capacity strategy or time flexibility from workforce
Level strategy
Given these constraints, the firm tries to maximise profits or mini-
mise costs by using linear programming. Linear programming is a
S
very effective method to find a solution that creates the maximum
profit while incorporating all the given constraints.
Linear programming is a very effective method that allows the firm
IM
to maximise profits or minimise costs, given certain constraints.
Problems in aggregate planning include smoothing costs, bottle-
neck problems, planning horizon and demand variations.
The implementation of aggregate planning involves the following
four elements:
M
Expand the resource-based view of the firm to include external

supply chain entities
Develop flexible aggregate plans
N
Re-run aggregate plans

Use aggregate planning as capacity utilisation increases
key words
Layoff:
An act through which employees are temporarily or
permanently discharged from their services.
Make-to-order approach: A strategy to make a product only
when a customer order is received.
Safety stock: The inventory held to satisfy the demand in ex-
cess of the forecasted demand.
Spreadsheet: An electronic document in which data is arranged
in rows and columns for calculations and manipulations.
Sub-contracting: A business practice through which functions
and activities are assigned to another party through a contract.

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2.7 DESCRIPTIVE QUESTIONS

1. Explain the concept of aggregate planning.
2. What are the different strategies of aggregate planning?
3. What are the problems related to aggregate planning?
2.8 ANSWERS AND HINTS
ANSWERS FOR SELF ASSESSMENT QUESTIONS
Topic Q. No. Answer

Meaning of Aggregate Planning 1. Aggregate Planning
2. True
Chase
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Aggregate Planning Strategies 3.
4. Inventory
Problems with Aggregate 5. Smoothing
Planning
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6. True
Implementing Aggregate 7. False
Planning in Practice

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1. Aggregate planning is the process of determining the ideal levels

of production, capacity, inventory, sub-contracting, stockouts
and pricing over a period of time. Refer to Section 2.2 Meaning
of Aggregate Planning.
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2. The strategies of aggregate planning include chase strategy,

capacity strategy and level strategy. Refer to Section 2.3 Aggregate
Planning Strategies.
3. The problems related to aggregate planning include smoothing,
bottleneck problems, planning horizon, etc. Refer to Section
2.4 Problems Related to Aggregate Planning.
SUGGESTED READINGS FOR

2.9
REFERENCE
SUGGESTED READINGS
BolstorffP., Rosenbaum R. (2007). Supply chain excellence. New
York: AMACOM.
Dolgui A., Proth J. (2010). Supply chain engineering. London:
Springer.

n o t e s
Folinas D. (2013). Outsourcing management for supply chain oper-

ations and logistics services. Hershey, PA: Business Science Ref-
erence.
Wang W., Heng M., Chau P. (2007). Supply chain management. Her-
shey, PA: Idea Group Pub., (an imprint of Idea Group).
E-REFERENCES
Managementstudyguide.com,. (2015). What is Aggregate Planning?
— Importance and its Strategies. Retrieved 5 December, 2015, from
http://www.managementstudyguide.com/aggregate-planning.htm.
Small Business - Chron.com. (2015). Aggregate Planning in Sup-
ply Chain Management. Retrieved 5 December, 2015, from http://
smallbusiness.chron.com/aggregate-planning-supply-chain-man-
agement-73641.html.
S
Small Business - Chron.com. (2015). The Advantages of Aggregate
Planning. Retrieved 5 December 2015, from http://smallbusiness.
chron.com/advantages-aggregate-planning-16096.html.
IM
Uoguelph.ca. (2015). Aggregate Planning. Retrieved 5 December,
2015, from http://www.uoguelph.ca/~dsparlin/aggregat.htm.
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N

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C h a
3 p t e r
SOURCING IN SUPPLY CHAIN MANAGEMENT
CONTENTS
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3.1 Introduction
3.2 Meaning of Sourcing
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3.2.1 Role of Sourcing in Supply Chain
Activity
3.3 Sourcing Strategies
3.3.1 Identifying Core Processes
3.3.2 Sourcing Planning and Analysis
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3.3.3 In-house Sourcing and Outsourcing: Make vs. Buy

Activity
3.4 Supplier Selection and Procurement Process
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3.4.1 Supplier Scoring and Assessment

3.4.2 Third- and Fourth-party Logistics Providers
Activity
3.5 Impact of IT on Sourcing Strategy
Activity
3.6 Risk Management in Sourcing
Activity
3.7 Summary

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COST-CUTTING AT MARUTI UDYOG LIMITED (MUL)

THROUGH SUPPLIER SCORING
Introduction
Maruti Udyog Limited (MUL), currently popular with the name

Maruti Suzuki India Limited, is an Indian automobile manufac-
turer. It is a subsidiary of a Japanese automobile and motorcycle
manufacturer, Suzuki Motor Company. The organisation manu-
factures and sells a range of cars. Some of its models include Alto,
Ritz, Celerio, A-Star, Swift, Wagon R, Zen, Swift Dzire, etc. It’s
headquartered in New Delhi.
Cost-cutting Approach
In 2000, Maruti Suzuki India Limited adopted a cost-cutting exer-
S
cise to offset the price cuts of automobiles laid down by the Indi-
an government. On June 24, 2000, the prices of its models Maruti
800, Omni, and Wagor RLX were approximately cut down in the
IM
range of ` 12,000 to ` 25,000. With a cut down on cars’ prices, the
organisation’s profit figures decreased substantially. Maruti Su-
zuki decided to retain its profit through reduction in the organi-
sation’s overall cost. A large share of the organisation’s resources
were utilised by its supply chain function. Therefore, Maruti de-
cided to bring down the supply chain and logistics expenditure.
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Maruti’s cost-cutting exercise was expected to derive the largest

share of savings through the suppliers of Maruti Suzuki. In order
to achieve this target, the organisation focussed on a supplier de-
velopment exercise. This included the following initiatives:
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Sourcing of suppliers
Developing a supplier selection strategy
Training of selected suppliers
Creating short- and long-term supplier strategies
Evaluating the performance of suppliers
Renegotiating with suppliers for cost benefits
Maruti sent 11 of its top suppliers to Japan for attending a work-

shop on cost reduction conducted by Suzuki Motor Company. The
workshop discussed strategies on the use of local technologies by
suppliers to cut expenditures on import of automobile parts and
components which could bring down overall supply chain costs
by four to five per cent. Maruti also brought down its supplier
base from 350 suppliers to 200 suppliers, which helped suppliers
to gain from economies of scale as a single supplier was now re-
sponsible for supplying larger volumes. A strategic sourcing en-
vironment was also developed at Maruti that connected the or-

SOURCING IN SUPPLY CHAIN MANAGEMENT 53
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ganisation to a powerful supplier network with superior tools,

expertise and information.
Consequences
By the end of the year, Maruti was able to lower down its costs to
the tune of approximately ` 60 crores. Sourcing strategies used by
Maruti helped it in gaining the following advantages:
Lead time reduced by 25–30 per cent
Delivery time improved by 20 per cent
Inventory costs lowered by 25–50 per cent
Increased responsiveness to customer needs and market dy-
namics
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learning objectives

>> Explain the meaning of sourcing
>> Describe sourcing strategies
>> Discuss supplier selection and procurement process
>> Explain the impact of IT on sourcing strategy
>> Discuss risk management in sourcing
3.1 Introduction
In the previous chapter, you have studied the meaning of aggregate
planning, its strategies, problems and implementation in practice.
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This chapter will focus on sourcing in supply chain management.
Sourcing is a value addition process of selecting suppliers for the sup-

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ply chain network of an organisation. The process of sourcing is sup-
ported by market intelligence, advanced analytics, a well-developed
strategy and information on suppliers’ performance. Organisations
use and adopt sourcing to meet various aims, such as concentrating
on core competencies, achieving cost reduction, minimising supply
chain risks and stabilising the supply process.
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In a supply chain, sourcing is one of the important processes. The rea-

son is that a wrong selection of suppliers can result into sub-optimal
use of organisational resources and unnecessary costs. Therefore, ef-
fective sourcing needs tasks, like reconfiguring supply specifications,
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streamlining supplier base and developing strategic partnerships with

selected suppliers.
Additionally, active management of the performance of suppliers is a

critical part of strategic sourcing. Before an organisation selects a sup-
plier, it must have extensive data on the performance of suppliers and
its impact on its operations. Analysis of this data helps organisations
to decide on its sourcing strategy.
This chapter covers sourcing, sourcing strategies, supplier selection

and procurement process. It also focusses on the impact of IT on
sourcing strategy. Towards the end, the chapter discusses about risk
management in sourcing.
3.2 Meaning of Sourcing

In today’s competitive business environment, organisations are seek-
ing for ways to reduce their procurement and purchase costs. One
of such ways is sourcing. It is a practice of identifying, selecting and

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evaluating suppliers who supply goods and services to an organisa-

tion with an aim to achieve long-term association between the organ-
isation and the supplier. It includes managing the supply market to
ensure access to adequate resources, defining a supply strategy and
identifying potential suppliers for the organisation. The main objec-
tives of sourcing are to minimise supply risks, achieve cost effective-
ness, maintain supply stability of a supply chain in the long run, and
so on. An organisation’s sourcing decisions include critical analysis of
all supply chain activities such as manufacturing, procurement, out-
bound logistics, inbound logistics, sales, operations and aftersales ser-
vices. After this, the organisation evaluates whether these activities
should be outsourced to an external party or performed internally.
Previously, organisations used to perform all the activities of its supply

chain internally. Nowadays, organisations tend to outsource their sup-
ply chain activities to reduce and control operating costs, gain access
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to world-class capabilities, share risks with a partnering firm, etc. For
instance, an automobile manufacturer would not outsource the pro-
cess of manufacturing engines for its automobiles as engines are the
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core component of an automobile and a minor manufacturing defect
in an engine can be disastrous. On the other hand, activities, such as
purchasing tyres and assembling smaller components, could be out-
sourced to an external supplier.
3.2.1 Role of Sourcing in Supply Chain

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Effective sourcing in the supply chain can increase profits for an or-
ganisation and total supply chain surplus in various ways. Some of the
key roles that sourcing plays in supply chain are as follows:
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Iforders within a firm are aggregated, sourcing helps the organi-

sation to achieve better economies of scale.
Sourcing helps in more efficient procurement transactions that
can significantly reduce the overall cost of purchasing, especially
where a large number of low-value transactions take place.
For products that are easier to make and distribute, design col-
laboration with third-parties can significantly reduce the overall
costs. This factor is significant for supplier products that contrib-
ute a major amount to product cost and value.
Sourcing helps in efficient procurement processes that can result
in better coordination with the supplier and improve forecasting
and planning. This, in turn, results in reduced inventories and im-
proves the balance of supply and demand.
Using auctions is useful in increasing competition among the sup-
pliers and can achieve lower purchase price for the buyer.

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1. __________ is a practice of identifying, selecting, and evaluating

suppliers who supply goods and services to an organisation
with an aim to achieve long-term association.
2. Sourcing helps in efficient procurement processes that can
result in better coordination with the supplier and improve
forecasting and planning. (True/False)
Activity
Find out the role of sourcing in the supply chain of a British manu-
facturing firm. Prepare a report on your findings.
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3.3 Sourcing Strategies
A successful sourcing strategy needs a comprehensive understanding
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of an organisation’s business strategy, the resources needed to deliver
that strategy, the market forces and the unique risks within the com-
pany related to manufacturing and launching a new product. A reg-
ular review of the sourcing strategy enables to achieve the intended
results and continued alignment with business objectives. Some of the
sourcing strategies that are used in supply chain management today
are shown in Figure 3.1:
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Sourcing
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Strategies
Single Insourcing
Mean Multisourcing
Median Outsourcing
Mode
Sourcing
Figure 3.1: Sourcing Strategies
Let us now study these sourcing strategies in detail.

Single sourcing: It is a strategy whereby a purchased part is sup-
plied by only one supplier. A Just-In-Time (JIT) manufacturer will
often have only one supplier for a purchased part so that close
relationships can be established with fewer suppliers. Such close
relationships (and mutual interdependence) promote high quality,
reliability, short lead times and cooperative action.
Multisourcing: It is a strategy which involves procurement of a
good or service from more than one independent supplier. Organi-

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sations use it to maintain healthy competition between the suppli-

ers in order to attain higher quality and lower price.
Outsourcing: Organisations have suppliers who provide goods
and services that were previously provided internally. Outsourcing
involves substitution, that is, the replacement of internal capacity
and production by that of the supplier.
Insourcing: This strategy involves organisations producing their
goods internally.
3.3.1 Identifying Core Processes
In today’s competitive business environment, organisations are look-

ing for creative ways to improve the quality of the final product, reduce
supply chain costs, improve customer service and achieve a faster de-
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livery time. Organisations can achieve these objectives successfully
with the use of effective sourcing. Sourcing helps supply chain man-
agers to find out the best quality materials and that too at the lowest
possible price from the most dependable suppliers. The following are
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core sourcing processes that help supply chain managers to make the
best possible procurement decision for an organisation:
Supplier selection
Procurement
Contract negotiation
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Design collaboration
Sourcing planning and analysis
We will study some of these core sourcing processes in detail in the

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subsequent sections.
3.3.2 Sourcing Planning and Analysis
It is the most essential part of the purchasing and supply management

process. It is a logical process that involves the application of ana-
lytical tools by competent, skilled and knowledgeable personnel. It is
needed for analysing supply markets and selecting suppliers with the
aim of delivering supply chain solutions and the best practices, which
results in meeting the pre-determined business requirements.
3.3.3 In-house Sourcing and Outsourcing: Make vs.

Buy
Each organisation needs to decide whether it should perform a busi-

ness activity in-house or outsource it to an outside vendor. In-house
sourcing is an activity of conducting a business operation or activity
within an organisation and not relying on external sources. An organ-
isation adopts this for activities that are core to its operations and for

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which it has the required competencies and expertise. For instance,

IT organisations employ their in-house engineers for writing technical
manuals for the equipment designed by them and do not outsource
the task to a technical writing organisation. An organisation utilises
its own time and employees to keep a business activity or business
in-house. Figure 3.2 shows various reasons why organisations adopt
in-house sourcing:
Proprietary Technology
Lack of Competent Suppliers
Better Quality Control
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Idle Capacity
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Minimised Lead Time, Transportation
and Warehousing Costs
Figure 3.2: Reasons for In-house Sourcing
Let us now discuss these reasons in detail.

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Proprietary technology: One of the key reasons for why organi-

sations adopt in-house sourcing is to safeguard their proprietary
technology. Organisations develop various procedures and tech-
nologies that are needed to be preserved to achieve a competitive
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advantage. They normally do not wish to disclose a certain tech-

nology to their suppliers even if the technology is patented.
Lack of competent suppliers: In-house sourcing is also adopted
when suppliers in the market do not fulfill the required selection
criteria. Later, they may develop supplier development strategies
for outsourcing tasks to existing or new suppliers.
Better quality control: Through in-house sourcing, an organisa-
tion can have a direct control over the manufacturing process. Ad-
ditionally, there is a better control over various factors, such as
quality, cost, design and labour. When an organisation is capable
and efficient to manufacture good quality products as compared to
its suppliers, it tends to opt for in-house sourcing.
Idle capacity: In some cases, organisations have extra idle capacity
that can be used for manufacturing products in-house for a short
duration. Specifically, this strategy is useful for organisations that
are into the manufacturing of seasonal products, such as umbrella
and woollen clothes. It helps in meeting a sudden rise in demand
and preventing layoffs of skilled labour.

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Minimised lead time, transportation and warehousing costs:

This in-house sourcing option permits organisations to have a
better control over lead time and logistics costs as they overlook
all phases of design, manufacturing and delivery processes. Some
organisations tend to buy raw materials from suppliers and manu-
facture the finished products on their own near consumption cen-
tres to minimise warehousing costs.
On the other hand, some organisations prefer to subcontract their pro-

cesses to other organisations and suppliers. Outsourcing is a process
of contracting some non-core or non-essential processes of an organ-
isation to an external party that has proven expertise in the field. The
main reason of organising outsourcing processes is to achieve signifi-
cant cost reduction. It permits an organisation to concentrate on their
core competencies by providing the responsibility of peripheral (not
necessary of processes) to external organisations. For instance, an IT
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organisation would focus on developing a new software and technol-
ogy while it outsources its peripheral activities like maintaining em-
ployee database, data entry and customer service. Figure 3.3 shows
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the reasons for outsourcing business processes:
Cost Advantage
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Insufficient Capacity
Lack of Expertise
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Quality
Figure 3.3: Reasons for Outsourcing
Let us now study these reasons in detail.

Cost advantage: Many supplies are unimportant to organisation-
al operations. For instance, generalised or standardised supplies
for which suppliers have the advantage of economies of scale can
be bought from external parties conveniently. In addition, mostly,
the quantities of supplies needed are quite small and the capital
investment put into manufacturing them cannot be justified inter-
nally. In such scenarios, the organisation finds it best to buy such
supplies from external vendors. Besides this, some organisations
outsource their activities because of low material and/or labour
costs.
Insufficientcapacity: In some instances, organisations do not
have enough capacity to manufacture some components internal-

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ly. This happens if the demand for products rises abruptly when
there is no anticipation or when the strategies of expansion fail
to fulfill the increasing demand. In such instances, organisations
prefer to buy components or parts from suppliers and concentrate
on their important operations. This process in which a part of the
task is assigned under a contract to an external party is called sub-
contracting.
Lack of expertise: At times, organisations lack the required ex-
pertise and technology to manufacture components or parts in-
ternally. In such instances, organisations tend to outsource the
related activities to a supplier and concentrate on their core activi-
ties. Sometimes, suppliers have a patented manufacturing process
which makes it necessary for an organisation to buy the required
parts or components from suppliers.
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Quality: Generally, suppliers have access to better expertise and
technologies to manufacture a product. They have improved pro-
cedures, skilled labour and a benefit of economies of scale. This
results in better quality of products, which is essential for organi-
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sations to achieve a competitive advantage.
The decisions related to sourcing are generally called make or buy

decisions. In other words, make or buy decisions involve making a
strategic choice between buying a product from an outside supplier
(outsourcing) or manufacturing it internally (in-house).
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Sourcing includes complex decision-making because it has a direct

impact on the competitive advantage and performance of an organ-
isation. Organisations adopt a standard method to reach a sourcing
decision. The make or buy decisions of an organisation are divided
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into four stages, which are shown in Figure 3.4:
Team creation and appointment of the

team leader
Preparation
Identifying the product requirements and analysis
Team briefing and aspect/area destitution
Collecting information on various aspects

of make-or-buy decision
Data Collection
Workshops on weightings, ratings, and cost for
both make-or-buy
Analysis of data gathered Data Analysis
Feedback on the decision made Feedback
Figure 3.4: Stages of a Sourcing Decision

(Source: http://www.tutorialspoint.com/management_concepts)

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These stages are discussed in detail.

1. Preparation: This stage includes developing a team to collect
information on customers’ requirements in a specific area of
supply. The team is led by a team leader who assigns particular
areas to be analysed to the team members.
2. Data collection: In this stage, the team collects the needed data
using historical records and makes a comparison of figures with
various characteristics of the make-or-buy decision. The team
can also collect information from workshops on supplier ratings.
3. Data analysis: After the data is collected, the team analyses
this data to make the ultimate sourcing decision. The team
also analyses various aspects, such as reliability of suppliers,
quality of products and impact of the decision on customers and
suppliers. For instance, labour and material costs are analysed
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by comparing the estimates of outsourcing against in-house
production. On the basis of this analysis, the team decides to
either make or buy a particular product.
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4. Feedback: At the end, the team gets a feedback on the decision
from various departments of the organisation. This feedback is
consolidated to get a consensus on the basis of which the ultimate
sourcing decision is made.

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3. Which of the following is a strategy whereby a purchased part

is supplied by only one supplier?
a. Insourcing
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b. Outsourcing
c. Multisourcing
d. Single sourcing
4. Outsourcing is an activity of conducting a business operation
or activity within an organisation and not relying on external
sources. (True/False)
5. __________ decisions involve making a strategic choice between
buying a product from an outside supplier (outsourcing) or
manufacturing it internally (in-house).
Activity
Visit a nearby manufacturing firm and identify whether it is out-

sourcing the supply chain functions or managing them in-house. In
case they are outsourcing, find out the factors responsible for the
increase of their supply chain surplus.

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Supplier Selection and

3.4
Procurement Process
Supplier selection is a process through which an organisation identi-
fies, evaluates and maintains contracts with suppliers. The selection
of capable suppliers has a direct impact on the competitive advantage
of an organisation. Therefore, an organisation should consider vari-
ous aspects before the selection of suppliers. Some of these aspects
are as follows:
Willingness to share technologies and knowledge
Delivery time
Value for money
Quality of products
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Location
Service
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Communication capability
Procurement process is aimed at improving and assessing the pur-

chasing activities of an organisation continuously. It includes various
activities, some of them are given as follows:
Assessing the supply market
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Assessing the current purchase expenses of an organisation

Creating a procurement sourcing strategy that includes demand
and supply situations, costs and supplier details
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Identifying suitable suppliers

Tracking results and re-evaluating them for improvement
Negotiating with suppliers
Implementing the new procurement system
3.4.1 SUPPLIER SCORING AND ASSESSMENT
Suppliers are an integral part of the supply chain. Poor performance

can affect a business and choosing the wrong supplier at the sourc-
ing stage can lead to issues later on. Effective supplier scoring and
assessment offers companies in-depth assessment of performance set
against the defined objective and established criteria.
Supplier scoring refers to metrics being used to measure the perfor-

mance of suppliers of an organisation. This is done against a set of
targets, which includes how suppliers perform with regard to delivery,
lead time, quality of products supplied, price, service levels, etc. This
type of scoring is useful as it helps organisations to assess all kinds of

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suppliers against a specific standard set of criteria. Supplier scoring

is carried out in an independent and objective manner to determine
whether suppliers are meeting the organisational requirements in an
acceptable manner.
Some supplier scoring systems use ‘weighting’ based on the impor-

tance of specific criteria. For example, if price is viewed as an extreme-
ly essential element, then it will be given a higher weighting than some
other less important element; for example, invoicing procedures, etc.
All the points that will be used to score a supplier will have the same
variances, especially complex quality and service issues. This makes
the complete scoring system quote an in-depth analysis of the manner
in which the supplier is performing.
It is also not just scoring suppliers but ranking them as well. Ranking
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enables customers to know the best performing supplier, the average
performing ones and the worst contenders.
Although organisations keep the ranking process confidential, some-

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times the ranking report may be published so that average and worst
performing suppliers know their score and work towards improving
their performance. Ranking also helps organisations to analyse the
potential of not only their current suppliers but also take decisions on
selecting their future suppliers as well.
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Apart from scoring and ranking, organisations may assess the perfor-
mance of suppliers by grouping them into three or four categories,
such as A, B and C. The category ‘A’ may refer to those suppliers who
need to maintain their excellent performance, ‘B’ may refer to those
who need to develop their current performance and ‘C’ may refer to
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underperformers.
3.4.2 Third- and Fourth-party Logistics Providers
Organisations around the world are increasingly opting for outsourc-

ing their logistics functions, if it is not their core business. They out-
source for a variety of reasons, some of which include:
Cost reduction
Improve operational capabilities
Gain competitive advantage
Transform their business
Overcome internal lack of competence
Increase market reach
Reduce inventory holdings
Increase sales
Reduce capital investment

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Turn fixed costs into variable ones

Improve cash flow
Increase focus on core business
Third-party logistics, also known as 3PL, refers to the outsourcing of

logistics in which a logistic service provider single-handedly manages
the entire logistical function of a retail enterprise. The trend of 3PL
started in Europe and America. Presently, 3PL is a very popular mod-
el of logistic outsourcing all over the world. Initially, 3PL service pro-
viders only provided transportation and warehousing services. How-
ever, presently 3PL service providers provide a range of value-added
services, such as packaging and supply chain planning. 3PL started in
India in the mid-1990s. In the beginning, the 3PL industry in India was
dominated by global logistics majors for providing logistics services to
automobile, electronics and FMCG companies in the country. After
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2000, the 3PL industry in India experienced a major growth. There
were more than 400 3PL service providers in India in 2005. There are
mainly three types of companies providing 3PL services in India: na-
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tional 3PL companies with nationwide presence, regional 3PL compa-
nies and small remote 3PL companies.
Third-party logistics provide innovative logistics solutions to retail

enterprises. 3PL service providers execute all the shipping require-
ments of retail enterprises. Some of the advantages of 3PL service
providers are as follows:
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3PL service providers possess better competence and modern

technology, which increases the operational efficiency of a retail
enterprise. 3PL service providers are specialised logistics compa-
nies. Therefore, they have the required infrastructure to meet the
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requirements of the clients. In addition, as logistics service pro-

viders provide services to a number of retail enterprises, at the
same time, they can invest more funds in acquiring technology
and building capacity.
3PL service providers have more expertise and enjoy economy
of scale in logistics, which, in turn, helps retail enterprises in re-
ducing costs. Economy of scale refers to reduction in cost due to
providing service on a larger scale. As mentioned earlier, a 3PL
service provider may provide logistics services simultaneously to
a number of retail enterprises and they are competent to handle
many clients at a time. Therefore, they can provide services at
lower cost to retail enterprises. In addition, 3PL service providers
tend to possess a lot of expertise as logistics is their core business.
Retail enterprises, on the other hand, possess less expertise in lo-
gistics, as it is not their core area of business.
3PL service providers have access to various facilities, such as
heavy transport facility and warehousing in order to meet the lo-
gistical needs of a retail enterprise.

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3PL services reduce the risks and liability of retail enterprises.

Because of their specialisation, 3PL service providers involve less
risk in their operations. In addition, legally enforced agreements
with the 3PL service providers reduce the liabilities of retail enter-
prises to a large extent.
3PL service providers provide a number of value-added services,
such as packaging. Therefore, retail enterprises do not need to
handle these activities, which, in turn, reduce costs and allow re-
tail enterprises to focus on their core business.
The 3PL market in India has high potential to grow in the future. Var-
ious government initiatives are supporting the growth of the industry.
However, there are a number of challenges that need to be addressed.
3PL service providers need to focus on providing quality services at
affordable prices and delivering consistency in their services.
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Fourth-party logistics, also known as 4PL, is a new trend in the lo-
gistics industry. The term ‘4PL’ was coined by Anderson Consulting
Company. According to this company, 4PL assembles and manages the
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resources, capabilities and technology of its own organisation with those
of the complementary service providers to deliver a comprehensive sup-
ply chain solution. In other words, 4PL service providers refer to the
enterprises that organise and manage all resources, capabilities and
technological requirements of logistics in a retail enterprise.
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There is a very minor difference between third-party and fourth-par-

ty logistics. Many experts think that 4PL is nothing but a new form
of 3PL. The concept of 4PL emerged with the advent of information
technology in supply chain and logistics. 4PL integrates the different
logistical functions of an enterprise with the help of IT tools. 4PL ser-
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vice providers provide additional services to retail enterprises along

with the services provided by the 3PL service providers. These addi-
tional services provided by the 4PL service providers include invoice
management, call centres, warehouses and distribution facilities, IT
integration and back-office services. In case a retail enterprise out-
sources logistics operations to a number of 3PL service providers for
different geographical locations, the 4PL service providers help in in-
tegrating those different 3PL service providers through IT tools. 4PL
forms the collaborative relationship among various logistic service
providers of a retail enterprise through IT. Some advantages of 4PL are
as follows:
Covering the entire supply chain of a retail enterprise
Collaborating between different logistics service providers of a re-
tail enterprise
Aligning logistics service providers with the help of IT-based tools
Providing flexibility and efficiency

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6. __________ is a process through which an organisation

identifies, evaluates and maintains contracts with suppliers.
7. Third-party logistics, also known as 3PL, refers to the
outsourcing of logistics in which a logistic service provider
single-handedly manages the entire logistical function of a
retail enterprise. (True/False)
Activity
Visit a manufacturing firm and find out whether they are using the
services of 3PLs or 4PLs. Make a note of your findings.
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3.5 Impact of IT on Sourcing Strategy
Current organisations use IT tools for their sourcing strategy to max-
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imise its benefits. The following are some key-sourcing softwares
which the organisations use to quicken their sourcing process, and
obtain efficient and effective results:
Design collaboration: This software enhances the design of prod-
ucts via collaboration between manufacturers and suppliers. This
is done by aiding the combined selection of components that have
M
either ease of manufacturability or commonality across several

end-products. This software also provides a functionality of shar-
ing option of engineering change orders between a manufactur-
er and its suppliers, thereby preventing costly delays that usual-
ly take place when many suppliers are simultaneously designing
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components for the manufacturer’s product.

Sourcing: This software helps supplier selection, contract man-
agement and vendor rating. The major objective is to analyse the
expenses on each supplier by a firm, revealing valuable trends or
areas for improvement. Suppliers are evaluated on various crite-
ria, like reliability, quality of supplies, timely execution of orders
and price. Vendor rating helps improve supplier performance and
assists in supplier selection. Contract management is another area
in which sourcing software plays an important role as it helps to
track various complex details (like volume-related price reduc-
tions) of supplier contracts.
Negotiation: The negotiation process involves an initial Request
For Quotation (RFQ), followed by design and execution of auctions
(and reverse auctions). The objective of this process is to negotiate
an effective contract that mentions price and delivery conditions
for a supplier in a way that fits the needs of the organisation. The
RFQ process and execution of auctions are automated by this soft-
ware.

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Buying: This software helps to generate the actual procurement of

material from suppliers as detailed in the contract. The creation,
management and approval of purchase are integral features of this
software. The entire procurement process is automated by this
software, resulting in significant savings in time and cost.
Supply collaboration: Once the relationship between the man-
ufacturer and supplier is established, supply chain performance
can be significantly improved by collaborating on inventory levels,
production plans and demand forecasts. This software aids these
collaborations.
The most crucial hurdle to the success of implementing new sourcing

software is that most often employees tend to oppose its implementa-
tion. Further, when successful use of IT system requires collaboration
among various organisations, not all firms support this initiative due
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to trust issues and competition.

IM
8. Which of the following softwares enhances the design of
products via collaboration between manufacturers and
suppliers?
a. Design collaboration
b. Buying
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c. Negotiation
d. Sourcing
9. The most crucial hurdle to the success of implementing new
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sourcing software is that most often employees tend not to

oppose its implementation. (True/False)
Activity
Visit a nearby business enterprise and find out how it uses IT in its
sourcing activity. Make a list of your findings.
3.6 Risk Management in Sourcing

An organisation may face several risks in its sourcing function. Sourc-
ing risk may occur due to the following:
inability to meet timely customer demands
increase in procurement costs
loss of intellectual property
Therefore, organisations must have adequate risk management strat-

egies in place, enabling it to mitigate a significant part of the risk.

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If there is a delay or disruption from the source of supply, it will result

in an inability to meet customer demand on time by the organisation.
This risk can be high, especially when there is a single source of sup-
ply or very few sources of supply. Delays from a source of supply can
be mitigated either by carrying inventory or by developing a more
responsive backup source of supply. For low-value products and prod-
ucts that do not become obsolete quickly, the best way to mitigate the
risk of delay is to carry inventory. However, for high-value products or
for products with shorter life-cycles, the best way is to develop a more
responsive backup source of supply.
The risk of higher procurement cost can be significant when:

The industry-wide demand of a product is more than the available
supply.
Exchange rates are unfavourable.
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There is a single source of supply.
The risk of higher procurement cost can be mitigated by a mix of long-

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and short-term contracts. Hedging is one of the most effective ways of
mitigating the risks arising out of unfavourable exchange rates. An-
other way of mitigating this risk is developing a global supply network
that is flexible for fine-tuning based on exchange rate fluctuation. The
risk arising out of a single source of supply can be mitigated by devel-
oping alternate sources of supply or by developing in-house capability
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to produce such products.
Risks related to intellectual property can be mitigated by keeping pro-

duction of key components in-house. When production is outsourced,
organisations can maintain ownership of part of the equipment if it is
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considered to be having significant property value. Due to this reason,

Motorola owns some testing equipment at the manufacturing facilities
of its outsourced partners.
10. The risk of higher procurement cost can be mitigated by a mix

of __________ contracts.
11. The risk arising out of a single source of supply can be mitigated
by developing alternate sources of supply or by developing in-
house capability to produce such products. (True/False)
Activity
Select an Indian manufacturing firm of your choice and find out the
risk management strategies it has in place to deal with the sourcing
risks. Prepare a report on your findings.

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3.7 Summary
Sourcing helps in efficient procurement processes that can result
and planning.
Single sourcing, multisourcing, outsourcing and insourcing are
the various sourcing strategies used in supply chain management
today.
In-house sourcing is an activity of conducting a business opera-
tion or activity within an organisation and not relying on external
sources.
Supplier selection is a process through which an organisation
identifies, evaluates and maintains contracts with suppliers.
S
Procurement process is aimed at improving and assessing the pur-
chasing activities of an organisation continuously.
Currentorganisations use IT tools on their sourcing strategy to
IM
maximise its benefits.
Hedging is one of the most effective ways of mitigating the risks
arising out of unfavourable exchange rates.
key words
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Purchasing: It is the transactional function of buying products

and services that includes floating enquiries/quotations, pre-
paring comparative statement/bid sheet, deciding the supplier
and preparation, placement and processing of a purchase order.
Procurement: It is the process of managing a wide range of pro-
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cesses that are related to an organisation’s acquisition of goods

and services.
Sourcing: It focusses on the supply chain impacts of procure-
ment and purchasing decisions and works cross-functionally to
attain optimum supply chain surplus/profitability.
Strategicsourcing: It is a procurement process that helps to
improve and re-evaluate the purchasing activities of an organ-
isation.
Supply chain surplus/profitability: It is the difference between
the value of a product for the customer and the total cost of all
supply chain activities involved in making the product available
to the customer.

1. Explain the role of sourcing in supply chain.
2. What are the various sourcing strategies used in supply chain
management today?

n o t e s
3. Describe supplier selection and procurement process.

4. Discuss the impact of IT on sourcing strategy.
5. Explain risk management in sourcing.
Topic Q. No. Answer

Meaning of Sourcing 1. Sourcing
2. True
Sourcing Strategies 3. d. Single sourcing
4. False
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5. Make or buy
Supplier Selection and 6. Supplier selection
Procurement Process
IM
7. True
Impact of IT on Sourcing Strategy 8. a. Design collaboration
9. True
Risk Management in Sourcing 10. Long- and short-term
11. True
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1. Sourcing helps in efficient procurement processes that can result
N
and planning. Refer to Section 3.2 Meaning of Sourcing.

2. Single sourcing, multisourcing, outsourcing and insourcing are
the various sourcing strategies used in supply chain management
today. Refer to Section 3.3 Sourcing Strategies.
3. Supplier selection is a process through which an organisation
identifies, evaluates, and maintains contracts with suppliers.
Procurement process is aimed at improving and assessing the
purchasing activities of an organisation continuously. Refer to
Section 3.4 Supplier Selection and Procurement Process.
4. Current organisations use IT tools on their sourcing strategy
to maximise its benefits. Refer to Section 3.5 Impact of IT on
Sourcing Strategy.
5. Hedging is one of the most effective ways of mitigating the risks
arising out of unfavourable exchange rates. Refer to Section
3.6 Risk Management in Sourcing.

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Suggested Readings for

3.10
Reference
SUGGESTED READINGS
Ayers,J. (2001). Handbook of supply chain management. (1st ed.).
Boca Raton: St. Lucie Press.
Chopra, S., and Meindl, P. (2014). Supply chain management.
(1st ed.). Hallbergmoos: Pearson.
Fredendall, L., and Hill, E. (2001). Basics of supply chain manage-
ment. (1st ed.). Boca Raton: St. Lucie Press.
Wisner,
J., Leong, G., and Tan, K. (2005). Principles of supply chain
management. (1st ed.). Mason, Ohio: Thomson/South-Western.
S
E-REFERENCES
Raack, D., and Rizza, M. (2015). Risk management archives – Stra-
IM
tegic sourcing. Retrieved 8 December 2015, from http://strategic-
sourcing.com/tag/risk-management/
Scm.ncsu.edu. (2015). Sourcing strategy – SCM | Supply Chain Re-
source Cooperative (SCRC) | North Carolina State University. Re-
trieved 8 December 2015, from https://scm.ncsu.edu/scm-articles/
article/sourcing-strategy
M
Supplychain-mechanic.com. (2015). Supplier scoring – The im-

portance of ranking your suppliers: supplychain-mechanic.com.
Retrieved 8 December 2015, from http://supplychain-mechanic.
com/?p=104
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C h a
4 p t e r
INVENTORY MANAGEMENT IN SUPPLY CHAIN
CONTENTS
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4.1 Introduction
4.2 Concept and Types of Inventory
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4.2.1 Cycle Inventory
4.2.2 Safety Stock
4.2.3 Decoupling Stocks
4.2.4 Anticipation Inventory
4.2.5 Pipeline Inventory
4.2.6 Dead Stock
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4.2.7 Seasonal Stock

Activity
4.3 Inventory Models
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4.3.1 Economic Order Quantity (EOQ) Model

4.3.2 Replenishment Model
Activity
4.4 Inventory-Related Costs
4.4.1 Ordering Costs
4.4.2 Inventory-Carrying Costs
4.4.3 Stock-out Costs
Activity
4.5 Optimal Level of Product Availability
Activity
4.6 Uncertainty in a Supply Chain
Activity

CONTENTS
4.7 Inventory for Short Life Cycle Products

Activity
4.8 Impact of Supply Chain Redesign on Inventory
Activity
4.9 Multiple-Item, Multiple-Location Inventory Management
Activity
4.10 Summary
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INVENTORY MANAGEMENT IN SUPPLY CHAIN 75
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SUPPLY CHAIN AND INVENTORY MANAGEMENT

AT WHIRLPOOL
(Source: www.logosdb.tk)
Whirlpool is one of the leading American multinational organi-

sations engaged in the manufacturing of home appliances. It is
a Fortune 500 organisation that generates annual revenue of ap-
proximately $19 billion. The organisation has around 70 manufac-
turing and technology research centres around the world. How-
S
ever, in 2000, a dip in the normally high standards was noticed in
the delivery performance of Whirlpool. The main reason behind
the unsatisfactory delivery was the failure of the existing supply
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chain to meet expectations. There were many inconsistencies in
the inventory levels and quality that embittered retail partners
and customers alike. The top management of Whirlpool felt the
need to fix ongoing supply chain issues.
The main reason behind the supply chain problems was the inte-
gration of different systems and procedures of the company at its
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geographically dispersed locations due to business expansion. All

these issues brought down the organisation’s overall availability
rate (a measure to know how often a product is in the right place
at the right time) to 83%. In comparison to industry standards,
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this proved to be a dismal failure for Whirlpool.
In order to solve these problems, SCM and IT teams of Whirlpool

initiated the task of replacing their myriad production scheduling
and distribution systems with a streamlined, standardised solu-
tion. In the new system, there was a central platform for all supply
chain functions, such as master scheduling, inventory planning
and deployment planning. Moreover, the system also provided
collaborative tools for forecasting and replenishment. As a result,
the organisation was able to achieve greater efficiencies and cost
savings across the board. Within a short span of the implemen-
tation of the new system, Whirlpool was able to bring down fore-
casting errors by 50% and reduce inventory levels by more than
20%. Moreover, its overall availability rate rose from 83% to 93%,
and reached 97% within five years of implementation. All these
accomplishments demonstrate that an efficient supply chain
management along with skilled personnel can have a deep impact
on an organisation’s system-wide performance and profitability.

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learning objectives

>> Explain the concept and types of inventory
>> Discuss the important inventory models
>> Define various inventory-related costs
>> Explain the importance of maintaining an optimal level of
product availability
>> Discuss uncertainty in a supply chain
>> Explain the management of inventory for short life-cycle
products
>> Describe the impact of supply chain redesign on inventory
>> Discuss multiple-item, multiple-location inventory manage-
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ment
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4.1 INTRODUCTION
In the previous chapter, you have studied the significance of sourcing
in supply chain management. This chapter will provide an overview of
inventory management, which is used to manage the goods/materials
an organisation stores/holds for further use/processing/shipment to
warehouses/retailers/end-customers.
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The terms ‘inventory’ and ‘stock’ are often used interchangeably.

Inventory is also used to describe a list of items compiled for some
purpose, such as furnishings and fixtures of a house. Thus, inventory
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management deals with the quantification and specification of stored

products.
The scope of inventory management includes the following:

Replenishment lead time
Carrying costs of inventory
Asset management
Inventory forecasting
Inventory valuation
Inventory visibility
Future inventory price forecasting
Physical inventory
Available physical space for inventory
Quality management
Replenishment

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Returns and defective goods

Demand forecasting
Balancing these challenging requirements leads to optimum inventory

levels and increased supply chain efficiency. Inventory management
includes the efforts made by an organisation to acquire and maintain
an appropriate inventory level, while, at the same time, restrain costs
associated with ordering, distributing and handling of goods or prod-
ucts. It also includes procedures that identify inventory requirements,
set targets, offer replenishment systems, report actual and estimated
inventory status and control and carry out all functions related to the
tracking and managing of material.
Inventory management also includes observing material that is moved

in and out of storehouses, and reconciling the final inventory balanc-
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es. The basic function of managing inventories is to control stock lev-
els by balancing the twin goals of ensuring product availability and
minimising stock holding and handling costs.
IM
The chapter begins by explaining the concept and types of invento-
ry. It also discusses various inventory models and inventory-related
costs. Next, it explains the importance of maintaining an optimal level
of product availability. It also discusses the conditions that may lead to
uncertainty in a supply chain. In addition, the chapter elaborates on
how to manage inventory for short life-cycle products and the impact
M
of supply chain redesign on inventory management. Towards the end,

the chapter elaborates on the concept of multiple-item, multiple-loca-
tion inventory management.
4.2 CONCEPT AND TYPES OF INVENTORY

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Inventory refers to goods or materials used by an organisation for pro-

duction and sales. This includes the raw materials that are used in the
production process as well as goods or materials kept in a godown or
stock-room for sales and distribution at a particular point in time.
Inventory plays a crucial role in the sales and productivity of an or-

ganisation. Therefore, it is important for the organisation to manage
its inventory effectively. Generally, a higher inventory means lesser
profit for an organisation as the inventory turnover would be low. In-
ventory is maintained to ensure the smooth flow of operations within
an organisation. However, an organisation should aim to achieve this
smooth flow at minimum inventory levels. This can only be done by
applying effective inventory management techniques.
Inventory management is all about storing goods/merchandise to be

used in the future. It involves keeping a tab on the current inventory,
which allows organisations to reorder products that are in demand
but currently out of stock. Therefore, it is necessary for any organi-
sation to maintain an optimum level of inventory. This is because a

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low level of inventory may lead to a shortage of products, while excess

inventory can incur unnecessary costs for the organisation.
If inventory is managed efficiently, it helps in preventing situations like

stock-outs, or overstock. These situations incur huge losses to the or-
ganisations. To manage inventory effectively, organisations should do
stock checks on a regular basis, which helps in identifying slow-mov-
ing inventory and reordering stock as and when it is required.
Depending on their requirements, different organisations need to

maintain different types of inventories at different times. Figure 4.1
shows the major types of inventories maintained by an organisation:
Cycle Inventory
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Safety Stock
Decoupling Stocks
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Anticipation Inventory
Pipeline Inventory
Dead Stock
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Seasonal Stock
Figure 4.1: Types of Inventory

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Let us discuss the different types of inventories in the following sec-

tions of the chapter.
4.2.1 CYCLE INVENTORY
Due to economies of scale, organisations usually produce and trans-

port goods in batches. The inventory that is generated from the pro-
duction or purchase in batches is called cycle stock because the lots
are produced in cyclic lots. Cycle inventory is built by purchasing
items in large quantities, so that normal production requirements of
the organisation can be met. However, today, companies that follow
Just-in-Time (JIT) or lean manufacturing, focus on reducing the cycle
inventory in order to reduce wastage.
4.2.2 SAFETY STOCK
Safety stock is maintained by organisations to meet stock-outs (when

an organisation runs out of stock). The demand for products always
fluctuates from the actual requirements. Sometimes, the demand ex-
ceeds the requirement due to various factors, such as changes in cus-

n o t e s
tomers’ expectations, fall in product price, etc. In such a case, a man-

ufacturer requires to meet the exceeding demand in order to satisfy
customers’ needs. Thus, the inventory that is kept and used to meet
this exceeding demand is referred to as safety inventory or a buffer
stock or a reserve stock.
Let us consider an example of a high-end retail store in India to under-

stand the importance of safety inventory in a supply chain. The store
sells designer handbags of an Italian manufacturer. The transporta-
tion cost of importing bags from Italy is high. Thus, the store manager
orders handbags in a lot size of 600 units. The average demand for
handbags per week is 100 units. The manufacturer takes three weeks
to deliver handbags after an order is placed. Under normal conditions
in which there is no demand uncertainty, if the store sells exactly 100
handbags in one week, the store manager may place the order for
more handbags when there are exactly 300 handbags left in the store.
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In this case, the new order would arrive as soon as the store sells the
last handbag. However, due to demand fluctuations and errors in fore-
casting, the actual demand in three weeks may be lower or higher
IM
than 300 units. In case of a higher demand, some customers may not
be able to make their purchases, resulting in the potential revenue
loss at the store. Therefore, the store manager decides to place the or-
der when the store has 400 handbags left. In such a case, the store has
a safety inventory of 100 handbags to meet the rise in demand.
Thus, it can be said that safety inventory is maintained by organisa-

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tions for smooth delivery of products even during a stock-out. This sit-
uation arises if there are frequent changes in the lead time and usage
rate of inventory, which are discussed in more detail below. In such
situation, if an organisation does not have an adequate level of safety
N
inventory, its delivery schedules can be adversely affected, which in

turn may have a serious impact on organisational performance and
customer satisfaction. Safety inventory plays a pivotal role in situa-
tions of demand and supply uncertainties. Therefore, it is of utmost
importance for a supply chain manager to determine an appropriate
level of safety inventory.
4.2.3 DECOUPLING STOCKS
A decoupled inventory or stock is the one that is kept aside in case of

a slowdown or stoppage in production. This inventory protects the
organisation against potential problems in the production line. For
example, an organisation needs to maintain a decoupling stock if one
part of the production line works faster or slower than the others.
When this happens, the production line is halted, and products re-
main unfinished. This ultimately reduces the replenishment rate of
the inventory.
Let us understand the concept of decoupling stock with the help of an

example. Suppose a video-game manufacturer requires assembling

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several complex parts, such as the Central Processing Units (CPUs),

internal hard drives, motherboards, connection ports, etc. Now, if the
process of producing microchips slows down, it will directly affect the
making of the CPUs, which will further halt the entire production line.
In such a scenario, a decoupled inventory could help the video-game
manufacturer in producing the products on time.
4.2.4 ANTICIPATION INVENTORY
Anticipation inventory stocks products that an organisation may re-

quire to meet any excess demand. For example, extra toys are stocked
up before the Christmas season. This is especially required by busi-
nesses during situations that are beyond their control, like transport
strikes, curfews, etc. Proper inventory management helps retailers in
anticipating such situations and keeping sufficient buffer stock for cri-
S
sis/abnormal situations. Generally, this kind of inventory is purchased
by the organisation in anticipation of events, like price increase, sea-
sonal increase in demand or a labour strike.
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4.2.5 PIPELINE INVENTORY
Pipeline inventory refers to the stock of those products or materials

that are in the company’s shipping chain and have not yet reached
their ultimate destination. Such type of inventory includes the prod-
ucts or components that are being moved from one location to an-
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other, such as from a warehouse to a factory. This kind of inventory

is also known as transit inventory. As the shipped items are still in
transit, they are considered a part of the shipper’s inventory (in case
the recipient is still to pay for the inventory). However, if the recipient
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has already paid for the items, the pipeline inventory goes on the re-
cipient’s inventory list even if the physical custody of the items is yet
to be taken.
Let us understand the concept of pipeline inventory with the help of

an example. In various overseas shipment cases, inventory can re-
main in transit for several days. For example, a shipment of mobile
batteries from Japan may take several days to arrive to an Indian port
by ship. In such a case, if the mobile manufacturer in India has al-
ready made the payment for the batteries, they would be counted as a
part of the mobile manufacturer’s inventory. However, it is only when
retail stores purchase the final products from the manufacturer that
the pipeline inventory would go into the retailer’s records.
4.2.6 DEAD STOCK
Dead stock refers to stock that has become outdated and the possi-
bility of selling it to the end-customers is very low. In other words,
dead stock is the non-moving items whose future demands are almost

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non-existent. This stock is not sold to the customers and, therefore,

requires to be removed from the sales section.
Dead stock includes products that become obsolete due to changes

in the customer’s preference or taste, design or production process.
However, many a time, dead stock is allowed to accumulate. Ideally,
such stock should be discarded on a periodic basis. The higher the
level of dead stock, the more difficult it is to dispose it off. This also
has an adverse impact on the financial results of the organisation in
that specific year.
4.2.7 SEASONAL STOCK
There are certain inventories that are sold only for few seasons, such
as the festive season, the rainy or winter season, etc. For example, the
sale of gift items, cards, food items, etc. are normally higher during
S
Diwali, Christmas, New Year, Holi, Eid, etc. than in normal days. To
meet the excess demand of end-users, the organisations need to man-
age their seasonal stocks with care.
IM
Similarly, during winters, retailers keep additional stock of woollen
items to meet the seasonal demand. Travel, leisure and recreational
activities also vary from season to season, which also affects the sea-
sonal demands for related products.
During seasonal sales, managing the inventory is difficult because the

M
duration of sales is short and the lead-time of delivery can be long to

manage this kind of situation. In such a situation, the seller must mon-
itor the inventory levels regularly and once the levels go below the de-
fined level, the goods should be ordered. Accurate demand forecast-
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ing is essential to ensure appropriate inventory levels of the seasonal

stock are maintained at all times.
1. The term _______________ is used for goods or materials kept

in a godown or stock room for sales and distribution at a given
point in time.
2. Which of the following inventories is built by purchasing items
in large quantities so that the normal production requirements
of an organisation can be met?
a. Cycle inventory
b. Safety stock
c. Decoupling stock
d. Anticipatory inventory

n o t e s
Activity
Visit a retail store near your house and identify the kind of dead
stock kept over there and explore the probable reasons for the dead
stock.
4.3 INVENTORY MODELS

An inventory model refers to a mathematical equation or formula that
helps an organisation in determining the economic order quantity, the
frequency of ordering, etc., so that orders or goods can be supplied
to the customers without any interruption. Let’s discuss some of the
most widely used inventory models in the following sections.
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4.3.1 ECONOMIC ORDER QUANTITY (EOQ) MODEL
One of the most popular techniques for calculating the right amount of
quantity to be ordered is the Economic Order Quantity (EOQ). Here,
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two basic costs are matched: the inventory acquisition cost and the
inventory-carrying cost.
The formula for determining the economic order quantity is as fol-

lows:
2 AP
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Q=
UC
where:
A is the annual consumption in units
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P is the procurement cost per order

C is the carrying cost of the inventory as a percentage
U is the unit price
The procurement cost per year = total number of orders, or:

A AP
=
×P =
Q Q
Average inventory = Q/2
Cost of carrying inventory = Value of average inventory × Inventory-

carrying cost
Q
=
×U × C
2
= QUC/2

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It can be inferred that as Q decreases, the number of orders increases

and the total procurement cost increases. If Q increases, the total in-
ventory-carrying cost decreases.
The objective EOQ is to optimise the procurement cost and the cost of
carrying inventory. Thus:
AP QUC
=
Q 2
2 AP
Q×Q =
UC
2 AP
Q=
UC
There are some objections with regard to the use of EOQ. These can
be listed as follows:
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The inventory-carrying cost and the ordering cost cannot be cal-
culated accurately.
EOQ is often calculated as a fraction.
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EOQ usually results in ordering at irregular time intervals, so the
suppliers get irregular orders.
EOQ does not factor fluctuation in demand and thus can lead to
high inventories.
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EOQ may not be applicable when the demand is irregular or when

an increase in price is forecast.
Real-time decisions are made on the basis of environmental factors,

such as pricing, competition, economic climate, new technology, reg-
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ulation of imports and exports. Thus, the decisions need to involve a

certain degree of human judgement.
4.3.2 REPLENISHMENT MODEL
Organisations use various replenishment models based on demand

situations. The replenishment model calculates the reorder point, the
point at which a replenishment order should be placed. For example,
if your re-order point is 10 and your order quantity is 4, then you will
place an order to your vendor when the on-hand inventory drops from
11 to 10 pieces. You will also place an order when your on-hand inven-
tory drops to 6 pieces or 2 pieces. In other words, you place an order
whenever your inventory position drops from 11 to 10 pieces.
This is the point at which if the inventory reaches, a re-order is re-

quired. In case the amount of inventory falls below the order point, it
may not be replenished in time by the vendor.
Re-order point = [(demand/day) × (lead time + review time)] + (back-

up stock)

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The lead time is the time between the recognition that a re-order
needs to be placed and when it actually arrives at the store and is
made ready for sale.
The primary thought behind all stock control methods is to identify a

re-order or replenishment level. When this level is reached, the sup-
plier is signalled that the stock needs to be replenished.
Figure 4.2 shows a normal stock replenishment system:
Max Level
Re-order Lead-time
point (200) consumption
Min. Level
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Buffer Stock
Figure 4.2: Re-order Level System

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The graph shows an average consumption of 100 units per month.
Supplies equal to 2 months’ consumption are bought at a time. The
safety or buffer stock is of 100 units or one month’s consumption.
The lead-time is 15 days, which means that when the stock reaches a
15 days’ consumption level above the minimum stock level, the re-
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plenishment should be ordered. This level is at 150 units and is called

the re-order level. The maximum stock held is at 250 units, i.e., re-or-
der quantity (150) plus the buffer stock level (100). This is called the
maximum stock level. Though, in the real time, such a smooth curve
may not occur, from the past experience and sales forecasts, you can
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determine the likely average consumption and, thereby, forecast the

stock levels.
A replenishment model uses the following techniques to identify the

re-order point:
Fixed time system: Here, fixed time intervals are considered for
re-ordering, instead of the stock levels. The time for replenish-
ment is chosen from an administrative point of view.
Imprest stock control: This is a simple method of stock control
and involves the identification of the level of stock at specified in-
tervals, say every Monday. In that case, if on a Monday the inven-
tory levels are found to be down, they are topped up immediately.
Two-bin system: Here two bins are kept with different levels.
When the first bin is depleted, it means it is time for replenish-
ment. The second bin serves like a safety stock. Space may be
saved if, instead of keeping vertical bins, horizontal bins are kept

n o t e s
with a separator. After the quantity of product in the first half of

the bin is exhausted, a brightly coloured separator is removed and
displayed near the edge of the bin. This indicates that the bin is
ready for replenishment.
3. The inventory-carrying cost and the ordering cost cannot be

calculated accurately. (True/False)
4. The _______________ is the triggering point for placing a
replenishment order.
Activity
With the help of the Internet, explore an inventory model that has
S
not been discussed in the chapter and make a note of the basic fea-
tures of the model.
IM
4.4 INVENTORY-RELATED COSTS
Investment in inventory is one of the largest assets of any business. An
organisation realises profit every time inventory is bought and sold.
For example, suppose the inventory of an organisation is sold only
once a year and the organisation gains a profit of ` 10 lacs, and on the
M
other hand, if the inventory is sold 12 times in a year, then the profit
will be substantially higher. The factors that create costs are affected
by excessive as well as insufficient inventory.
Inventory costs are broadly divided into direct and indirect costs.
N
Direct costs include capital costs, storage space costs, service costs
and risk costs. Whereas indirect costs include business risks due
to lost sales and loss of customers, opportunity cost due to inabil-
ity to invest in alternatives, infrastructure costs, such as facilities,
transportation, etc.
Apart from this, the inventory-related costs can be divided into three
major types as shown in Figure 4.3:
Ordering Costs
Inventory-carrying Costs
Stock-out Costs
Figure 4.3: Inventory-related Costs

n o t e s
Let us discuss these types of costs in the following section.
4.4.1 ORDERING COSTS
Ordering cost or inventory acquisition cost includes the cost associat-

ed with the process of the purchase order, salaries, rentals, stationery,
communication costs and other related costs. These costs are calcu-
lated for the duration of one year. The following data is required for
calculating ordering costs:
Total number of purchase orders issued.
Payroll costs of the entire purchase department; inventory control;
the receiving and inspection section, which includes the accounts
personnel that pass bills for payment and the officials who sit on
tender committees, etc.
S
Stationery and supplies.
Rental and office overheads like phone, etc.
IM
Receiving and inspection costs.
Travelling costs of the purchase officers to the vendor’s premises.
Once the sum of these costs is obtained, it should be divided by the

number of purchase orders placed during the period. This gives the
cost incurred per purchase order. It can further be divided among the
products ordered. Thus, the total number of products ordered divided
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by the total cost of ordering gives the cost of ordering of each product.
4.4.2 INVENTORY-CARRYING COSTS
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Inventory-carrying costs are the costs that are associated with holding
the inventory at a store for a particular period of time. The invento-
ry-carrying costs include the following expenses:
Interest accrued on the capital invested in inventory: In case the
capital is borrowed from a financial institution, the rate of interest
that the financial institution levies on the borrowed capital is the
interest cost. In case the organisation uses its own funds to finance
the inventory, the cost is known as opportunity cost. This opportu-
nity cost is the return on investment that the investor would have
got by deploying this capital in some other investment opportuni-
ty. For example, if the investor had put the same amount of money
in a bank account, the interest that he/she would have received
would be regarded as opportunity cost.
Rent: Payment for the space occupied by the inventory also comes
under inventory-carrying costs.
Insurance cost: The insurance premium paid for the safety of the
inventory from unforeseen contingencies is also calculated under
inventory-carrying costs.

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Obsolescence cost: In case the inventory is stored too long, the

products, especially if they are fashion products, may become ob-
solete. Certain products may be perishable or the material from
which they are made may have a limited shelf life. They would
become unfit for consumption if stored for too long. For example,
fashion garments may become out-of-fashion in a year. Similarly,
potato chips may become unfit for consumption after six months.
Medicines typically have printed expiry dates, after which they be-
come unfit for consumption.
Shrinkage cost: Some materials may shrink in volume if kept in
storage for longer periods of time.
Evaporation cost: Certain products, such as chemicals, shrink in
volume due to evaporation if kept for longer periods of time.
Spoilage cost: Certain products like cabbage may spoil if kept in
S
storage for too long. Spoiled inventory may also put a huge burden
on the organisations in terms of increased cost and lowered revenue.
Retention cost: This includes costs incurred on salaries and wages
IM
of the employees hired to maintain the inventory.
Overheads: These include costs incurred on repairs and infra-
structure maintenance, such as electricity and godown mainte-
nance costs. These costs are required to be borne for the duration
of the storage of the product.
M
Consolidating these costs for a year gives the inventory-carrying cost.

This is usually quoted in terms of the percentage of the average value
of the inventory carried.
N
4.4.3 STOCK-OUT COSTS
Another type of cost associated with inventory is the stock-out cost.

When a product required by a customer is not available in the inven-
tory, it is called a stock-out of that product. As a result of stock-out, the
organisation incurs certain costs, called stock-out costs. In a manufac-
turing environment, a stock-out of some raw material may result in
stopping the production process, resulting in idle men and machine
time. This would further delay product delivery. Stock-out costs can
be managed through effective inventory management and regular
stock audits.
5. __________inventory costs include capital costs, storage space

costs, service costs and risk costs.
6. Which of the following costs of the inventory refer to the cost
that is incurred by the organisations over a certain period of
time to hold and store its inventory?

n o t e s
a. Ordering costs
b. Inventory-carrying costs
c. Stock-out costs
d. Inventory reduction costs
Activity
Talk to the store manager of a store near you and find out from him/
her the various factors that may lead to stock-out costs.
OPTIMAL LEVEL OF PRODUCT

4.5
AVAILABILITY
S
As discussed in the previous section, inventory is the stock stored by
an organisation with the objective of preventing a stock-out situation
or meeting exceeding demands. However, what should be an optimal
IM
level of inventory that an organisation must maintain to ensure prod-
uct availability? It must be noted that maintaining inventory incurs
a huge cost to the organisation. Therefore, excessive inventory may
lead to huge loss and wastage. The formula to calculate the optimal
level of inventory is as follows:
M
Inventory = (Maximum usage rate – Average usage rate) × Lead time
Or
Inventory = Reorder point [– {Lead-time (in days) × average usage}]

N
Here usage rate is the rate at which an organisation uses its inventory.
For example, if the usage rate of an organisation is 300 units, it means
it uses 300 units of inventory everyday. Similarly, lead-time is the time
taken by suppliers in delivering products to customers after the place-
ment of the purchase order.
The reorder point is defined in terms of the level of inventory at which

an order should be placed to replenish the current stock of inventory.
In simple words, reorder point may be defined as the level of invento-
ry when a fresh order should be placed for procuring additional inven-
tory. It can be calculated as follows:
Reorder point = (Lead-time × Average usage) + Safety stock
Although there is no defined way of identifying an optimal level of

inventory, there is a common process used by the organisations to de-
cide the right level of inventory. The process involves a number of
steps, which are shown in Figure 4.4:

n o t e s
Measuring Demand Uncertainty
Identifying Lead Time
Measuring Product Availability
Deciding a Replenishment Policy
Identifying Product Defects

and Delivery Lapses
S
Reviewing Usage
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Figure 4.4: Steps involved in Determining Optimal Inventory Level
Let us now discuss these steps briefly:

1. Measuring demand uncertainty: This is the first step of
the process where fluctuations in demand are determined.
Uncertainties in demand take place due to various factors, such
M
as fall in product prices and increase in customers’ expectations.

In this step, all these factors are considered (that may cause
fluctuations in demand) so that the right level of inventory can
be determined to meet such uncertainties in demand.
N
2. Identifying lead time: This step involves estimating the lead

time between the placement of orders and the projected delivery
dates. This can be done by working closely with suppliers to
identify the average time required to process orders of a specific
quantity. After the expected delivery date of products from
suppliers is known, adjustments in the quantity of orders are
made to ensure that adequate inventory is available to meet
delivery schedules until each subsequent order is processed and
received.
3. Measuring product availability: In this step, product availability,
which is the manufacturer’s ability to fulfill customer orders
from the available inventory, is measured. Product availability is
measured by calculating the product fill rate, the order fill rate,
and the cycle service level. The product fill rate is the fraction of
demand fulfilled from the available inventory. The cycle service
level is the fraction of replenishment cycles that end when a
customer demand is met.

n o t e s
4. Deciding a replenishment policy: Replenishment is a process

of refilling safety inventory by making reorders. For this, an
organisation needs to decide the replenishment policy for
refilling inventory.
5. Identifying product defects and delivery lapses: The chances of
product defects and delays in product delivery are always there.
In this step, the reasons for delays and defects in products are
identified. In case of product defects, a percentage difference is
created, which is added to the new order. For example, suppose a
production process requires replacement of 10 units of a certain
item each week. However, 2 out of 10 ordered units are presumed
to be defective in some manner, which could slow production.
In such a case, an order for 12 units is made. The difference of
2 units is also added to the new order so that even in the case of
defective products, inventory may not suffer.
S
6. Reviewing usage: In this step, the usage of inventory is regularly
monitored so that variations can be determined. The review is
done once one or twice a week or every month. The review helps
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in finding variations in the average daily usage of items. The data
collected through such reviews is then used to determine the size
of the next purchase order that is yet to be placed.

M
7. Product __________ is the fraction of demand satisfied from

the available product inventory.
Activity
N
With the help of the Internet, find out how a company of your choice
maintains optimal inventory.
4.6 UNCERTAINTY IN A SUPPLY CHAIN

Just as demand is subject to fluctuations, similarly there are uncer-
tainties in supply too, which have a major impact on the level of in-
ventory. For example, if suppliers fail to deliver components to Hew-
lett-Packard (HP) on time, the organisation would be unable to meet
its production targets, which would hamper its supply of computers
to retailers in the market. Thus, HP needs to maintain a certain level
of inventory of components so that its production process is not hin-
dered and the supply to the retailers is smooth.
Generally, suppliers fail to deliver raw material to manufacturers due

to various reasons, such as rise in the price of raw material, increase
in the number of manufacturers in the market and adverse climatic
and transportation conditions. A lack of supply would lead to product
unavailability in the market. This would eventually increase cost at

n o t e s
the manufacturer’s end since efforts for finding new alternatives for
the supply of raw material would be made. In such a case, maintaining
an appropriate level of stock by the manufacturer would help in main-
taining a smooth supply of products to retailers.
8. Rise in the price of raw material may ultimately result in

uncertainty in the supply chain. (True/False)
Activity
With the help of the Internet, explore at least one case study of a
company that is successfully dealing with uncertainties in the sup-
ply chain.
S
INVENTORY FOR SHORT LIFE CYCLE
4.7
PRODUCTS
IM
A product can be defined as any good or service that satisfies the re-
quirements of customers. It is offered in the market by an organisa-
tion to earn revenue. However, based on its durability, a product can
be classified as durable and non-durable products. Durability denotes
the life-span of a product. Durable products provide benefits for a
M
longer period of time. On the other hand, non-durable products are

purchased for immediate consumption and have a short life-span. For
example, refrigerators, televisions, or clothes are durable products,
while eatables or beverages are non-durable products.
N
An organisation needs to keep stock of various short- and long-life-cy-

cle products in order to meet the requirements of customers on time.
However, due to their short life-span, non-durable products cannot be
stored for a long time. They may also require additional facilities or
conditions, such as moisture-proof rooms for their storage, automatic
temperature adjustment amenities, etc., so that are in a perfect con-
dition, when they are delivered to target customers. Organisations try
to keep the stages involved in the SCM process at a minimum so that
short life-cycle goods/material can reach the target audience in the
minimum possible time.
9. ___________denotes to the life-span of a product.
Activity
Visit a small retail store and try to understand how the shopkeeper
manages the demand of the Diwali gifts, many of which are short
life-cycle products.

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IMPACT OF SUPPLY CHAIN REDESIGN

4.8
ON INVENTORY
A supply chain redesign is required at times when the SCM objectives
do not get fulfilled. In addition, there are number of reasons why a
supply chain redesign could be required. These reasons may include:
High cost
Inefficient supply chain
Unsatisfied suppliers/customers
Entry of new market players
Use of obsolete technology in the supply chain
Supply chain redesign may help organisations in redefining their
S
SCM objectives and assessing the current processes. It is only after
the organisation has done this that it can build an improved and effec-
tive SCM process. However, while redesigning the SCM processes, the
IM
organisation should remember that the primary function of any SCM
is to sell goods/materials to the customers as per their requirements.
For this, it is important for it to procure the right quantity of products
and meet the financial goals. The whole process of redesigning the
supply chain should be based on five major components, which are as
follows:
M
Supply chain analysis: It involves determining the needs of the

target segment and buying the merchandise accordingly.
Objective re-establishment: It involves establishing policies and
procedures in order to determine whether the stated SCM objec-
N
tives have been achieved.

Goods/material procurement: It involves acquiring merchan-
dise from the right manufacturers or wholesalers. It is a planned
process that starts with determining the quantity and quality of
merchandise to be supplied to the target customers. So, you can
say that product procurement involves deciding what to purchase,
how much to purchase and where to purchase.
Goods/material distribution: A proper distribution channel is es-
sential for products to reach the destined locations or customers in
time. In the absence of an efficient distribution channel, custom-
ers’ demands may remain unfulfilled, which, in turn, has negative
financial consequences in terms of revenue foregone.
Goods/material evaluation: It involves establishing performance
guidelines, objectives and plans for obtaining merchandise for
selling. Merchandise planning involves making decisions related
to the merchandise mix, merchandise variety, merchandise bud-
get and merchandise assortment.

n o t e s
10. A supply chain redesign may help organisations in redefining

their SCM objectives and assessing their current processes.
(True/False)
Activity
Make a group of your friends and discuss the impact of supply chain
redesign on inventory.
MULTIPLE-ITEM, MULTIPLE-LOCATION
4.9
INVENTORY MANAGEMENT
S
Inventory management is difficult if it involves multiple items that are
located at multiple points. Managing multiple-item, multiple-location
inventory is a challenging task as the organisation would not only re-
IM
quire identifying the needs of the customers at different locations, but
also provide them the logistics services as per their requirements.
For the efficient management of a multiple-item, multiple-location in-

ventory, the following steps should be undertaken:
1. Understanding the needs of the customers: The most
important point to be considered while managing multiple-
M
item, multiple location inventory is to understand the needs of

the customers. This could help the organisation in arranging
the supplies accordingly. For example, if a wedding dress
manufacturer from Europe starts its operations in India, it
N
would require understanding the needs of the Indian customers.

Therefore, it may require keeping different inventories for its
manufacturing and supply processes in India, keeping to the
tastes and preferences of the Indian customers. These would be
quite different from the inventory the manufacture has for its
businesses in Europe.
2. Managing efficient logistics: It is very necessary for an
organisation, dealing with a multiple-item, multiple-location
inventory, to manage its logistics efficiently. This could enhance
the capability of the organisation and enable it to distribute and
transfer its products from one place to another more quickly and
effectively.
3. Conducting demand forecasting: The effectiveness of a supply
chain is directly linked with customer satisfaction. To achieve
this, an organisation needs to have sufficient inventory to meet
market demands. However, it is particularly challenging for an
organisation with a multiple-item, multiple-location inventory
to determine the right quantities of products for supplying. To
overcome this challenge, the organisation must anticipate the

n o t e s
demand for the products to be produced and then supplied to the

market. This could further help the organisation in developing
effective delivery and production schedules and prevent
situations of overproduction or underproduction.
4. Maintaining safety inventory: Demand does not always remain
the same due to the dynamic nature of the market. This results
in unnecessary delays in product delivery to customers. Thus, an
organisation with a multiple-item, multiple-location inventory
must ensure that an adequate level of safety inventory is
maintained to meet variations in demand. In the present business
environment, customers can easily switch to competitors for
availability of alternative products. This has made the market a
place with highly diverse products and services where demand is
difficult to forecast. In such a situation, organisations are forced
to raise the level of their safety inventory. Safety inventory plays
S
a significant role in ensuring the availability of products in the
market for customers, particularly in situations such as a stock-
out.
IM
11. Name the steps that should be taken by an organisation for

managing multiple-item, multiple-location inventory.
M
Activity
With the help of the Internet, find out how a global retailer of your
choice manages its multiple-item, multiple-location supply chain
system.
N
4.10 SUMMARY
Inventory refers to goods or materials used by an organisation for
production and sale. This includes items that are used as support-
ive materials to facilitate production.
Different types of inventories include cycle inventory, safety stock,
decoupling stocks, anticipation inventory, pipeline inventory, dead
stock and seasonal stock.
An inventory model refers to a mathematical equation or formu-
la that helps an organisation in determining the economic order
quantity, the frequency of ordering, etc., so that orders or goods
can be supplied to customers without any interruption.
The Economic Order Quantity (EOQ) model and the replenish-
ment model are two widely used inventory models.
Investment in inventory is one of the largest assets of any business.
An organisation realises profit every time inventory is bought and
sold.

n o t e s
Inventory costs are broadly divided into direct and indirect costs.
Direct costs include capital costs, storage space costs, service costs
and risk costs. Whereas, indirect costs include business risks due
to lost sales and loss of customers, opportunity cost due to inabil-
ity to invest in alternatives, infrastructure costs, such as facilities,
transportation, etc.
Inventory-related costs can be divided into three major types— or-
dering costs, inventory-carrying costs, and stock-out costs.
Determination of the optimal inventory level includes the follow-
ing steps:
1. Measuring demand uncertainty
2. Identifying lead time
3. Measuring product availability
S
4. Deciding a replenishment policy
5. Identifying product defects and delivery laps
IM
6. Reviewing usage
Just as demand is subject to fluctuations, similarly there are un-
certainties in supply too, which have a major impact on the level
of inventory.
Generally, suppliers fail to deliver raw material to manufacturers
due to various reasons, such as rise in the price of raw material, in-
M
crease in the number of manufacturers in the market and adverse

climatic and transportation conditions.
An organisation needs to keep stock of various short- and long-life-
cycle products in order to meet the requirements of the customers
N
on time.
A supply chain redesign is required at times when the SCM objec-
tives do not get fulfilled.
A supply chain redesign may help organisations in redefining their
SCM objectives and assessing their current processes.
Inventory management is difficult if it involves multiple items
that are located at multiple points. Managing multiple-item, mul-
tiple-location inventory is a challenging task as the organisation
would not only require identifying the needs of the customers at
different locations, but also provide them the logistics services as
per their requirements.
key words
Buffer stock: Reserve stock kept aside to meet unforeseen high

demands.

n o t e s
Central Processing Unit (CPU): The most important part of a

computer system, in which execution and control of operations
take place.
Economic Order Quantity (EOQ): The order quantity that mi-
nimises the total holding and ordering costs.
Lead time: Total time span between the initiation and comple-
tion of a particular task.
Payroll: The expenses associated with preparing and distribut-
ing payroll as a part of employee compensation.

1. What do you mean by inventory? Define the different types of
S
inventory.
2. What do you mean by safety stock? Why is it maintained?
IM
3. Mention two major inventory models. Explain the approaches of
these two models.
4. Why do organisations need to maintain an optimal level of
inventory? What are the steps involved in determining the
optimum inventory level?
5. Elaborate on the impact of supply chain redesign on inventory.
M

N
Topic Q. No. Answer

Concept and Types of Inventory 1. Transit inventory
2. a. Cycle inventory
Inventory Models 3. True
4. Re-order point
Inventory-related Costs 5. Direct
6. b. Inventory-carrying costs
Optimal Level of Product 7. Fill rate
Availability
Uncertainty in a Supply Chain 8. True
Inventory for Short Life Cycle 9. Durability
Products
Impact of Supply Chain Rede- 10. True
sign on Inventory

n o t e s
Topic Q. No. Answer

Multiple-item, Multiple-location 11. Understanding the needs
Inventory Management of the customers, managing
efficient logistics, conduct-
ing demand forecasting, and
maintaining safety inventory

1. Inventory refers to goods or materials used by an organisation
for production and sale. This includes items that are used as
supportive materials to facilitate production. Refer to Section
4.2 Concept and Types of Inventory.
2. Safety stock refers to the level of stock that is maintained to meet
any unforeseen high demand. Refer to Section 4.2 Concept and
S
Types of Inventory.
3. Two major models of inventory are the Economic Order Quantity
(EOQ) model and the Replenishment model. Refer to Section
IM
4.3 Inventory models.
4. Optimal level of inventory needs to be maintained to minimise
supply chain cost and provide an optimal level of customer
service. The steps involved in determination of the optimal
inventory level includes measuring demand uncertainty,
identifying lead time, measuring product availability, deciding
M
replenishment policy, identifying product defects and delivery

laps and reviewing usage. Refer to Section 4.5 Optimal Level of
Product Availability.
5. A supply chain redesign is required at times when the SCM
N
objectives do not get fulfilled. Refer to Section 4.8 Impact of

Supply Chain Redesign on Inventory.

4.13
REFERENCE
SUGGESTED READINGS
Fogarty, D., Blackstone, J., Hoffmann, T., & Fogarty, D. (1991). Pro-
duction & inventory management. Cincinnati, OH: South-Western
Pub. Co.
Sadler,I. (2007). Logistics and supply chain integration. Los Ange-
les: SAGE.
Wang, J. (2011). Supply chain optimization, management and inte-
gration. Hershey, PA: Business Science Reference.

n o t e s
E-REFERENCES
Apics.org,. (2015). APICS OMBOK Framework 59. Retrieved
9 December 2015, from http://www.apics.org/industry-content-re-
search/publications/ombok/apics-ombok-framework-table-of-con-
tents/apics-ombok-framework-5.9
eFinanceManagement,. (2014). Types of Inventory/Stock. Retrieved
9 December 2015, from http://www.efinancemanagement.com/
costing-terms/types-of-inventory-stock
Home.ubalt.edu,. (2015). Inventory Control. Retrieved 9 December
2015, from http://home.ubalt.edu/ntsbarsh/business-stat/otherap-
plets/inventory.htm
Logility.com,. (2015). Inventory Optimization Software, Inventory
Management System. Retrieved 9 December 2015, from https://
S
www.logility.com/inventory-optimization-software
Logility.com,. (2015). Inventory Optimization, Multi-Echelon Inven-
tory Optimization. Retrieved 9 December 2015, from https://www.
IM
logility.com/solutions/inventory-optimization/voyager-invento-
ry-optimization
Toolkit.smallbiz.nsw.gov.au,.(2015). Types of Inventory. Re-
trieved 9 December 2015, from http://toolkit.smallbiz.nsw.gov.au/
part/13/66/280
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C h a
5 p t e r
DESIGNING AND PLANNING

TRANSPORTATION NETWORKS
CONTENTS
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5.1 Introduction
5.2 Role of Transportation in a Supply Chain
IM
Activity
5.3 Different Transportation Decisions
Activity
5.4 Modes of Transportation and their Performance
M

Activity
5.5 Transportation Infrastructure and Strategy
N
Activity
5.6 Design Options for Transportation Network
Activity
5.7 Transportation Costs
Activity
5.8 Summary

n o t e s
SLOW GROWTH OF RAIL TRADE BETWEEN CHINA

AND EUROPE
In 2011, Hewlett Packard (HP) started using railways to transport

goods from the internal Chinese manufacturing plants to the Eu-
ropean markets. In present times, these rail networks are being
developed across several Chinese cities. However, it is being af-
flicted with a common operational challenge known as dead head-
ing (which means the completion of a trip by a train or any other
commercial vehicle without carrying any passengers or cargo).
Transporting goods from Chinese manufacturing sites straight

to European markets via rail is a sensible decision as the 11,170
km journey takes only 11 days saving more than 20 days in com-
parison to transporting goods through ocean shipping. Thus, rail
S
transport makes the transportation of goods considerably shorter
compared to ocean-based shipping and also at a considerably re-
duced cost in comparison to air transport.
IM
Due to the early success enjoyed by HP, China developed and be-
gan working on its vision of a Silk Road Economic Belt as part of its
“One Belt, One Road” initiative. China has developed rail freight
services from 11 Chinese cities to Europe including Chongqing
which began transporting HP computer parts and accessories to
Duisburg in Germany through railways in 2011.
M
There is a much bigger demand for goods moving to Europe

than of exporting goods from Europe to China. “Only single-digit
[numbers of] containers return every month; so we can’t even fill
a train,” Gong Qinghua, a sales director at a freight forwarder op-
N
erating between Yiwu and Madrid in Spain, told the South China
Morning Post.
This situation is made more complicated due to the fact that Chi-
nese exports to Europe like consumer electronics, auto parts,
food, apparel, etc. can be transported easily through rail. How-
ever, European exports such as heavy machinery and equipment
cannot be easily transported through rail.
Moreover, several European organisations are wary of shipping

their goods via trains operated by the Chinese government. “It
is a difficult sale for Chinese companies to convince a European
freight forwarder to bring products on their train,” Darryl Had-
away, a consultant for the Eurasia cargo carrier business, also told
the South China Post.
As per the China Railway Corporation, in the first two quarters

of 2015, 200 train loads went from China to Europe in comparison
to 50 coming back from Europe to China. Furthermore, several of

DESIGNING AND PLANNING TRANSPORTATION NETWORKS 101
n o t e s
these return trains travel nearly empty laying a huge burden on

cost of train operations. However, trade is growing between a few
European cities and China. For example, the Duisburg-Chongq-
ing railway line expects the number of return trains to reach 100
in 2015 and the same number for 2016 compared to just 22 in 2014.
However, the Chinese government intends to remain patient

about the situation. “Silk Road is a long-term strategy for China,”
a leading trade academic in the country says.
There is room for huge growth for the volume of rail trade to grow
between China and Europe. In 2014, the trade volume stood at a
mere US$ 4.9 bn through freight trains between China and Eu-
rope while the overall trade was more than US$ 600 bn. It reveals
that the share of rail was a mere fraction of the total trade with a
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lot of room for growth.
IM
M
N

n o t e s
learning objectives

>> Discuss the role of transportation in a supply chain
>> Explain various transportation decisions
>> Describe various modes of transportation and their perfor-
mance
>> State the importance of transportation infrastructure and
strategy
>> Explain design options for transportation network
>> Describe transportation costs
S
5.1 INTRODUCTION
In the previous chapter, you studied the role of inventory manage-
ment in a supply chain. Apart from this, transportation is another im-
IM
portant element of a supply chain. In this chapter, you will study the
significance of transportation in a supply chain.
Transportation is a major contributor to the effectiveness of a supply

chain of an organisation. It is an activity that connects an organisation
to its supply chain partners and influences the level of customer sat-
M
isfaction. This is because if the transportation network of an organi-

sation is responsive, goods will be delivered to customers on time. In
order to have a responsive transportation network, it is important for
an organisation to have a well-defined strategy in place.
N
A transportation strategy is a plan of action that directs overall trans-

portation operations of an organisation. It focuses on deciding the
best mode of transportation (air, rail, water, etc.) to move goods from
one place to another. Transportation modes and their availability vary
across different locations. Therefore, the organisation must choose
one or a combination of transportation modes according to the ex-
isting conditions and as per the policy of the organisation. Another
important aspect considered in a transportation strategy is transpor-
tation cost. Organisations always look for economical modes of trans-
portation in order to generate high revenues.
In this chapter, you will study the role of transportation in a supply

chain. After that, you will study different transportation decisions and
modes of transportation; transportation infrastructure strategy; de-
sign options for a transportation network and transportation costs.

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ROLE OF TRANSPORTATION IN A
5.2
SUPPLY CHAIN
As discussed in the previous chapters, a supply chain is a network of
various businesses that are interconnected with each other in order to
ensure effective delivery of a product or service to end customers. The
management of a supply chain can be separated into three distinct
areas namely acquisition of raw materials, manufacturing and trans-
portation. Here, emphasis is laid on the role of transportation in a sup-
ply chain. Transportation is a vital supply chain process and forms
the supply chain strategy development, network design and total cost
management processes of organisations. It develops a link between
different supply chain parties at the same time maintaining a smooth
flow of goods between their facilities. Therefore, it can be said that
transportation is critical to the fulfilment of demand in a supply chain.
S
In order to maintain a responsive supply chain network, an organi-
sation must implement an effective transportation network. A trans-
IM
portation network is said to be effective if goods reach the desired
destination on time at economical costs. However, organisations gen-
erally view transportation as a necessary evil due to high costs and
risks associated with it. According to the supply chain sector research
(Chang, 1998), transportation accounts for as much as 30 per cent of the
total cost of supply chain operations which is as much as the combined
cost of warehousing and inventory.
M
However, managers can maintain a cost-effective transportation net-

work by using various cutting-edge technologies. These technologies
allow managers to monitor, control and enhance the performance of
N
transportation networks. Cloud computing is one such technology

that has made the implementation of effective transportation network
easier.
A Bloomberg survey report elucidates that around 73 per cent of sup-

ply chain managers are identifying the transportation network as a
vital focus area in 2014. Furthermore, the current adoption rate of im-
plementation of transport solutions is underdeveloped as only 46 per
cent of survey participants acknowledged using a transport solution
while 22 per cent said that were planning to adopt a transport solu-
tion in 2014. As reiterated by the survey, transportation is much more
than just a financial drain associated with trucks, railways and ware-
houses. Transportation helps in developing operational efficiency and
enhancing the bottom line of the organisation if there are appropriate
measures.

n o t e s
Figure 5.1 shows the example of the transportation network of organ-

isations:
Retailer Distribution Center Urban Stores

Manufacturer A Warehouse A
Manufacturer B Warehouse B
Manufacturer C Warehouse C
Manufacturer D Warehouse D
Non-Urban Stores
Manufacturer E Warehouse E
Manufacturer F Warehouse F
S
Manufacturer G Warehouse G
IM
Manufacturer H Warehouse H
Figure 5.1: An Example of a Transportation Network
Exhibit
Transport Corporation of India to Profit from

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the Implementation of the GST Bill
The Transport Corporation of India (TCI) is projected to be one

of the main beneficiaries of enactment of Goods and Services Tax
(GST) Bill and growth in ecommerce.
N
TCI has a huge network of 1,400 branches, 10.5 million square feet
warehouses and 9,000 owned and managed trucks, which pose a
challenge for its competitors to emulate them. “We have over 6,000
trained staff and several decades of relationship with the customers
gives a competitive edge over other players,” said Vineet Agarwal,
Managing Director of TCI.
TCI mainly operates in 4 divisions, namely freight, express, supply

chain and seaways division. In the freight division, the company
provides services related to the transportation of full truck, less
than truck load (LTL) and parcel delivery services. TCI employs
a price escalation clause with most of its customers which enables
it to pass on any jumps in fuel prices to them. TCI utilises its own
as well as rented trucks for road transportation. However, for the
transportation of freight through rail, it has a joint venture with
Container Corporation of India (ConCor) to ensure effective cargo
movement.

n o t e s
TCI is expected to be one of the primary gainers of the booming

ecommerce industry because of its established network of ware-
houses and branches. According to a BCG report, the Indian ecom-
merce market is projected to grow at a CAGR of 30-34 per cent in
the subsequent 5 years. This development would result in the aug-
mentation of the logistics spend of ecommerce companies by four-
fold by 2020.
TCI would also gain from the implementation of GST Bill. The GST
Bill would enforce a uniform pan-India tax system, which would
allow organisations to outsource their logistics needs to third-party
logistics companies, hence, lowering their overall costs.
“Implementation of GST will lead to need for larger warehousing

and more movement to hubs. It would also mean lesser paper work
S
and faster movement of trucks,” said Agarwal.
TCI plans to invest `275 crores in the year 2016, of which 60 per
cent would be kept separate for the creation of warehousing hubs.
IM
Moreover, the organisation is preparing to demerge its express di-
vision into a different entity, which will improve shareholder value
in the future.
(Source: The Economic Times. ‘Transport Corporation of India in Pole Position to Gain
from Ecommerce Boom, GST – The Economic Times’.)
M
1. __________________ is a vital supply chain process and forms

the supply chain strategy development, network design and
N
total cost management processes of the organisations.

2. Managers can maintain a cost-effective transportation network
by not using various cutting-edge technologies. (True/False)
Activity
Suppose you are the transportation manager of an FMCG compa-

ny. Elucidate the strategies that you would use to ensure regular
and prompt shipment of your products to consumer markets.
DIFFERENT TRANSPORTATION
5.3
DECISIONS
Nowadays, transport managers face various challenges like increas-
ing customer expectations, varying fuel prices, equipment shortage,
economic uncertainties, high labour cost, stringent safety and social
regulations, technological advancement and so on. To meet these

n o t e s
challenges, managers need to make certain quick and informed deci-

sions related to transportation. Figure 5.2 depicts some major trans-
portation decisions taken by managers:
Mode Selection Decisions
Lane Operation Decisions
Dock-level Decisions
Figure 5.2: Drivers of Transportation Decisions
S
Let us discuss these decisions in detail.
Mode selection decisions: These decisions are taken with the pur-
IM
pose of selecting the best mode of transportation. For this, manag-
ers need to decide which mode of transportation to be selected for
inbound and/or outbound of goods. These decisions are made by
taking into consideration various factors, such as cost associated
with a particular mode of transportation, weather conditions, time
involved, nature and volume of products to be transported, spe-
cial handling requirements, etc. A detailed explanation of different
M
modes of transportation is given in the next section.

Lane operation decisions: These decisions are related to daily
freight transactions. To make these decisions, transport managers
utilise real-time information on product movements in inter-facili-
N
ty, inbound and outbound shipping lanes to fulfill service require-

ments at reduced costs. The following are lane operation decisions
taken by managers:
Inbound or outbound consolidation: Inbound logistics is the
transportation, storage and delivery of products imported by
organisations. Outbound logistics, on the other hand, refers to
transportation, storage and delivery of products exported by
organisations. In such a case, to lower transportation costs,
managers merge inbound and outbound freight in order to de-
liver shipments in larger volumes.
Temporal consolidation: Less-than-volume-load (LVL) ship-
ments, being transported to the same geographic area on con-
secutive days, may be held until adequate volume of products
exists to validate a full load on one carrier with multiple stops.
This is known as temporal consolidation.
Vehicle consolidation: By averting the LVL terminal system,
freight held by transportation managers often arrives at the
same time or earlier than the original LVL shipment and at a

n o t e s
reduced cost. Several small shipments that are either coming

from suppliers or are being sent to customers in the same geo-
graphic area can be combined on one vehicle. This is possible
when these shipments have to be delivered on the same day.
The vehicle may have to pay full-volume rates and stopover
charges but can save on multiple LVL rates. This is known as
vehicle consolidation.
Carrier consolidation: By allocating higher shipping volumes
to fewer carriers, lesser per-unit transportation costs are af-
forded to the shipper’s increased freight. Moreover, by consol-
idating the carrier base, the shipper can recognise dependable
carriers in need of backhaul (freight carried on a return trip
back to the shipping base) miles. This is known as carrier con-
solidation.
S
Dock-level decisions: These transportation decisions include
dock-level activities like scheduling and routing of loads. These
activities are performed to execute the planned route schedules.
Dock-level decisions are basically concerned with utilising the
IM
transportation vehicle space in a better manner; identifying the
most efficient routes for the delivery of consignments; making op-
timal use of equipment, facilities and drivers on a given day and
so on.

M
3. ________________ are taken with the purpose of selecting the

best mode of transportation.
4. Lane operation decisions are related to daily freight
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transactions. (True/False)
Activity
Suppose you are the transportation manager of a logistics firm and

have to ship airplane parts to Japan. Which mode of transportation
would you use to carry out the delivery? Give reasons to justify your
decision.
Modes of transportation and

5.4
their performance
To move products from one place to another, an organisation needs to
select an appropriate mode of transportation. There are various types
of transportation modes available for the organisations. To select the
best mode of transportation, organisations need to analyse various
factors, such as size of operations, type of products to be manufac-
tured and the distance of the delivery destination.

n o t e s
Figure 5.3 shows some common modes of transportation:
Road
Rail
Air
Water
Pipeline
S
Figure 5.3: Different Modes of Transportation
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Let us discuss various modes of transportation and their performance
in the context of India:
Road: Roads are the most widely used mode of transportation in
India. India has the second largest road network in the world es-
timated at 4.7 million kilometres. The road infrastructure is being
M
upgraded constantly as the National Highways Authority of India

(NHAI) is adding approximately 18 kilometres of roads daily (as of
October 2015). There is approximately 0.66 kilometres of road per
square kilometre of area in India. However, India severely lacks
lane roads. There are only 24,000 kilometres of 4 or 6 lane roads in
N
India. There are 3.8 kilometres of road per 1000 people as against
21 kilometres in the US.
Trucks are the primary source of road transportation in India. The
trucking industry consists of two major segments: Truck Load
(TL) and Less than Truck Load (LTL). TL operations are charged
for full truck irrespective of the quantity loaded. However, rates
tend to differ with the amount of distance travelled. TL operations
have relatively low fixed costs. The idle time and travel distance
between successive loads adds to the cost of TL operations. Carri-
ers, thus, try to schedule shipments to fulfill service requirements
while reducing both their trucks’ idle and empty travel time. On
the other hand, LTL operations are charged on the basis of quan-
tity loaded and distance travelled by trucks. These operations are
cheaper in comparison with TL operations.
Rail: Railways are another most important transport mode in
India for long distance and transportation of bulk commodities
at cheaper prices. The price structure and heavy load capability

n o t e s
makes rail an ideal mode for carrying large, heavy, or high-density

products such as consumer durables, cars, etc. over long distances
within the country. India has the third largest railway network un-
der single management in the world as of 2015. It transports about
7.651 billion passengers and 1,101 million tonnes of freight annual-
ly. The Indian railway network is more than 64,600 kilometres with
about 7,172 railway stations. About 19,000 trains run on a daily ba-
sis across the country. However, there can be long transportation
time involved in rail. Major operational issues in railroads include
vehicle and staff scheduling, track and terminal delays and late
delivery of products.
Air: Air transport is majorly used for consignments having per-
ishable and short-lived products. This is because shipments can
be delivered over long distances in a matter of hours through air
transport. At present, there are 23 international and 68 domestic
S
airports in India. Commercial planes are used as carriers in air
transport for the movement of goods. However, air transport is the
costliest mode of transportation. Presently, air transport consti-
IM
tutes relatively small amounts of freight. Major issues associated
with air carriers are identifying a location and number of hubs;
assigning planes to routes; establishing maintenance schedules for
planes; scheduling crews; managing prices; ensuring the availabil-
ity of planes at different prices; and so on.
Water: As per the recent data, there are 12 major and 187 minor
M
ports in India. While roads and railways are the most important
means of transportation within India, sea transport is the best for
international trade. Sea transport is used for transporting goods,
such as petroleum products, iron ore, coal, etc. India has approxi-
N
mately 14,000 kilometres of navigable rivers and canals but inland

water transportation is still at the nascent stage.
Water transport is used when there are large shipments such as
heavy machinery to be delivered at longer distances. It is used
more often by organisations due to low costs. It can be used to
transport all types of products, such as cars, grains, and apparel.
One major disadvantage of using water transport is that it is the
slowest among all modes of transport, which can result in delays.
Thus, it is not appropriate for short-haul trips.
Pipeline: The use of pipelines began in 1870 throughout the world.
Initially, pipelines were used for transporting petroleum products.
However, now they are used for transporting ammonia, alcohol fu-
els, coal and iron (in slurry form), hydrogen, water, natural gas,
etc. Pipelines are used for transporting crude petroleum, refined
petroleum products and natural gas. It is appropriate for trans-
portation of relatively stable and large flows of products. The cost
of constructing pipelines depends on three aspects: the diameter
of the pipe, the distance over which transportation has to be done
and the number of pumping stations required along the way.

n o t e s
India had over 5,000 kilometres of pipeline in 1980, whereas it is more

than 7,000 kilometres now. There are various advantages of pipeline
transport, such as lower cost of transportation, fewer transit losses,
economies of scale, environmental friendliness.
5. Roads are the most widely used mode of transportation in

India. (True/False)
6. The price structure and heavy load capability makes ________
an ideal mode for carrying large, heavy, or high-density
products, such as consumer durables, cars, etc. over long
distances within the country.
S
Activity
Using the Internet, prepare a report on the benefits and drawbacks

of different modes of transportation used for the shipment of goods.
IM
TRANSPORTATION INFRASTRUCTURE
5.5
AND STRATEGY
Transportation is crucial to the movement of products from one place
(production unit) to another (wholesaler/distributor/retailer). Thus, it
M
is of paramount importance for organisations to have well-maintained

transportation infrastructure that encompasses the availability of dif-
ferent mediums of transportation depending on the type of products
to be delivered. However, the transportation infrastructure and its
N
availability vary substantially from one country to another as well as

within the country. As discussed in the previous section, there are vari-
ous types of transportation options available for organisations, such as
roads, railways, sea (maritime), air, pipelines, etc. However, the selec-
tion of a particular option depends on the nature of products (perishable
or non-perishable) and delivery schedules of organisations. In order to
have well-maintained transportation infrastructure, it is important for
the organisations to have well-defined transportation strategy.
A strategy refers to a proposed plan of action that is developed to

achieve a long-term or overall goal. Companies develop and imple-
ment strategies and associated policy documents for all the functions
and sub-functions. For example, a company will have a different strat-
egy for HR and marketing functions. Similarly, in a supply chain, a
transportation strategy is all about selecting the best mode of trans-
portation that matches organisational requirements among all avail-
able alternatives. In other words, a transportation strategy aims at
having an effective transportation medium in place so that the prod-
ucts can be moved from one place to the other in a good condition. Or-
ganisations prepare a transportation strategy to manage and optimise
their transportation operations.

n o t e s
To develop and implement an effective transportation strategy, it is

important for an organisation to take into consideration the following
questions:
What is the type of business the organisation deals into?
What is the nature of products (perishable or non-perishable;
fast-moving or slow-moving, etc.)?
What are the demand patterns in the market?
What are the available modes of transportation and their respec-
tive costs?
Is there any requirement of intermediate distribution centre
(warehouse)?
What is the distance between production units and delivery points
(retail outlets)?
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What are all feasible route options available?
Whether the organisation has own logistics operations or out-
sourced logistics operations or a combination of both?
IM
What type of carrier policies does the organisation have for its lo-
gistics partners?
What is the level of integration among different transportation
processes?
Are people, processes and technology aligned?
M
An organisation may use an intermodal strategy to lower overall trans-

portation costs. The intermodal strategy focusses on the utilisation of
more than one mode of transportation for transporting goods. The
most common intermodal combination used by organisations is truck-
N
rail. Intermodal transport is best suited for global trade operations to

reach destinations located faraway. The major issues involved in in-
termodal transportation are the delays brought by shipment transfers.
Let us study about the transportation strategy of Dell. The company

follows a green transportation and logistics strategy that focusses on
using those modes of shipping that have minimal impact on the envi-
ronment and minimising packaging. This is done without increasing
transport costs.
(Source: http://www.supplychain247.com/article/4_supply_chain_lessons_from_att_
best_buy_dell/green)

n o t e s
The current strategy of Dell was developed in 2011 by its Global Ful-
fillment and Logistics (GFL) team. The important aspects of this strat-
egy include:
Transportation network optimisation: Dell makes an efficient
use of various modes of transportation such as air and water for
all processes including receiving raw materials, shipping the final
products, delivering services and accepting returns.
Air to sea initiative: Dell has launched an initiative to use sea
transport as much as possible instead of using air transport.
Retail partner expansion: Dell follows a strategy to consolidate all
orders in as few shipments as possible and fulfill the orders near
the point of delivery (retail partners).
Developing innovative internal processes: Dell focusses on con-
S
tainer optimisation and packaging innovations in order to reduce
waste and increase shippability.
Container optimisation: Dell always tries to use the maximum
IM
container space and increase container density to the highest level
because containers that have more density use less fuel and pro-
duce less carbon emissions.
Packaging innovation: Dell uses bamboo-based packaging for
lightweight products whereas it uses mushroom-based packaging
for heavier products. Also, to reduce packaging cost (part of trans-
M
port cost), paper and plastic used in shipping Dell products is re-
cycled and used again.
Product returns: Dell fixes issues in the returned products (about
94%) and sends them again for resale. However, the remaining 6%
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returned products, which cannot be fixed, are recycled.

Collaborating with partners: Dell’s strategy supports alignment
with logistics partners. The major logistics partners of Dell are
DHL, FedEx and UPS.
7. The __________ focusses on the utilisation of more than one

mode of transportation for transporting goods.
8. A transportation strategy aims at having an effective
transportation medium in place so that products can be moved
from one place to the other in a good condition. (True/False)
Activity
Study the transportation strategy of some major e-Commerce com-

panies in India and prepare a report on the same.

n o t e s
DESIGN OPTIONS FOR

5.6
TRANSPORTATION NETWORK
A transportation network is an arrangement of transportation infra-
structure (air, water, road, railways, etc.) to move goods from one place
(production unit) to another (distributor/wholesaler/retailer) or vice
versa in case of product returns. As discussed earlier, it is of utmost
importance for an organisation to have an efficient transportation
network in order to have a responsive supply chain. To design and
develop a transportation network, an organisation needs to take into
consideration various available modes of transportation. In general,
there are four types of transportation networks available for shippers,
which are:
Direct shipment network: This transportation network is de-
S
signed in such a way that all shipments are directly delivered from
different suppliers to their respective buyers’ locations. In this net-
work, the route of each shipment and the quantity to be shipped is
pre-determined. This type of network is used when the demand of
IM
the buyer is large [close to a truck load (TL)] so that the capacity
of the truck may not go waste. Figure 5.4 presents the structure of
direct shipment network:
Suppliers Buyer Locations

M
N
Figure 5.4: Direct Shipment Network

Direct shipping with milk runs: A milk run refers to a round trip
made by a vehicle on a particular route in which the vehicle either
delivers products from a single supplier to multiple retailers or de-
livers products from multiple suppliers to a single retailer and vice
versa. The shipper defines the route of each milk run in which
goods are delivered to multiple parties falling at the same route.
This helps the transporter in significantly reducing transportation
costs. Direct shipping with milk runs is shown in Figure 5.5:

n o t e s
Suppliers Buyer Locations Suppliers Buyer Locations
S
Figure 5.5: Direct Shipping with Milk Runs
Shipments via a central distribution centre: In this type of net-
work, a supplier does not send goods directly to a buyer (retail-
IM
er). A central distribution centre (CDC—a type of warehouse) is
made for a number of buyers or retailers belonging to the same
geographical region. The supplier sends shipments to the CDC,
which further ships the goods to the intended buyers or retailers.
Here, a CDC plays two roles: one as a transfer location and sec-
ond as a warehouse. It is used when supplier and buyer locations
M
are separated by large distances. The supplier usually supplies in

large quantities and the CDC can send the goods to the buyers
in small quantities as per the demand while the rest of the goods
are held in inventory. In this way, there is a reduction in overall
N
transportation cost. Figure 5.6 shows the structure of shipments

via CDC:
CDC
Figure 5.6: Shipments via a CDC

n o t e s
Shipping via CDC using milk runs: This type of transportation

network is devised as an extension to direct shipping with milk
runs. The working of this network is similar to direct shipping with
milk runs except the addition of a CDC between the supplier(s) and
buyer(s). In milk runs, all small shipments can be combined, which
lead to reduced transportation costs. However, suppliers have to
bear additional warehousing costs as goods are transported as per
the demand. Figure 5.7 shows shipping via CDC using milk runs:
CDC
S
IM
Figure 5.7: Shipping via CDC using Milk Runs
M
9. A transportation network is an arrangement of transportation

infrastructure to move goods from __________ to distributor/
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wholesaler/retailer.
10. If the demand of the buyer is approximately equal to Truck
Load (TL), which of the following design options will be used
for transportation?
a. Direct shipment network
b. Direct shipping with milk runs
c. Shipments via a Central Distribution Centre (CDC)
d. Shipping via a CDC using milk runs
Activity
Prepare a list of 10 Indian companies that use milk runs while opti-
mising their transportation design.

n o t e s
5.7 TRANSPORTATION COSTS

Transportation costs (both inbound and outbound) are the most
important part of the overall logistics cost. This is because about
one-third to two-thirds of the total logistics costs is attributed to trans-
portation costs. Transportation costs comprise container costs, pallets,
labour and time costs, fuel costs, etc. However, transportation costs
usually vary across organisations depending on the nature, quantity
and weight of products. For example, if a product is small in size and
has low weight, transportation costs will be low. On the contrary, if
the product being transported is big, bulky and low-valued, transpor-
tation costs would be high. In case of low transportation costs, the
organisation may earn high revenues. However, if transportation costs
are high, it will make supply chain managers to revise the transporta-
tion strategy.
S
From 1990s till late 2000s, there was high availability of transporta-
tion infrastructure at low prices and the costs of holding inventory
were comparatively higher. This led to the development of fast and
IM
frequent delivery mechanisms such as Just-In-Time (JIT) and lean
systems. However, the prices of crude oil have been unstable since the
late 2000s, which has led to frequent changes in transportation costs.
These changes have created a need for organisations make shifts in
their supply chain strategies on a regular basis. In the last decade,
organisations have made three major shifts in their supply chain strat-
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egies, which are:

Shift from offshoring to near shoring: It aims at reducing the
distance shipments have to travel before reaching the final users.
It also reduces expensive cross-country movements. In addition,
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freight movements can also be adjusted as per the changing de-

mand of the final users.
Shift from ordinary product design to shippable product design:
Organisations nowadays develop product design and packaging in
a manner that can achieve space efficiency and increase the ease
of handling. This is done to enhance the shippability of products.
Shift from lean systems to hybrid lean systems: Hybrid lean sys-
tems are the combination of lean and ordinary supply chain strate-
gies. For example, the combination of lean system and agile supply
chain strategy is called leagile supply chain strategy.
Supply chain managers may take certain steps for reducing transpor-
tation costs, which are as follows:
Including third-party logistics (3PL) operators as they help in op-
timising the freight network
Working closely with carriers
Consolidating shipments
Measuring carrier performance on a continuous basis

n o t e s
Exhibit
New Shipping Container Rule for Avoiding

Ship Accidents
The world has witnessed various ship disasters in the recent histo-
ry. For example, in January, 2007, MSC Napoli, which was a 275-me-
ter long ship carrying oil was caught in stormy weather and it was
ultimately wrecked. It has been noticed that two major causes of
such sea accidents were unpredictable weather conditions, which
sometimes become so drastic that they cannot be faced, and over-
loading of ships with more weight than their capacity. The first
cause is a natural one and hardly any steps can be taken for lower-
ing such risks. However, the second cause is man-made, which can
be checked.
S
IM
M
In order to reduce the instances of ship disasters due by man-made

causes, recently, a new shipping safety rule has been introduced.
According to this rule, all the containers must be weighed before
they are loaded on the ships. This will help in reducing ship ac-
N
cidents. However, according to most of the companies (retailers,

manufacturers and logistics companies), this rule will lead to in-
crease in transport costs and delays in shipping. This rule will be
applicable from July 2016 onwards in 171 countries.
As per the new rule, exporters would be required to certify the
weight of the containers before loading them onto the ship. Ship-
ping companies require these weights to avoid overloading of ships.
In addition, this practice will also make shippers liable to weigh
containers and if they are found violating this rule in the case of
any ship disaster, they can be held responsible. However, most of
the shippers and carrier owners are not aware of the new rules and
have little or no idea as to how this practice would be enforced.
This rule along with many other rules has been framed by various
government representatives along with shipping industry associa-
tions. These rules have been adopted by the International Maritime
Organisation (United Nations arm to regulate shipping safety) in 2014.
(Source: http://www.wsj.com/articles/new-shipping-container-rule-riles-
exporters-1449243222)

n o t e s
11. List any two components of transportation costs.
Activity
Assume that you are the supply chain manager of a logistics organ-
isation. Your organisation has clients in various parts of the world,
especially the US. What steps can you take to reduce logistics costs
to increase your organisation’s revenue?
5.8 SUMMARY
In order to maintain a responsive supply chain network, an or-
S
ganisation must implement an effective transportation network.
A transportation network is said to be effective if goods reach the
desired destination on time at economical costs.
IM
In present times, transport managers face various challenges, like
increasing customer expectations, varying fuel prices, equipment
shortage, economic uncertainties, high labour cost, stringent safe-
ty and social regulations, technological advancement and so on.
The major transportation decisions taken by managers are mode
selection decisions, lane operation decisions and dock-level deci-
M
sions.
There are various types of transportation modes available for the
organisations. These are road, rail, air, water and pipeline.
Transportation is crucial to the movement of products from
N
one place (production unit) to another (wholesaler/distributor/

retailer).
The selection of a particular mode of transport depends on the
nature of products (perishable or non-perishable) and delivery
schedules of the organisations.
In a supply chain, a transportation strategy is all about selecting
the best mode of transportation that matches organisational re-
quirements among all the available alternatives.
Organisations prepare a transportation strategy to manage and
optimise their transportation operations.
To develop and implement an effective transportation strategy, the
organisations take into consideration questions such as: type of
business the organisation deals into, demand patterns in the mar-
ket, etc.

n o t e s
To design and develop a transportation network, an organisation

needs to take into consideration various available modes of trans-
portation.
There are four types of transportation networks available for ship-
pers, including direct shipment network, direct shipping with milk
runs, shipments via central distribution centre and shipping via
CDC using milk runs.
Itis of utmost importance for an organisation to have an efficient
transportation network in order to have a responsive supply chain.
Transportation costs (both inbound and outbound) are the most
important part of the overall logistics cost.
Iftransportation costs are high, it will make supply chain manag-
ers to revise the transportation strategy.
S
key words
Cloud computing: It can be defined as a technique of using

IM
computing services, such as software and hardware as a service
over a network.
Less-than-truckload: It refers to the transportation of compar-
atively small freight.
Truckload: It refers to the minimum amount of load that is
needed for the shipping of goods at predetermined rates.
M
Mushroom-based packaging: It refers to a type of protective

packaging that is developed by using mushroom materials,
which includes renewable biomaterial grown from fungal my-
N
celium.
Lean system: It is a type of production methodology that em-
phasises eliminating waste and non-value adding activities and
improving production efficiency.

1. Describe some major transportation decisions taken by managers.
2. Discuss the various modes of transportation and their
performance in the context of India.
3. What are the various factors that an organisation has to keep
into consideration while developing a transportation strategy?
4. Explain various design options for the transportation network.
5. Explain the importance of transport costs in supply chain
management.

n o t e s
Topic Q. No. Answer

Role of Transportation in a 1. Transportation
Supply Chain
2. False
Different Transportation 3. Mode selection decision
Decisions
4. True
Modes of Transportation and 5. True
their Performance
6. Rail
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Transportation Infrastructure 7. Intermodal strategy
and Strategy
8. True
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Design Options for Transpor- 9. Production unit
tation Network
10. a. Direct shipment network
Transportation Costs 11. Container costs, labour costs
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1. The major transportation decisions taken by managers are
mode selection decisions, lane operation decisions and dock-
level decisions. Refer to Section 5.3 Different Transportation
N
Decisions.
2. There are various types of transportation modes available for the
organisations. These are road, rail, air, water and pipeline. Refer
to Section 5.4 Modes of Transportation and their Performance.
3. An organisation must consider factors, such as nature of products,
available modes of transportation and their respective costs, all
feasible route options, etc. while developing a transportation
strategy. Refer to Section 5.5 Transportation Infrastructure
and Strategy.
4. There are four types of transportation networks available for
shippers, including direct shipment network, direct shipping
with milk runs, shipments via central distribution centre and
shipping via CDC using milk runs. Refer to Section 5.6 Design
Options for Transportation Network.
5. Transportation costs usually vary across the organisations depending
on the nature, quantity and weight of products. If transportation
costs are high, it will make supply chain managers to revise the
transportation strategy. Refer to Section 5.7 Transportation Costs.

n o t e s

5.11
REFERENCE
SUGGESTED READINGS
Simchi-Levi, D. et al (2004). Managing the Supply Chain: Definitive
Guide. Tata-McGraw Hill Publishing Limited.
Coyle,J. et al. (2011). Transportation: A Supply Chain Perspective.
South-Western Cengage Learning.
Hazen, J.K. and Lynch, C.F. (2008). The Role of Transportation in
the Supply Chain. CFL Publishing.
E-REFERENCES
S
Eyefreight. ‘The Role of Transportation in Supply Chain Manage-
ment’.
Manufacturing Business Technology. (2015). Reducing Supply
IM
Chain Costs With Better Transportation Logistics.
Bensinger, Greg. ‘Amazon Buys Semi-Truck Fleet to Shuttle In-
ventory’. WSJ. N.p., 2015. Web. 8 Dec. 2015.
M
N

N
M
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S
C h a
6 p t e r
Designing Distribution Networks and

Application to e-Business
CONTENTS
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6.1 Introduction
6.2 Role of Distribution in a Supply Chain
IM
Activity
6.3 Factors Influencing Distribution Network Design
Activity
6.4 Process of Distribution Network Design
M

Activity
6.5 Different Distribution Network Designs in a Supply Chain
N
Activity
6.6 Network Operations Planning
Activity
6.7 Network Design Problems
Activity
6.8 Role of IT in Network Design
6.8.1 Data for Network Design
Activity
6.9 Uncertainty in Network Design
Activity
6.10 Summary

n o t e s
DELL’S DISTRIBUTION NETWORK DESIGN
DELL, named after its founder, Michael Dell, is an American mul-

tinational computer technology that develops, sells and repairs
computers and other related products. It has brought a revolu-
tion in the personal computer industry. Dell has a direct distri-
bution network in which there are no retailers or resellers. The
key factor behind Dell’s success is innovation in the supply chain,
manufacturing and distribution strategy. It incorporates the latest
technology in its product lines. It keeps inventory for maximum
6 days as compared to its competitors where inventory is kept for
40 days only. Dell has earned a lot of success by directly dealing
with customers.
Customers have a benefit of approaching the company 24 hours
S
a day and 7 days a week. It deals with 10,000 customers per day
through e-mail or phone. Dell had started its Internet initiative in
the late 1980s to provide customer support. Through direct dis-
IM
tribution network designs, Dell offers customised system config-
uration at a discounted price which Dell can save by eliminating
retail middleman. Through this direct model, the organisation
is able to forecast demand trends and carry out segmentation
strategies.
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N

Designing Distribution Networks and Application to e-Business 125
n o t e s
learning objectives

>> Explain the role of distribution in a supply chain
>> Discuss the factors influencing distribution network design
>> List the steps in the distribution network design process
>> Explain different distribution network designs in a supply
chain
>> Describe network operations planning
>> Explain network design problems
>> Discuss the role of IT in network design
>> Explain uncertainty in network design
S
6.1 INTRODUCTION
IM
In the previous chapter, you have studied the designing and planning
of the transportation network. In this chapter, you will study how to
design distribution networks.
Distribution is a process of the flow of goods from the point where it

is produced (manufacturing site) to the point where it is to be con-
sumed (end-users). An effective analysis is required for designing a
M
distribution network. All the organisations cannot work on the same

distribution network. It differs from product to product and industry
to industry. The advent of technologies has simplified the function of
distribution.
N
The ability and inclination of the organisations to embrace these tech-

nologies play a key role in improving the distribution performance of
the organisations. Moreover, the implementation of advanced technol-
ogies in the distribution helps the organisations in many ways, such
as cost reduction, increased capital investments, easy communication,
reduced lead time, etc.
In this chapter, you will study the role of distribution in the supply
chain. Factors influencing distribution network design and network
operations planning are discussed in detail. The chapter also discuss-
es the role of IT in network design. In the end, the chapter discusses
uncertainty in network design.
ROLE OF DISTRIBUTION NETWORK IN A

6.2
Supply chain
Distribution is a process through which the manufactured products are
made available to the end-customers. A mode through which products
are transferred to the final users is called distribution channels. These

n o t e s
modes can be middlemen or intermediaries, such as wholesalers and

retailers. An organisation can make its product available in the mar-
ket by using one or more distribution channels. Distribution plays a
crucial role in the success of an organisation by making the product
available at the right time to the right users. An effective distribution
mechanism is able to widen the customer base of the organisations by
reducing response time and providing fast product delivery. A delay
in the delivery of products may cause customer dissatisfaction. In ad-
dition, a better distribution mechanism saves the supply chain cost,
which results in high profitability.
Thus, an organisation needs to have a well-defined and organised

distribution network for its supply chain. The design of a distribu-
tion network differs across organisations based on their distribution
needs. There are generally three types of distribution networks in a
supply chain, which are discussed as follows:
S
Direct distribution network: In this network, there is no mid-
dleman and products are made available to consumers through
manufacturer-owned retail stores or door-to-door sales. Examples
IM
include Tupperware, Eureka Forbes and Asian Sky Shop. The cir-
cumstances under which the direct distribution network is used
are:
Local market: This is situated near a production unit. For in-
stance, fast-moving consumer goods (FMCG) manufacturers
M
(such as manufacturers of bread, biscuits, juice, etc.) make

their products available in the local market directly.
Small lot size: This is a small quantity of products according to
the requirements of individual customers. Manufacturers cre-
N
ate products in bulk and sell them in small sizes through super
bazaars and departmental stores directly.
Indirect distribution network: This type of network is used by
large-scale manufacturers since they produce goods in bulk. Thus,
they need to sell goods through wholesalers, agents or retailers.
This network can be of two types, which are discussed as follows:
Single-party selling network: It includes only one middleman
between manufacturers and customers in the form of online
retailers and retail stores.
Multiple-party selling system: It involves two or more middle-
men for distributing products to the end-users.
Hybrid (mixed) distribution network: This is a combination of
more than one distribution network for reaching out to custom-
ers. Examples include online stores, wholesalers, retail stores and
vending machines to sell products and services. The benefits of
the hybrid distribution network include lower distribution costs
and increased market penetration with the use of a suitable distri-
bution channel and just-in-time delivery of products and services.

n o t e s
1. In which network there is no middleman and products are

made available to consumers through manufacturer-owned
retail stores or door-to-door sales?
a. Direct distribution network
b. Indirect distribution network
c. Hybrid (mixed) distribution network
d. Seller distribution network
2. Single-party selling network is a part of hybrid distribution
network. (True/False)
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Activity
Find information on the distribution network of any two Indian

manufacturers.
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FACTORS INFLUENCING DISTRIBUTION
6.3
NETWORK DESIGN
Distribution network design decisions of the organisations are influ-
enced by many factors. Therefore, it is of paramount importance for
M
the organisations to thoroughly take into consideration these factors.

This is because any wrong decision at any phase may bring serious
effects to the entire distribution network of an organisation. Figure 6.1
shows the factors that affect network design:
N
Organisation’s Strategy
Organisational Infrastructure
Technological Factors
Macroeconomic Factors
Political Factors
Figure 6.1: Factors Affecting Distribution Network Design
Let us discuss these factors in detail.

Organisation’s strategy: The decision of a distribution network
design largely depends on the overall strategy of an organisation.

n o t e s
For example, the organisations focussing on the minimisation of

cost look for low-cost manufacturing locations near the consump-
tion points. On the other hand, the strategy of some organisations
focusses on attaining supply chain efficiency. For example, Zara,
an apparel manufacturer, did not move its manufacturing plant
outside the US. This is because Zara’s strategy is to increase the
responsiveness of its supply chain.
Organisational infrastructure: If the organisation has poor in-
frastructure, it incurs additional costs. The availability of good in-
frastructure is the primary requirement for locating a facility in
any area. Availability of sites, labour, proximity to transportation,
availability of local utilities, etc. are infrastructure elements.
Technological factors: The decision of a distribution network de-
sign depends on technological factors. If an organisation uses a
S
cutting-edge manufacturing technology for achieving the econo-
mies of scale, high-capacity locations are the best choice for the
organisation.
IM
Macroeconomic factors: These include tax incentives, tariffs and
exchange rates. These are external factors that cannot be con-
trolled by an organisation. An organisation may not opt for loca-
tions where there are high tariffs applicable.
Political factors: Politically stable nations not only provide a mar-
ket base to the manufacturers but also have well-defined rules and
M
laws regarding trade and commerce. Organisations always prefer

to invest or conduct business in countries that have a politically
stable framework. On the other hand, an unstable political gov-
ernment may create legal hassles for the organisations. Therefore,
organisations consider political stability as one of the important
N
factors in making decisions related to the distribution network.
3. The availability of good infrastructure is the primary

requirement for locating a facility in any area. (True/False)
4. __________include tax incentives, tariffs and exchange rates.
Activity
Research on the Internet how the government influences the de-

sign of distribution networks of the organisations.
Process of Distribution Network

6.4
Design
Manufacturers always strive to reach out to customers within a short
time to earn profits and gain customer loyalty. For this, they need to

n o t e s
design an effective distribution network. Designing a distribution net-

work is a systematic process that involves a number of steps, which
are shown in Figure 6.2:
Studying customer service needs
Defining distribution network objective
Identifying major distribution network alternatives
S
Evaluating major distribution network alternatives
Figure 6.2: Steps in Designing a Distribution Network

IM
Let us discuss these steps in detail.
1. Studying customer service needs: In this step, the service needs
of a particular customer segment are identified and analysed.
For example, consumers of FMCG products need timely delivery
and convenience in buying products. Thus, in this case, a
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manufacturer would require a distribution network that is highly

responsive with a short cycle time.
2. Defining distribution network objectives: This step involves
determining the goals of a distribution network after analysing
N
customers’ needs. For example, the objective of the distribution

network of grocery items would be to achieve responsiveness
and efficiency, whereas the distribution network of an online
shopping retailer aims to gain cost effectiveness and maintain
product quality even if the response time is long (in some cases).
By defining goals and objectives, an organisation can design a
network that best meets its requirements.
3. Identifying major distribution network alternatives: As studied
earlier, different distribution network options or alternatives are
available to organisations to choose from. In case a particular
option does not yield the desired results (such as being unable
to reach out to customers on time), an organisation may look for
other design alternatives. For instance, if an organisation aims to
achieve responsiveness of its distribution network, it may choose
from options like distributor storage with last mile delivery or
manufacturer or distributor storage with consumer pickup. For
this, an organisation has to consider the pros and cons of each
alternative with respect to its distribution requirements in order
to select the most appropriate distribution network option.

n o t e s
4. Evaluating major distribution network alternatives: In this

step, the most suitable and profitable distribution network to
reach out to customers from all the identified alternatives is
selected. This is done by evaluating the strengths and weaknesses
of each distribution alternative and taking into account various
supply chain drivers and constraints. Generally, organisations
adopt a distribution network that can be effectively controlled
and managed.
Exhibit
Framework for Network Design
A framework for the distribution network is a structure that reflects

the working of the product distribution function of an organisation.
The distribution framework of any organisation can be divided into
S
various phases. An organisation needs to make important decisions
at every phase of the framework. The following figure shows the
framework for a distribution network:
IM
Phase I: Decision
Stages of supply related to supply Corporate strategies
chain system chain
strategy/design
Cost of logistics
M
Exchange-risks and
Phase II: Decision
political-risk
related to the Existing and rising
regional facility competitors
Regional tariffs and
configuration
tax incentives
Response time
N
Phase III:
Production Available
Decision related to
methodology infrastructure
potential sites
Figure: Framework of Network Design Decisions
Let us now discuss the decisions taken at each phase of the frame-
work.
Phase I: Decisions related to supply chain strategy/de-
sign: This phase encompasses decisions related to supply chain
sourcing (which has been discussed in detail in the previous
units). In this phase, the supply chain requirements of an or-
ganisation are aligned with customers’ requirements. After
that, decisions related to supply chain capabilities are made in
this phase.
Phase II: Decisions related to regional facility configura-
tion: This phase starts with the demand forecasting of products.
It helps in determining whether customers’ requirements are

n o t e s
homogeneous or vary across different regions. Homogeneous

requirements favour large consolidated facilities, whereas var-
ied requirements need small and localised facilities. There are
different factors associated with regions that influence facility
configuration decisions. Some of these factors are as follows:
Exchange and political risks of regional markets
Regional tariffs and tax incentives
Existing and rising competitors of every region
Response time desired by customers in each regional market
Cost of logistics in each region

Based on the above information, an approximate number of fa-
cilities in the distribution network for each region is decided.
S
Moreover, an organisation also decides whether a facility would
produce a few products for all markets or a particular market.
Phase III: Decisions related to potential sites: Decisions
IM
regarding a potential site is taken on the basis of analysis of the
available infrastructure that can support the desired produc-
tion methodology. Infrastructure requirements can be of two
types, namely hard infrastructure requirement and soft infra-
structure requirement. The availability of suppliers, transporta-
tion services, communication, utilities, and warehousing infra-
M
structure is referred to as hard infrastructure, whereas the soft

infrastructure includes the availability of a skilled workforce,
employee turnover and community receptivity to business and
industry.
N
5. Different distribution network options or alternatives are

available to the organisations to choose from. (True/False)
Activity
Suppose you are the in-charge of a newly established apparel facto-

ry. What steps would you take to design your distribution network?
Different DISTRIBUTION NETWORK

6.5
DesignS IN A SUPPLY CHAIN
A distribution network is designed after considering different aspects
of a supply chain, such as whether the products or services would be
delivered directly or through intermediaries, such as wholesalers and
retailers, to customers. This design varies across organisations based
on their distribution needs. There are different distribution network

n o t e s
designs available for the organisations to choose from based on their

requirements. Figure 6.3 shows different designs of a distribution net-
work:
Manufacturer storage with direct shipping

and in-transit merge
Distributor storage with package carrier delivery
Distributor storage with last mile delivery
Manufacturer/distributor storage with

costumer pickup
S
Retail storage with customer pickup
IM
Figure 6.3: Different Designs of a Distribution Network
Let us now discuss these designs in detail.

Manufacturer storage with direct shipping: Retailers get or-
ders from customers and assign these orders to the corresponding
manufacturers, who deliver products to customers directly. For in-
M
stance, customers can place their orders through online shopping

portals, such as flipkart.com, amazon.in and myntra.com. However,
customers receive their products from manufacturers. This kind of
delivery is also called drop shipping. Figure 6.4 depicts this model:
N
Manufacturer
Retailer
Customers
Product Flow
Information Flow
Figure 6.4: Manufacturer Storage with Direct Shipping

This design option requires extensive information infrastructure
as an accurate information must be given to customers about de-
livery status and product availability. In drop shipping, response
time tends to be higher because order details are communicated

n o t e s
from retailers to manufacturers, post which the order is shipped

to customers. This design generally works best for low volume and
high cost items that have low demand where customers can wait
for the order. There should be only minimal sourcing locations for
each customer order that makes drop shipping successful.
Manufacturer storage with direct shipping and in-transit merge:
In this type, the pieces of the order coming from different locations
(different manufacturers) are combined to make a single delivery
to the customer. Therefore, a customer has multiple orders but re-
ceives a single delivery. In this option, transportation cost is lower
as compared to drop shipping because products are first merged
before they are delivered to customers. Figure 6.5 depicts the in-
formation and product flows for the in-transit merge network:
S
Factories
IM
In-transit merge by Carrier
Retailer
Customers
M
Product Flow
Information Flow
Figure 6.5: Manufacturer Storage with Direct Shipping

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For example, a customer places a single order through flipkart.

com to order different kitchen items of different brands. To pro-
cess this order, Flipkart would merge all these items from different
manufacturers in order to make a single delivery to the customer.
This process of merging different products from different manu-
facturers to make a single delivery is called in-transit merge.
The response time of this design is comparable to drop shipping
where customers need to wait for a reasonably long duration.
However, customers are possibly to have better experience as they
get a single delivery for even multiple orders. The only drawback
of in-transit merge is that it needs additional efforts at the end of a
retailer end to merge orders.
Distributor storage with package carrier delivery: This distri-
bution design is ideal for fast-moving and medium items. This de-
sign is used by W.W. Grainger, one of the industrial distributors
of lighting, motors, fasteners, material handling, safety supplies,
plumbing and tools. In this option, retailers or distributors hold
inventory in intermediate warehouses. Package carriers transport
products from an intermediate location to the end-customer. Prod-

n o t e s
ucts are delivered to customers through package carriers from an

intermediate location. Figure 6.6 depicts information and product
flows when using distributor storage with delivery by a package
carrier:
Factories
Warehouse Storage by Distributor/Retailer
Customers
S
Product Flow
Information Flow
Figure 6.6: Distributor Storage with Package Carreir Delivery

IM
Transportation costs are lower as economical modes of transpor-
tation, such as truckload, are used. In addition, information infra-
structure is less complex because information sharing happens
only at a single level, that is, between a distributor and a customer.
The response time is smaller as compared to manufacturer stor-
age. This is because the warehouses of distributors and retailers
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are generally situated near to customers.

Distributor storage with last mile delivery: Last mile delivery
refers to a mechanism where the distributor or retailer directly
delivers products to end-customers. It requires a distributor ware-
N
house to be much closer to the customer, increasing the number of

warehouses required. The use of this delivery is generally done for
distributing high-demand and fast-moving products such as gro-
cery items. Figure 6.7 depicts the distributor storage with last mile
delivery network:
Factories
Distributor/Retailer
Warehouse
Customers
Product Flow
Information Flow
Figure 6.7: Distributor Storage with Last Mile Delivery

n o t e s
In this design option, the response time is less and information

infrastructure is less complex. The delivery of products is made
within 24 hours and such a fast service is charged by many distrib-
utors. Therefore, this option is appropriate where orders are large
and customers are willing to pay to avail the services.
Manufacturer or distributor storage with consumer pickup: In
this network design, the inventory is stored at the manufacturer
or distributor warehouse but customers come to a pickup centre
to collect the orders after placing the order over phone or online.
Customers order over phone calls or through online portals and
choose a pickup point of their orders on their own. Transportation
cost in this design option is lower in comparison to other design
options. This is because in this case, customers are responsible to
pick up their respective orders. Figure 6.8 depicts manufacturer or
distributor storage with consumer pickup:
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Factories
IM
Retailer Cross Dock DC
Pickup sites
M
Customers
Customer Flow
Product Flow
N
Information Flow
Figure 6.8: Distributor Storage with Consumer Pickup

For this distribution network, an organised and well-maintained
information infrastructure is needed. In this case, the response
time is neither too long nor too short. Customers receive the pick-
up information right after placing the order. After this, the order is
moved from the warehouse of a distributor or manufacturer to the
pickup site for customers from where they can pick up.
Retail storage with customer pickup: In this design option, inven-
tory is kept in retail stores. Customers can choose either placing
an order over the phone or Internet or walking in stores. Trans-
portation cost is much lower as compared to any other distribution
option because products just need to be shipped from production
units to stores. A very simple information infrastructure is needed
because customers can contact over the phone or Internet or walk-
in to stores for obtaining any information. The response time is
less due to the storage of inventory locally.

n o t e s
6. In which network design the pieces of the order coming from

different locations (different manufacturers) are combined to
make a single delivery to the customer?
7. Distributor storage with package carrier delivery is ideal for
fast-moving and medium items. (True/False)
Activity
Find information on the companies following manufacturer storage

with direct shipping design.
6.6 Network Operations planning
S
Earlier, distribution networks of the organisations were passive. How-
ever, they have now been converted into active networks as they are
IM
equipped with high-tech communication infrastructure and effective
data analysis and monitoring techniques. Maintaining an efficient
distribution network depends on the level to which distribution op-
erations are planned. For this, organisations use various planning
methods. One of such methods is to match the pattern of demand and
supply of a product in order to plan its distribution pattern. This is be-
cause it is the product demand that drives the operations of the supply
M
chain network. The demand for a product depends upon the following
attributes:
Demand rate: The demand rate can be calculated by estimating
the total demand across all Stock Keeping Units (SKUs).
N
Demand mix: This is the percentage split of each SKU to the total
demand.
For example:
Demand for SKU-A: 16 units/day
Demand for SKU-B: 25 units/day
Demand for SKU-C: 31 units/day
Demand rate = 72 units/day
Demand mix for SKU-A = 22.2%
Demand mix for SKU-B = 24.7%
Demand mix for SKU-C = 43.1%

n o t e s
Figure 6.9 shows the type of supply required for matching the type of
demand:
Repetitive Supply
Last Time Supply

One-time Supply
Seasonal Supply
Branch Supply
Continuous Demand
Seasonal Demand
Promotional Demand
S
One-time Demand
IM
Figure 6.9: Matching Demand and Supply
Let us discuss the type of demand that may arise in a supply chain.
Continuous demand: It is a demand that is unceasing in nature.
Products, such as bread, milk, cereals, etc. have continuous de-
M
mand.
Seasonal demand: This demand varies from season to season. For
example, woollen clothes in winters and air conditioners in sum-
mers.
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Promotional demand: This demand is influenced by advertising,

discount coupons, etc. For instance, apparel stores promote the end-
of-the season inventory by introducing various discount schemes.
One-time demand: This demand is rare demand in which a single
customer places a single order. This is common in engineer-to-or-
der business.
The types of supply required for matching the above demands are
discussed as follows:
Flow supply: This supply is made for matching continuous de-
mand. Supply flows continue until all raw materials finish up.
Batch supply: Products are divided into batches. Supply contin-
ues until the batch is consumed.
Repetitive supply: This supply follows an unbroken flow.
Seasonal supply: This supply is as per the season.

n o t e s
8. The _____________can be calculated by estimating the total

demand across all Stock Keeping Units (SKUs).
Activity
Using the Internet, find information on how seasonal demand is

balanced with seasonal supply in distribution network of air con-
ditioners.
6.7 Network design Problems

The design of a distribution channel depends on the level of services
S
expected by customers and the type of products. The three major de-
cisions related to designing a distribution channel are to:
Decide the role of a distribution channel to achieve organisational
IM
objectives.
Define the intensity of a product distribution channel.
Decide the need of a particular intermediary to achieve the objec-
tives of the organisation.
While designing a distribution network, there are a number of prob-

M
lems that need to be tackled. The major problems in distribution net-

work design are as follows:
Warehouse location: This affects the cost of transportation. If a
warehouse is located close to a customer base, it greatly reduces
N
transportation and operational costs. Therefore, choosing a loca-

tion to build a warehouse is a major challenge.
Visibility: It is all about making a transparent flow of information
related to orders, shipment, number of units, vehicles, etc. among
all supply chain partners. This can be done by making optimal util-
isation of advanced technologies such as Management Informa-
tion System (MIS). Improving visibility in a supply chain would
benefit an organisation in multiple ways.
Training of channel members: Channel members represent or-
ganisations by selling their products in the market. In such a case,
any mistake at the members’ end may affect the reputation of an
organisation. Therefore, it is essential for an organisation to train
its channel members by conducting various capability-enhancing
programmes for them.
Conflicts handling: A complex distribution network design may
lead to conflicts between channel members due to unclear roles
and responsibilities. Conflicts may arise when two or more chan-
nel members compete for the same market share and operate at

n o t e s
different levels of distribution. The conflict of Hindustan Unilever

Limited with its distributors on the issue of commission is an ex-
ample of such a conflict.
Amendments in channel design and arrangements: An organi-
sation intends to modify distribution network design when it does
not work as planned due to various reasons, such as changes in
customers’ preferences, level of competition and introduction of
new distribution means. Amendments can take place in channel
design in terms of adding or eliminating any channel members or
developing new ways to sell goods.
Access to the latest technology: The world of technology is con-
tinuously changing at a very fast pace due to rapid innovation and
development. Distribution networks in a supply chain too demand
highly technological advancements. It is a challenge for the organ-
S
isations to decide and maintain a balance between their require-
ment for a technology and the budget to acquire it.
Multichannel capability: Due to rapid increase in online orders
IM
and international shipping and returns, distribution design must
be capable of quickly reacting to different order channels and pro-
cessing order distribution smoothly and efficiently. Future software
must fulfill the requirements of e-Commerce and multi-channel
sales.
M
9. A complex distribution network design may lead to conflicts

between channel members due to unclear roles and
responsibilities. (True/False)
N
Activity
Assume yourself the distribution manager of a manufacturing com-

pany. What problems may you face while designing a distribution
network?
6.8 ROLE of IT IN Network design

Information technology helps in integrating entire supply chain dis-
tribution set up and enables an organisation to achieve higher service
levels, maintain lower inventory and incur lower supply chain costs.
Implementing IT applications in supply chain operations quickens
processes, reduces the occurrence of errors and facilitates informa-
tion flow, which, in turn, helps organisations to better coordinate with
retailers, suppliers and customers.
Information technology is the backbone for a distribution network. It

helps from the point a customer places an order to the point when the

n o t e s
customer gets the final product. A better information system results

in satisfactory customer experience and increased revenues for an or-
ganisation. For example, organisations nowadays have an information
system that enables customers to track the status of products in tran-
sit through messages or e-mails.
e-supply chain management (e-SCM) is one such web technology

that helps in effective network design by managing the flow, both up-
stream and downstream, within and outside an organisation. It also
supports the initial product design, procurement of raw materials,
shipping, distribution, warehousing, etc. e-SCM also benefits in net-
work design to streamline and manage logistics. An effectively imple-
mented e-SCM can benefit an organisation in network designing in
the following ways:
Binds together all channel members from the acquisition of raw
S
materials to the final point of distribution.
Enables all channel members to have real-time market informa-
tion so that they can anticipate and adjust their operations with
IM
respect to the changing market conditions.
Helps in optimising inventory levels and eliminating costly stock-
piling against demand spikes, freeing up resources and reducing
costs.
Lowers costs, improves speed of delivery and increases the accu-
M
racy of data shared within a supply chain.

Creates value for an enterprise by integrating its operations with
those of its supply chain partners and shareholders.
N
6.8.1 Data for network design
Data is crucial to successful functioning of an organisation. A distribu-

tion network is built over the data collected from the various sources.
While designing a distribution network, a large amount of data is re-
quired. This data pertains to the following:
Different types of network designs
Cost of designing networks
Objectives of a network design
Number of customers
Areas of distribution
Policies of the organisation
Jobs in progress
Data on faults and measurements

n o t e s
10. ______________________is a web technology that helps in

effective network design by managing the flow, both upstream
and downstream, within and outside an organisation.
Activity
Find information on the role of Customer Relationship Manage-

ment (CRM) system of an organisation in a distribution network.
6.9 uncertainty in network design

There is a significant investment made in the designing of distribution
S
networks. Investment decisions once made cannot be altered in the
long run. Thus, it is necessary for the organisations the to evaluate all
the factors in a supply chain before making any investment. It should
be noted that all the decisions or investments made will be successful
IM
as per the plan. However, various uncertainties may hamper the oper-
ations of network design. These uncertainties in network design may
occur due to fluctuating demand, changing prices and exchange rates,
level of competition, etc.
A network design that looks perfect under the current environment

M
may fail if the situation changes. For example, if there is uncertainty

in demand for products, the organisation may prefer production ca-
pacity, which is flexible in nature to avoid increase in costs. Following
decisions are taken for planning network designs under uncertain sit-
uations:
N
Integratingstrategic planning with financial planning during net-

work design
Using various metrics for evaluating network designs
Using financial analysis as an input to decision-making
Using estimates along with sensitivity analysis
A methodology is necessary for estimating the uncertainty in network

design decision-making process. One of the important methods for
taking uncertainty in account is the decision tree. It is a graphical de-
vice for taking decisions under uncertainty. In decision tree analysis,
alternatives for a particular decision are generated and represented
as the branches of a decision tree that come out of a decision node.
A decision tree has three types of nodes, namely the decision node,
chance/alternative node and the end node. However, representing the
end node is not compulsory. Figure 6.10 shows the example of a deci-
sion tree:

n o t e s
Outcome 1
A Outcome 2
C
Outcome 3
1
Outcome 4
Outcome 5
2
Outcome 6
B
S
Outcome 7
Decision Uncertainty
IM
Figure 6.10: An Example of a Decision Tree
These trees are helpful in taking decisions when there are uncertain-
ties in network design due to the fluctuating prices, exchange rates
and demand. Following are the steps taken for decision-tree analysis:
M
1. Defining the time period for which a decision is evaluated

2. Identifying factors that will be considered; for example, demand,
price, etc.
N
3. Representing uncertainty associated with a particular network

design
4. Deciding the periodic discount rate for each period
5. Defining states for each period
6. Identifying the optimal decision and expected cash flows at each
decision
11. ____________________ is a graphical device for taking decisions

under uncertainty.
Activity
What other techniques can be used in network design under uncer-

tain situations?

n o t e s
6.10 SUMMARY
Distribution plays a crucial role in the success of an organisation
by making the product available at the right time to the right users.
An effective distribution mechanism is able to widen the custom-
er base of organisations by reducing response time and providing
fast product delivery.
Distributionnetwork design decisions of the organisations are in-
fluenced by many factors. The factors affecting distribution net-
work are organisation’s strategy, organisational infrastructure,
technological factors, macroeconomic factors and political factors.
The process of distribution network includes the following:
Studying customer service needs
Defining distribution network objectives
S
Identifying major distribution network alternatives
Evaluating major distribution network alternatives
IM
The different design options available for networks are:
Manufacturer storage with direct shipping and in-transit merge
Distributor storage with package carrier delivery

M
Distributor storage with last mile delivery

Manufacturer/distributor storage with costumer pick-up
Retail storage with customer pick-up
N
Maintaining an efficient distribution network depends on the level

to which distribution operations are planned. For this, the organ-
isations use various planning methods. One of such methods is to
match the pattern of demand and supply of a product in order to
plan its distribution pattern.
While designing a distribution network, there are a number of
problems that need to be tackled, such as warehouse location, vis-
ibility, conflict handling, etc.
Information technology is the backbone for a distribution network.
It helps from the point a customer places an order to the point
when the customer gets the final product. A better information
system results in satisfactory customer experience and increased
revenues for an organisation.
A network design that looks perfect under the current environ-
ment may fail if the situation changes. For example, if there is
uncertainty in demand for products, the organisation may prefer
production capacity which is flexible in nature to avoid increase
in costs.

n o t e s
key words
Engineer-to-order business: It is a process in which a product

is designed only when order is received.
Exchange rate: It is defined as the value of one currency with
respect to another.
e-SCM: This is the process of using e-business concepts and
web technology for managing supply chain networks.
Supply chain management: It is the management of all activi-
ties that are performed at different stages of production for ef-
fective product delivery in the market.
Tariffs: These are various kinds of duties paid when products
or equipment are moved across the boundaries of cities, states
S
and nations.

IM
1. How do distribution networks help in supply chains?
2. What factors influence network design decisions? Explain them.
3. Explain the process of designing distribution networks.
4. Write a note on network operations planning.
M
5. Describe the role of IT in network design.

N
answers for SELF ASSESSMENT QUESTIONS
Topic Q. No. Answer

Role of Distribution Network in 1. a. Direct distribution
a Supply Chain network
2. True
Factors Influencing Distribution 3. True
Network Design
4. Macroeconomic factors
Process of Distribution Network 5. True
Design
Different Distribution Network 6. Manufacturer storage with
Designs in a Supply Chain direct shipping and in-transit
merge
7. True
Network Operations Planning 8. Demand rate

n o t e s
Topic Q. No. Answer

Network Design Problems 9. True
Role of IT in Network Design 10. e-supply chain management
(e-SCM)
Uncertainty in Network Design 11. Decision tree

1. An organisation can make its product available in the market
by using one or more distribution channels. Refer to Section
6.2 Role of Distribution Network in a Supply Chain.
2. The factors affecting distribution network are organisation’s
strategy, organisational infrastructure, technological factors,
macroeconomic factors and political factors. Refer to Section
S
6.3 Factors Influencing Distribution Network Design.
3. Designing a distribution network is a systematic process that
involves a number of steps. Refer to Section 6.4 Process of
IM
Distribution Network Design.
4. Maintaining an efficient distribution network depends on the
level to which distribution operations are planned. Refer to
Section 6.6 Network Operations Planning.
5. Information technology is the backbone for a distribution
network. It helps from the point a customer places an order to
M
the point when the customer gets the final product. Refer to
Section 6.8 Role of IT in Network Design.

N
6.13
REFERENCE
SUGGESTED READINGS
Bolstorff
P., Rosenbaum R. (2007). Supply chain excellence. New
York: AMACOM.
Springer.
erence.
shey, PA: Idea Group Pub. (an imprint of Idea Group).

n o t e s
E-REFERENCES
Degruyter.com, (2012). Generalized Network Design Problems. Re-
trieved 9 December 2015, from http://www.degruyter.com/view/
product/179389
Indiadomain.com, (2015). Welcome to India Domain. Retrieved
9 December 2015, from http://www.indiadomain.com/escm_ebusi-
ness.htm
SearchITChannel, (2015). The importance of a network design plan.
Retrieved 9 December 2015, from http://searchitchannel.techtar-
get.com/tip/The-importance-of-a-network-design-plan
S
IM
M
N

C h a
7 p t e r
PRICING AND REVENUE MANAGEMENT
CONTENTS
S
7.1 Introduction
7.2 Role of Pricing and Revenue Management in Supply Chain
IM
Activity
7.3 Revenue Management for Multiple Customer Segments
7.3.1 Pricing under Capacity Constraints for Multiple Segments
Activity
M
7.4 Revenue Management under Uncertain Demand and Limited Capacity

Situations
Activity
N
7.5 Revenue Management for Inventory Assets: Markdown Management

Activity
7.6 Innovative Pricing
Activity
7.7 Summary

n o t e s
BoostING Revenue AND Brand Value by WORKING

ON THE Supply Chain
Consumers are willing to pay more and wait longer for sustain-
ably delivered products, but supply chain executives aren’t mak-
ing sustainability a high-enough priority, according to a study by a
business and technology consulting firm, West Monroe Partners.
The study reveals that 49 per cent supply chain executives of

North America don’t find sustainability a strategic priority. How-
ever, more than half of the consumers are willing to pay at least
5 per cent more for products delivered sustainably, and 76 per
cent don’t have a problem waiting an extra day for climate-friend-
ly transport.
S
According to the study, 64 per cent of the companies surveyed
by West Monroe Partners don’t plan to incorporate sustainabili-
ty into their operations despite customer demand. It is clear that
these companies are missing an opportunity to maximise their
IM
revenue. This fact is further supported by a study by the World
Economic Forum, which found an increment in revenue from
5 per cent to 20 per cent, a reduction in costs from 9 per cent to
16 per cent and a boost in the brand value from 15 per cent to
30 per cent for companies that engaged in sustainable supply
chain initiatives.
M
According to Yves Leclerc, Managing Director and leader of West

Monroe Partner’s supply chain practice, a firm may face multiple
implications if it fails to develop a sustainable supply chain. These
include: higher forward costs due to lower efficiencies; greater risks
N
of reduced resource availability; lost sales due to inability to demon-

strate sustainable supply chain practices; higher cost of capital, or
reduced access to capital sources, due to not adopting sustainability
practices; reduced competitiveness; lower customer acceptance or
purchases; and missing opportunity to positively impact organiza-
tion EBITDA.
On the other hand, W. Michael Wilson, Vice President of mark-

ing and communications at Afflink, a supply chain management
firm, says creating sustainable supply chain matters not only to
the environment, but to companies’ bottom line. Improving supply
chain management can improve efficiencies on multiple fronts. Ev-
erything from water and energy audits, to recycling and waste rec-
lamation, and even instituting a ‘healthy workplace’ campaign will
all drive costs out of the system, increase productivity and position
your company as a good steward of the environment.
According to Jennifer Clipsham, Principal Consultant, Corporate

Strategy Solutions for Thinkstep, for most companies, the supply

PRICING AND REVENUE MANAGEMENT 149
n o t e s
chain represents the biggest opportunity for creating a more sus-

tainable business. For companies manufacturing non-energy using
products, close to 70 per cent of their environmental footprint can
be in the supply chain. This means that a high percentage of your
material sustainability issues are likely in your supply chain and if
you aren’t managing the environmental and social impacts in your
supply chain, you are facing a much higher degree of risk.
Clipsham adds, “Set expectations and clearly communicate those,

whether those are in the form of a code of conduct or supplier ques-
tionnaire or other form of engagement,” she says. “We find imple-
menting a software solution or mechanism for assessing supplier
performance against the code of conduct or questionnaire helps au-
tomate performance management and leads to improvement oppor-
tunities. It also highlights which suppliers are succeeding and those
S
falling short of expectations and needing additional engagement.”
In addition to the carbon footprint, corporates should consider

other issues faced by the suppliers across the globe. These in-
IM
clude extreme weather patterns, rising water costs, carbon taxes,
natural resource constraints and the impact of pollution. All these
issues result in volatility in commodity prices. This further leads
to an increase in the cost of supply chain inputs, which cause dis-
ruption in the growth of companies.
M
In addition, the organisations that don’t look beyond first-tier

suppliers are more prone to various risks, such as environmental,
social and governance risks. These risks can adversely affect rev-
enue and reputation of an organisation.
N

n o t e s
learning objectives

>> Explain the role of pricing and revenue management in sup-
ply chain
>> Discuss the significance of revenue management for multi-
ple customer segments
>> Describe revenue management under uncertain demand
and limited capacity
>> Explain revenue management for inventory assets
>> Discuss the concept of innovative pricing
7.1 INTRODUCTION
S
In the previous chapter, you studied the role of distribution in a sup-
ply chain. It included the factors that influence distribution network
IM
design, network operations planning, network design problems, the
role of IT in network design, data required in network design and un-
certainty in network design.
Pricing is an important component for enhancing supply chain profits

by efficiently matching supply with demand. Revenue management
makes use of a pricing strategy to enhance the profits generated from
M
a limited source by a firm. Organisations need to first use pricing to

attain some balance between supply and demand and only then in-
vest in assets. Supply chain assets can be of two types, capacity and
inventory. Capacity assets in the supply chain can be associated with
N
production, transportation and storage, whereas inventory assets can

be found throughout the supply chain and are responsible for product
availability.
Revenue management involves the use of differential pricing based on

customer segment, product life-cycle, and product or capacity avail-
ability to enhance supply chain surplus. Revenue management has a
major impact on supply chain profitability when there is variation in
the value of the product in different market segments; the product is
highly perishable; seasonal demand; and the product is sold both in
bulk and in spot market.
In this chapter, you will study the role of pricing and revenue manage-
ment in a supply chain. You also learn about revenue management in
multiple customer segments. In addition, the chapter discusses reve-
nue management under the situations of uncertain demand and limit-
ed capacity. Moreover, the chapter explains revenue management for
inventory assets. Towards the end, the chapter describes the concept
of innovative pricing.

n o t e s
ROLE OF PRICING AND REVENUE

7.2
MANAGEMENT IN SUPPLY CHAIN
Pricing is a process by which determination of the prices of various
products and services is done by an organisation. In today’s competi-
tive scenario where every firm faces tough competition from another,
it becomes important that an organisation work up its pricing strategy
all attentively.
Revenue management refers to the application of disciplined analyt-

ics that helps in predicting consumer behaviour, optimising availabil-
ity of products and determining prices so that the revenue growth of
an organisation can be maximised.
An organisation designing its supply chain needs to consider both
S
pricing and revenue management so that the main aim of the organi-
sation, i.e., to earn decent profits without compromising on customer
satisfaction, can be obtained. It must be noted that the concepts of
IM
pricing and revenue management cannot be separable as the pricing
of a firm directly affects its revenue.
As discussed, an organisation’s revenues depend upon its pricing

strategies. The role of pricing is very important in supply chain man-
agement, as only by systematic pricing can the profitability be main-
tained through the use of limited assets. Revenue management is de-
M
fined as a process by which pricing strategies are utilised to increase

profits and optimise the allocation of available supply chain resources.
Following are the two types of resources in a supply chain:
N
Capacity resources: These resources are utilised for enhancing

the capacity of the existing supply chain, such as transportation,
production and facilities.
Inventory resources: The availability of the product is ensured by
the utilisation of these resources throughout a supply chain.
It is important to note here that a standard price cannot be offered

to each segment catered by a firm. The strategic use of pricing, lead-
ing to a decent result of revenue management, requires variation in
the price offered by the firm to different customer segments in differ-
ent time periods. On the basis of this, various approaches are used by
firms for revenue management. Some of the commonly used ones are
as follows:
Charging those customers lower prices who have long-term asso-
ciations with the organisation. On the other hand, charging those
customers higher prices who are ordering at the last minute and
for the first time.

n o t e s
Charging those customers lower prices who are placing their or-
ders well in advance. On the other hand, charging those customers
higher prices who are placing their orders at the last minute.
Charging lower prices during periods of low demand and higher
prices during periods of high demand.
On the basis of the explanation given above, it can be concluded that

revenue management affects a supply chain positively only when the
firm deals with various markets, prices and customers. Following are
the situations when revenue managemnet is required in the supply
chain of a firm:
When products are perishable in nature
When product values differ in different market segments
When products are sold both in the spot market and in bulk
S
When the demand for products is seasonal
As already discussed, revenue management deals with offering differ-

IM
ent prices to different customers at different periods of time in accor-
dance with the capacity available to increase profits.
The most common example is airline ticketing, where flight tickets are
booked on the basis of:
Customer segmentation: In airlines, customer groups are made;
M
for example, there are economy class tickets, business class tickets
and first class tickets for different segments of customers.
Reading days: It refers to the number of days between the book-
ing of a ticket and departure of the flight. The pricing of tickets is
N
highly impacted by the number of reading days.
1. ________ refers to the application of disciplined analytics that

helps in predicting consumer behaviour, optimising availability
of products and determining prices so that the revenue growth
of an organisation can be maximised. (True/False)
2. A standard price cannot be offered to each segment catered
by a firm. (True/False)
Activity
With the help of Internet, find out about any three firms that failed
to manage revenue by following poor pricing strategies. Make a
report comprising suggestions that would have led to an efficient
revenue management.

n o t e s
REVENUE MANAGEMENT FOR

7.3
MULTIPLE CUSTOMER SEGMENTS
The concept of revenue management becomes more relevant when a
firm caters to multiple customer segments. In this case, revenues can
be improved by setting different prices for each segment.
A firm having multiple customer segments needs to set prices in

accordance with the respective designs of the segments so that the
customers willing to pay more for the product can be clearly distin-
guished from the customers willing to pay less. In other words, such
price barriers are set on the basis of time, location, prestige or extra
service.
To manage revenues effectively while catering to a number of custom-
S
er segments concurrently, an organisation can implement the follow-
ing strategies in its supply chain:
Different prices should be set for different segments.
IM
Prices should be decided on the basis of the value assigned to each
customer segment.
Forecasting should be performed at the segment level.
7.3.1 PRICING UNDER CAPACITY CONSTRAINTS FOR

M
MULTIPLE SEGMENTS
Capacity constraints are seen as a major bottleneck in any process or

resource of an organisation. Therefore, organisations charge differ-
ent prices so that capacity utilisation can be ascertained by them. The
N
following pricing strategies can ensure the maximisation of growth

in the revenue of organisations, especially those catering to multiple
segments:
Pricing by purchase channel: Under this strategy, organisations
decide prices based on the channels used by customers for pur-
chasing products. For example, customers have a variety of options
today to buy, such as online, in-store, phone and mail order. The
costs associated with each channel in a supply chain are different.
Therefore, organisations implement pricing strategies on the basis
of the channels used for making products available to customers.
Pricing by purchase location: Under this strategy, an organisation
decides its product prices on the basis of customers’ locations. For
example, mineral water of a specific brand is sold at a higher price
at tourist spots, whereas the same bottle is sold at a lower price in
a residential area.
Pricing by time of use: Under this strategy, organisations decide
the prices of products on the basis of time at which products would
be used. This strategy is utilised in industries with perishable in-

n o t e s
ventory and a fixed capacity. Examples of such industries are air-

lines, parking garage, hospitality, telecommunications and rental
car. Take the instance of telecom organisations that provide vari-
ous free calls during nights and discount options.
Pricing by quantities purchased: Organisations generally offer
heavy discounts on the purchase of large quantities by customers.
This is done because of reasons like intense competition for large
orders, price sensitivity of such customers, attainment of econo-
mies of scale and lower processing cost in serving large orders.
Pricing by metering: Metering refers to indirect price discrimi-
nation that identifies high-value consumers by how intensely they
use a product. For example, prices of cartridges will be low for a
commercial printer, while it would be higher for a customer who
purchases the cartridge for personal use.
S
It is important to note that the multiple segments of a firm should be
served systematically considering the capacity constraints. Pricing in
this case should be very competitive. Table 7.1 shows the pricing of a
IM
firm under the consideration of its capacity constraints:
TABLE 7:1 PRICING STRATEGY UNDER

CAPACITY CONSTRAINTS
Ticket Price Ticket Seats Seats Total Revenue (in
for Business Price for Allocated allocated thousands)
M
Traveller Tourist to Business to Leisure

Traveller Traveller
7 6 90 30 7×90+6×30=810
8 5 60 60 8×60+5×60=780
N
9 4 30 90 9×30+4×90=630
If we carefully analyse this table, we can evaluate that the firm en-
sures revenue management by offering different prices to different
customer segments. So the question arises, how to determine optimal
prices? Optimal price can be determined by using the optimisation
model. Optimisation is a branch of applied mathematics that is con-
cerned with the minimising or maximising of a certain function un-
dergoing constraints. The optimisation model used in revenue man-
agement works on maximising the revenue function under capacity
constraints.
3. Metering refers to indirect ______ that identifies high-value

consumers by how intensely they use a product.
4. Organisations implement same pricing strategies on the basis
of channels used for making products available to customers.
(True/False)

n o t e s
Activity
Identify any five industries that charge different prices to different

market segments. Make a report on the findings.
REVENUE MANAGEMENT UNDER

7.4 UNCERTAIN DEMAND AND LIMITED
CAPACITY SITUATIONS
Uncertain demand means an organisation has issues in accurately
projecting future customer demands. This poses a major challenge be-
cause it makes inventory hard to control and manage. Organisations
can use appropriate technology to monitor sales over time, which can
help offset the demand that fluctuates from one period to the next.
S
In uncertain demand and limited capacity situations, the capacity
needs to be allocated based on the following assumptions:
IM
Demand of the low price segment is unlimited, while, in the case of
high price segment, the demand is uncertain.
Bookings in the low price segment are higher than those in the
high price segment.
Capacity needs to be controlled by placing a limit upon low-price
booking.
M
For example, hotel and airline industries that form the leisure segment
normally charge high prices. However, determination of demand in
this leisure segment is highly uncertain. In the case of spot markets,
N
which are less price-sensitive, the demand is highly uncertain, where-

as prices are normally low in the forward market with the demand
usually on the higher side.
In an airline industry, the capacity is allocated by using the following

formula:
Let
Pb be the price charged to the business traveller
P1 be the price charged to the leisure traveller
Co refers to the cost of overstocking = P1
Cu refers to the cost of understocking = Pb−P1
Then,

n o t e s
Optimum service level = (Cu×100) / (Cu+Co) = (Pb−P1)×100 / (Pb−

P1+P1)
Or, (Pb−P1)×100/Pb
The optimum protection level for the high-price segment will be com-
puted in following manner:
Mean demand for the high-price segment + K×Standard deviation of

the demand for high price
Where K = Service factor for the optimal service level
This can be explained through the following example:
ABC Airlines has a capacity of 180 seats and has decided to charge
` 3,000 to leisure travellers, who are expected to book flight tickets 15
S
days ahead of the scheduled flight. The airlines planned to charge `
5,000 to business travellers. The demand from leisure travellers for
the tickets is more than 180 seats. At the price of ` 5,000, the mean
IM
demand will be 60 seats and the standard deviation will be 20 seats.
So, the tickets allocation for leisure travellers and business travellers
can be made by using the following formula:
3000×100 / (3000+2000) = 60%
Service level of 60 means k = 0.25

M
Therefore, high-price protection level for business travellers = 60+

0.25×20 = 65 seats
So, the booking limit for low-price fares will be:

N
180−65 = 115 seats
Similarly, capacity allocation in multiple segments can be on the basis

of forward market vs. spot market.
Let
Pf be the forward price
Ps be the spot price
Co refers to the cost of overstocking = Pf
Cu refers to the cost of understocking = Ps−Pf
Then,
Optimum service level = (Cu×100) / (Cu+Co) = (Ps−Pf)×100 / (Ps−

Pf+Pf)
= (Ps−Pf)×100/Ps

n o t e s
Optimum protection level for the spot segment can be computed in

the following manner:
Mean demand for the spot market segment + K×Standard deviation

of the demand available in the spot market
Where K = Service factor for the optimal service level
An organisation has a warehouse in another city that has the capacity

of storing 50000 MT. The organisation aims to determine how much
capacity is to be reserved for spot market customers in the coming
month.
In the current scenario, in the forward market, the demand is unlim-

ited, and the prevailing market price is ` 150 per MT, while the spot
S
market price is ` 200 per MT. The demand for warehousing capacity
in the spot market in December follows normal distribution with the
standard deviation of 3000 MT.
IM
In the above case,
Cost of understocking will be 200−150 = 50
Cost of overstocking = 150
Optimal service level = 50*100/200 = 25%

M
K = −0.7
Optimum reserve capacity for the spot market will be:

N
10,000−0.7×3,000 = 7,900
There could be another situation: Hotel and airline industries often

see last minute cancellations, so there will be vacant rooms in the ho-
tel or unused seats in the aircraft. Therefore, they have to take provi-
sions of earning revenue in case a cancellation takes place.
Hotel A has 100 rooms and saw frequent cancellations over the last
few months. The normal distribution with the mean of 15 and stan-
dard deviation of 5 is present. The room rent charged by the hotel is
` 2,600, and in case the hotel faced shortage of rooms, it paid ` 4,000 to
another hotel for providing accommodation to its extra customers. So
in this case, the optimum number of overbooking can be computed by
using the following formula:
Cu=P=2,600 and Co=b=4,000−2,600 = 1,400

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Optimum service level = 2,600*100 / (2,600+1,400) = 65%
So, K = 0.4
Optimum number of overbookings = Mean cancellations + K*Stan-

dard deviation of cancellations, where k is equivalent to service factor
So, optimum number of overbookings = 15 + (0.4*5) = 17
5. __________ means an organisation has issues in accurately

projecting future customer demands.
Activity
S
Select a leading Indian healthcare company and find out how it
deals with the situations of uncertain demand and limited capacity.
Present your findings.
IM
REVENUE MANAGEMENT FOR
7.5 INVENTORY ASSETS: MARKDOWN
MANAGEMENT
Inventory of assets is an important aspect of supply chain manage-
M
ment as the demand is highly uncertain for seasonal goods, and the
order for meeting demands has to be placed before the start of the sea-
son. So to address this issue, markdown management is adopted that
means the forecast is updated on the basis of the demand observed
N
initially.
Setting the initial price of a product is not an easy task for organi-
sations. While deciding the price of a product, important factors like
quality, brand, season of goods, etc., need to be considered. As a re-
sult of intense market competition, organisations need to rethink their
pricing strategies and have to change their perceptions of markdown.
Markdown is a strategy that is a reduction on price done by organisa-

tions, generally, to clear inventory before it becomes obsolete or has to
be removed to make way for the new stock. It is a planned reduction
in the selling price of a product.
Organisations implement a systematic markdown management pro-

cess, as shown in Figure 7.1:

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Starting with a Plan
Considering Price Elasticity
Planning Markdown at
Different Levels
Managing Product Life

Gycles
S
Figure 7.1: Markdown Management Process
Let us now study the steps in the process in detail:

IM
1. Starting with a plan: An organisation needs to start the
markdown management process with a plan that can help it to
determine how much it is willing to spend on the markdowns so
that the financial targets of the organisation are not affected. Once
the plan is framed for markdown, it is important to evaluate the
markdown plan on a regular basis. This allows making quicker
M
adjustments to achieve financial targets and organisational

objectives.
2. Considering price elasticity: Price elasticity is an important
factor that should be considered by organisations, as it helps
N
in understanding how markdowns can impact the rate of sale

of a product. The rate of sale is an important parameter that
helps organisations to decide the pricing strategy of a particular
product in a markdown.
3. Planning markdown at different levels: In this step,
organisations need to mark down the plans at both product and
aggregate levels, which can be done by evaluating inventory
levels, price elasticity and rate of sale of the product. This kind of
strategy provides a holistic view to the organisation and allows
understanding of how much of potential price cuts of a particular
product can impact the revenue targets.
4. Managing product life cycles: Markdown also helps organisations
to efficiently manage product life cycles. Effective management
of life cycles allows organisations to ensure that less stock is left
at the end of a season. It also helps them to take decisions in
respect of the launch of new products.

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The key factor that can help organisations in adopting an efficient

markdown policy is technology, as it helps in integration with the rest
of the planning solutions. Technology also enables organisations to
continuously monitor markdowns and evaluate their performance
against the set targets.
6. While deciding the price of a product, important factors like

quality, brand, season of goods, etc., need to be considered.
(True/False)
7. __________ is a strategy that is a reduction on price done by
organisations, generally, to clear inventory before it becomes
obsolete or has to be removed to make way for the new stock.
S
Activity
Find out the markdown management process in any three global

IM
organisations of your choice. Write a brief note on their comparison.
7.6 INNOVATIVE PRICING

According to the economic theory of firms, businesses aim to estimate
the single price that increases profits. In fact, many organisations can
M
extract more revenue and enhance profits with pricing strategies that
are far more innovative than the single-price strategy. However, there
is no “one-size-fits-all” pricing strategy. Some pricing strategies are
better suited to some circumstances than others. For example, Sam’s
N
Clubs, owned by Walmart, charge a membership fee for the right to

purchase the store’s inventory, whereas Walmart does not.
The innovative pricing helps organisations in determining the price

level that will be applied to a specific product. With the advancement
in technologies, it has become difficult for organisations to fix the pric-
es of complex products. Innovative pricing is mostly adopted for the
products that can be easily accessed without any charge.
The innovative pricing strategy is appropriate when the level of un-

certainty is at a higher level and the rate of product innovation is even
higher in the market. Through innovative pricing strategy, organi-
sations aim to provide differential prices to end users even in cases
when there are no capacity constraints.
Some examples of innovative pricing strategies of organisations are

as follows:
Offers of discount coupons by Procter & Gamble (P&G) whereby
one can get discount on every next purchase made.

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Provision of happy hours by pubs and restaurants whereby drinks

are offered at prices less than normal rates.
However, organisations need to be careful in adopting the innovative

pricing strategy as the differential pricing scheme is quite often per-
ceived by many as an unfair trade practice scheme.
8. Through innovative pricing strategy, organisations aim to

provide differential prices to end users, even in cases when
there are no capacity constraints. (True/False)
Activity
Find information on the innovative pricing strategy of an Indian
S
retail firm. Prepare a report on your findings.
7.7 SUMMARY
IM
Pricingis a process by which determination of the prices of vari-
ous products and services is done by an organisation.
Revenue management refers to the application of disciplined an-
alytics that helps in predicting consumer behaviour, optimising
availability of products and determining prices so that the revenue
M
growth of an organisation can be maximised.

Capacity resources are utilised for enhancing the capacity of the
existing supply chain such as transportation, production and facil-
ities.
N
The availability of a product is ensured by the utilisation of inven-

tory resources throughout a supply chain.
The concept of revenue management becomes more relevant when
a firm caters to multiple customer segments. In this case, revenues
can be improved by setting different prices for each segment.
Pricing strategies used by firms having multiple customer seg-
ments include pricing by purchase channel, pricing by purchase
location, pricing by time of use, pricing by quantities purchased
and pricing by metering.
Uncertain demand means an organisation has issues in accurately
projecting future customer demands.
Inventory of assets is an important aspect of supply chain manage-
ment as the demand is highly uncertain for seasonal goods, and
the order for meeting demands has to be placed before the start of
the season.

n o t e s
Markdown is a strategy that is a reduction on price done by organ-

isations, generally, to clear inventory before it becomes obsolete or
has to be removed to make way for the new stock.
Steps in the markdown management process are starting with a
plan, considering price elasticity, planning markdown at different
levels and managing product life cycles.
Through innovative pricing strategy, organisations aim to provide
differential prices to end users, even in cases when there are no
capacity constraints.
key words
Barriers: It can be defined as an obstacle that prevents move-

ment or access.
S
Brand: It is a term, name, symbol, design or some other feature
that makes the product of one seller distinctive from others’.
Product life cycle: A new product progresses through the stages
IM
of growth, maturity and decline. This sequence is called prod-
uct life cycle and is related to changing market dynamics, which
impact marketing mix and marketing strategy.
Revenue: It is an income earned by an organisation.
Spot market: It refers to the commodities or securities market
where goods are sold for cash and delivered instantly.
M

1. Explain the significance of pricing and revenue management in
N
supply chain.
2. Discuss the role of revenue management in case of multiple
customer segments.
3. Describe the markdown management process in detail.
4. Explain innovative pricing.
Topic Q. No. Answer

Role of Pricing and Revenue 1. Revenue management
Management in Supply Chain
2. True
Revenue Management for 3. Price discrimination
Multiple Customer Segments

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Topic Q. No. Answer

4. False
Revenue Management under 5. Uncertain demand
Uncertain Demand and
Limited Capacity Situations
Revenue Management for 6. True
Inventory Assets: Markdown
Management
7. Markdown
Innovative Pricing 8. True

1. The role of pricing is very important in supply chain management,
as only by systematic pricing can profitability be maintained
S
through the use of limited assets. Refer to Section 7.2 Role of
Pricing and Revenue Management in Supply Chain.
2. The concept of revenue management becomes more relevant
IM
when a firm caters to multiple customer segments. In this
case, revenues can be increased by setting different prices for
each segment. Refer to Section 7.3 Revenue Management for
Multiple Customer Segments.
3. Steps in the markdown management process are: starting
M
with a plan, considering price elasticity, planning markdown at

different levels and managing product life cycles. Refer to Section
7.5 Revenue Management for Inventory Assets: Markdown
Management.
N
4. Through innovative pricing strategy, organisations aim to provide

differential prices to end users, even in cases when there are no
capacity constraints. Refer to Section 7.6 Innovative Pricing.

7.10
REFERENCE
SUGGESTED READINGS
Geunes,Joseph, and P. M Pardalos. Supply chain optimization.
New York: Springer, 2005. Print.
Hugos, Michael H. Essentials of Supply chain management. Hobo-
ken, N.J.: John Wiley & Sons, 2003. Print.
Mentzer, John T. Supply Chain management. Thousand Oaks, Ca-
lif.: Sage Publications, 2001. Print.

n o t e s
E-REFERENCES
Revenue Management, Pricing And Revenue Integrity Future In-
dustry Events 2009’. Journal of Revenue and Pricing Management
8.1 (2009): 112-113. Web.
Edwards, Sarah. ‘Revenue Management: Maximising Revenue In
Hospitality Operations’. Journal of Revenue and Pricing Manage-
ment 12.1 (2012): 94-95. Web.
Westermann, Dieter. ‘Important Aspects To Allow Revenue Man-
agement To Deliver’. Journal of Revenue and Pricing Management
14.2 (2015): 123-126. Web.
S
IM
M
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C h a
8 p t e r
Demand Forecasting in Supply Chain
CONTENTS
S
8.1 Introduction
8.2 Meaning of Demand Forecasting
IM
8.2.1 Characteristics of Demand Forecasting
8.2.2 Approaches to Demand Forecasting
Activity
8.3 Role of Demand Forecasting in Supply Chain Management
M
Activity
8.4 Qualitative Forecasting Methods
Self-Assessment Questions
Activity
N
8.5 Quantitative Forecasting Methods

Activity
8.6 Measures of Forecast Error
Activity
8.7 Role of IT in Forecasting
Activity
8.8 Risk Management in Forecasting
Activity
8.9 Summary

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Role of Forecasting in a petrochemical

manufacturing company
The polyethylene plant of Reliance Industries Limited is situated

at Hazira. Forecasting for such a large-scale organisation is not a
simple task as there are a number of complexities in its processes.
A wide range of factors impact the functioning of the company by
affecting the demand and supply of products that include fluc-
tuation in exchange rates, movement across geopolitical regions,
huge installed capacity, and excise and custom tariff schedules.
Let’s understand the company’s forecasting process and nature

of decisions taken.
The process of forecasting starts here with certain assumptions
S
pertaining to the tariff structure for custom and excise, prevail-
ing local price, exchange rate fluctuation, import price and nature
of competition. After considering these assumptions, the compa-
ny calculates the total market for polyethylene by doing medi-
IM
um-term forecasting. After this, an analysis of the supply-demand
position is done on the basis of its own capacity and competitor’s
capacity. Based on these all, the demand to be made during the
next planning year is arrived at.
A series of forecasting exercises follow at various levels by collect-

M
ing and analysing the end-user data of the previous year. Aggre-
gation is applied at this level. For example, there will be several
grades of polyethylene in production, and several new grades will
be introduced during the planning year. This data needs to be
aggregated in order to analyse capacity requirements and match
N
them with capacity availability. Similarly, the end user data is

corrected at the territory level and progressively aggregated at
regional and national levels. This data is used in the forecasting
exercise carried out to estimate future demands.
The date retrieved from forecasting is used for several purposes.

The foremost use is balancing capacity availability to the actual
projected requirement for the planning year. For this, the com-
pany engages in debottlenecking schedules, adjusting plants
maintenance schedules and reworking some technology upgra-
dation initiatives. Furthermore, the forecasting exercise needs a
detailed production planning for the year. During this stage, the
data is disaggregated into specific product variance and sched-
uling plans for each variant arrived at. At this stage, changeover
considerations from one product variant to another are taken into
consideration. The forecasting exercise also helps in establishing
performance targets for the year for various departments such as
production, materials and marketing, as well as in the setting up
of control systems.

Demand Forecasting in Supply Chain 167
n o t e s
learning objectives

>> Explain the concept of demand forecasting
>> Discuss the role of demand forecasting in supply chain man-
agement
>> List and discuss qualitative and quantitative forecasting
methods
>> Describe the role of IT in forecasting
>> Explain risk management in forecasting
8.1 INTRODUCTION
S
In the previous chapter, you studied about pricing and revenue man-
agement. Let us move ahead with demand forecasting in supply chain.
IM
Nowadays, the market is crowded with numerous organisations, most
of which compete for the same target group of customers. It is there-
fore important to differentiate from the rest if a firm wants to lead the
market, and forecasting helps firms in obtaining the desired results.
Forecasting can be defined as a planning tool that helps in discovering

the uncertainties of future. It provides a competitive edge to a firm
M
by exploring those uncertainties. All the planning of a firm depends

upon the forecast made by it. Therefore, it is important to pay serious
attention when forecasting is happening.
Based on the pattern of data, there are two methods of forecasting,

N
that is, quantitative and qualitative. It is important to consider all the

aspects of forecasting before it gets initiated by a firm. One of the most
important aspects is forecasting error. A firm working on a forecast
should ensure that the data collected by it is less prone to randomness
so that the chances of forecasting errors can be reduced.
In this chapter, we cover the concept of demand forecasting, including

a discussion on its role in supply chain management. The methods of
forecasting and measures of forecasting errors are also explained. In
addition, the role of IT in forecasting is brought to light. Towards the
end, we discuss about risk management in forecasting.
8.2 MEANING OF DEMAND FORECASTING

Future is uncertain, and to prepare organisations for this uncertainty,
there is a planning tool known as forecasting. For forecasting, the past
and present data is collected and analysed to identify the trend so that
the future can be predicted on the basis of that trend.

n o t e s
According to Evan J. Douglas, demand estimation (forecasting) may be

defined as a process of finding values for demand in future time periods.
In the words of Cundiff and Still, demand forecasting is an estimate of

sales during a specified future period based on proposed marketing plan
and a set of particular uncontrollable and competitive forces.
In simpler words, forecasting is a process of predicting or estimating

the future of an organisation based on its past and present data. Fur-
ther, demand forecasting is the anticipation of demand of the products
or services of a company. The following are the main objectives of
demand forecasting:
To lower inventory levels by evaluating the organisation’s require-
ment for raw material, semi-finished goods, spare parts, etc.
To develop effective production and delivery schedules so that the
S
situations of overproduction and underproduction can be prevent-
ed
To help the organisation in arranging the required resources for
IM
production
To establish sales targets and ways to achieve them
The market is full of competitive forces. Therefore, the business firms

wanting to survive in such a market need to make evaluation of the
market based on the trends so that they can come up with more com-
M
petitive strategies. For example, if a firm dealing in electronic home

appliances wants to add a new product, say microwave, to its product
line, the decision will require a good understanding of the nature of
the demand for the range of microwave ovens to be manufactured by
N
the firm.
Only after conducting a systematic forecasting will the manufacturer

be able to evaluate the trends for the demand of microwave ovens,
based on timing and magnitude. On the basis of the results, the man-
ufacturer may plan further for the plant, machinery, marketing strat-
egies, etc., required.
Broadly, there are three types of forecasting:

Short-term forecasting: The ongoing modifications in an existing
plan are based on short-term forecasting. For example, a company
can modify its current sales strategies after analysing the trends
in the sales of the last quarter. The time duration for this kind of
forecasting varies from 1 day to 3 months.
Medium-term forecasting: This forecasting is done for a period of
3 months-24 months. An organisation uses this type of forecasting
to plan the annual business. For example, if a company offers 15
variants of a product, the demand for the product is estimated at
an aggregate level. Based on this information, capacity and mate-
rial plans are made.

n o t e s
Long-term forecasting: Unlike short- and medium-term forecast-

ing, long-term forecasting is based on extensive research so that
long-run strategies can be developed and implemented. The du-
ration of long-term forecasting exceeds 24 months. Most reputed
brands usually undertake this kind of forecasting so that in future,
they can come up with the most accepted product line.
8.2.1 CHARACTERISTICS OF DEMAND FORECASTING
Demand forecasting lays foundation for an organisation’s supply

chain process. It supports other supply chain activities such as in-
ventory management and capacity planning. Thus, it is important for
forecasters to understand the features of demand forecasting before
actually carrying out the process. The following are the main features
of demand forecasting:
S
Forecasts may be inaccurate: As discussed, forecasting is a plan-
ning tool that is used so that patterns of the dynamic business en-
vironment can be identified. It is important to note that the results
IM
of a forecast are based on several assumptions. There are chances
that the forecast result in a wrong estimation and, if employed, can
affect the business adversely. Therefore, the forecast process has
to consider the respective errors of each value forecasted.
In order to match supply with demand, it is essential for managers
to forecast values as well as the errors associated. This will help in
M
developing plans so as to reduce uncertainty of events in future.

Accuracy in short-term forecasts is higher than that in long-
term forecasts: It is important to note that a short-term forecast
is more accurate than a long-term forecast because the former has
N
a smaller standard deviation of forecast error as compared to the

latter.
For example, an order is placed by a store manager at around 11
AM and the delivery of the order takes place on the same day by 6
PM. The short lead time would result in a better forecasting as the
manager is supposed to take care of the supply requirement for
only few hours.
Accuracy in aggregate forecasts is higher than that in disaggre-
gate forecasts: Disaggregate forecasts are usually characterised
by comparatively less accuracy than aggregate forecasts. This is
possible because aggregate forecasts usually represent a smaller
rate of standard deviation of error relative to mean value. For in-
stance, it is easier to forecast the requirement of the grocery con-
sumed by a group of families residing in a particular area rather
than forecasting the grocery requirement of every family general-
ly. The difference between the two is the degree of aggregation. A
group of family is an aggregation of a number of families togeth-
er, whereas each and every family is disaggregated. Therefore, a
greater aggregation results in more accurate forecast.

n o t e s
8.2.2 APPROACHES TO DEMAND FORECASTING
As already discussed, the performance of an organisation depends on

the accuracy of the forecast made by it or for it. The forecasting pro-
cess is a six-step approach that ensures that the organisation is con-
ducting an effective forecasting. Following are these steps:
1. Analyse and understand the objective of forecasting: A firm
needs to identify the objective for which the forecast is to be
made. It is an important step to identify all the decisions that will
be supported by the end result of forecasting. These decisions
may include the quantity of a product to be manufactured or the
quantity of a product to be ordered. All the players of the related
supply chain must be aware of the link between the decision and
the forecast. For example, Tata’s plans to discount a product for
a period must be shared with the manufacturer, transporter and
S
others involved in filling the demand, as they play an important
role in the forecasting of demand. All the concerned parties have
to come up with common trends of forecast for promotion and a
shared plan of action based on the forecast. If a firm fails to make
IM
these decisions jointly, it may result in either too much or too
little produce in various stages of the supply chain.
2. Integrate demand planning with forecasting: A firm must
integrate its forecast in all the planning activities pertaining to
the supply chain such as the planning of capacity, production,
promotion and purchasing. This integration is required because
M
a variety of functions involved in forecasting get affected by the

outcome of the planning process. To make it clearer, consider a
scenario where a retailer develops forecasts based on promotional
activities, whereas a manufacturer develops a different forecast
N
for its production planning based on historical orders. As a result,

both the forecasts lead to a gap between supply and demand,
which causes poor customer service.
In order to accomplish this integration, it is good for an
organisation to include the heads of each of its functional groups,
such as finance, human resource, marketing, etc., while arriving
at a forecast for the organisation.
3. Identify customer segments: In order to create an accurate
forecast, a firm must identify the customer segment, which is
a group of customers targeted by the supply chain. A firm can
group customers based on similarities in service requirements,
demand volumes, demand volatility, order frequency and so forth.
Different forecasting methods can be used for various customer
segments. An accurate and simplified approach adopted by an
organisation to forecasting requires a clear understanding of the
customer segments on target.
4. Identify all major factors affecting demand forecast: A firm
must take into account all the aspects related to demand and
supply of a product that may influence the demand forecast.

n o t e s
One of the aspects related to demand is the state of demand. For

evaluating this, the organisation must determine whether the
demand is showing a growing pattern, a declining pattern or a
seasonal pattern. For example, an automobile company promoted
one of its brands in the month of December. As a result, this
brand got higher demand than other brands. The automobile
company should not consider the sales data to estimate the
demand; instead, it should use the demand that would have been
in the absence of the promotional activity. The aspect related to
supply includes the factors that affect the availability of supply
sources.
The firm should have the awareness of the number of variants
of the product it is dealing in. If a product substitutes another
product, forecasts should be made jointly for both the products.
For example, when a two-wheeler manufacturer introduces a
S
modified or improved version of an existing two-wheeler, it is
likely that the demand for the existing two-wheeler will decline
because new customers will buy the improved version. Therefore,
IM
demand for both the two-wheelers should be forecasted jointly.
5. Determine the appropriate forecasting technique: In order
to select an appropriate forecasting technique, a firm needs to
understand the dimensions such as geographic area, product
groups and customer segment. Further, the firm should
understand the differences in demand for each dimension. Based
M
on this understanding, the firm may take up different forecasting

techniques, qualitative or quantitative, for each dimension.
6. Establish performance standards and measures of error
for the forecast: To evaluate the accuracy and timeliness of a
N
forecast, a firm should establish clear performance measures.

The correlation of these measures must be ensured with the
business decisions based on the forecast. For example, consider a
garment shop that has a large demand of shoes in a festive season.
Suppliers take one month to send in the orders. Therefore, the
shoe shop must ensure that the forecast is done at least one
month prior to the start of the sales season. At the end of the
sales season, the shop must compare the actual demand with
the forecasted demand to estimate the accuracy of the forecast.
Based on the result, the shop can plan for reducing the error rate
for next future forecasts.
1. Future is uncertain, and to prepare organisations for this

uncertainty, a ______ is used known as forecasting
2. The time duration for _____ forecasting varies from 1 day to 3
months.

n o t e s
3. Disaggregate forecasts are usually characterised by

comparatively less accuracy than aggregate forecasts.
(True/False)
Activity
Make a note based on your research about the methods of demand

forecasting used by popular online e-commerce giants around the
world.
ROLE OF DEMAND FORECASTING IN

8.3
SUPPLY CHAIN MANAGEMENT
Demand plays a crucial role in the success of a supply chain by pro-
S
viding insight into the potential supply chain risks in advance. The fol-
lowing points explain the role of demand forecasting in supply chain
management:
IM
Satisfying customers: Every supply chain aims at achieving cus-
tomer satisfaction. Demand forecasting helps in fulfilling this aim
by providing a fair idea of market trends, customers’ tastes and
buying capacities, etc. Based on this information, an organisation
can plan its production, thereby fulfilling customers’ needs.
Preparing budget: Demand forecasting is important in the prepa-
M
ration of budget by estimating costs and expected revenues. Based

on the estimate, an organisation can allocate budget for different
supply chain activities. For example, the organisation can decide
which supply chain functions need to be outsourced or performed
N
in-house based on its allotted budget.

Stabilising production: By producing according to the forecasted
demand of products, an organisation can eliminate wastage and
thus reduce cost. This further helps the organisation to hire supply
chain personnel as per the requirement. For example, if an organ-
isation expects a rise in the demand for its products, it may opt for
extra labour to fulfil that increased demand.
Evaluating performance: Demand forecasting also helps an or-
ganisation in appraising the performance of its existing supply
chain and fulfilling gaps in it. For example, if the demand for one
of its products is less, it may enhance the quality of that product to
boost its demand.
4. Demand forecasting plays a crucial role in the preparation of

_____ by estimating costs and expected revenues.

n o t e s
Activity
Outline the key features of some world famous organisations that

make them stand out from the rest.
8.4 QUALITATIVE FORECASTING METHODS

These methods are subjective in nature and based on human expertise
and judgements. Whenever an organisation finds it difficult to obtain
historical data, the qualitative method is used to retrieve the forecast-
ed results. For instance, when a new product is launched by a firm or
a new advertisement channel is used, the firm may opt for qualitative
methods in the absence of the historical data for forecasting. Some of
the popular qualitative methods are discussed as follows:
S
Delphi approach: It refers to a group decision making technique
of forecasting. In this method, questions are individually asked of a
group of experts to obtain their opinions on an event in the future.
IM
These questions are repeatedly asked until a consensus is reached.
In addition, this method provides each expert with the information
regarding the estimates made by the other in the group so that he/
she can revise his/her estimates with respect to others’ estimates.
In this way, forecasts are crosschecked among experts to arrive at
a more accurate decision making.
M
Every expert is allowed to react or provide suggestions on others’

estimates. However, the names of experts are kept anonymous
during this exchange to facilitate a fair judgment. The main ad-
vantage of this method is that it is time and cost effective as a num-
ber of experts are approached in a short time without spending
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on other resources. However, this method may lead to subjective

decision making.
Market research: It helps an organisation in discovering its tar-
get market. While conducting market research, the thinking of
these target groups for the products or services to be launched by
the firm can be analysed. Under this technique, the tools such as
surveys, product testing and focus groups are used to assess the
viability of the new product or service. A firm may conduct the
research itself or outsource the services of a market research firm.
For example, various telecommunication firms like Airtel, Aircel,
etc., make calls to their customers to ask for their feedback as well
as give new service details.
Market research is conducted for obtaining new product ideas,
preferences of customers for certain products, popularity of com-
petitive products within a particular class and so on. The tech-
niques that are used to gather this information include surveys,
interviews and questionnaires.

n o t e s
Life cycle analogy: All products go through various life stages

during their life span. These stages include introduction, growth,
maturity and decline, as shown in Figure 8.1:
Maturity
25
20
Demand (000s)
Growth Decline
15
10
S
0
0 10 20 30 40
Month
IM
Figure 8.1: Life Cycle of a Product
This technique is used for forecasting the demand of a new prod-
uct. In this technique, a firm analyses the life cycle data of an old
product having similar characteristics. On the basis of the result,
the life cycle of the new product can be forecasted. For example,
M
Reliance Industries Limited wants to launch new engine oil. To

forecast its demand in different time periods, the company can
analyse the life cycle of a similar lubricant produced by it.
Informed judgement: It refers to a method in which experts are
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requested to provide their opinions about particular products.

For example, in an organisation, sales representatives act as ex-
perts who can assess the demand for products in different areas,
regions or cities. These sales representatives are in close contact
with customers; therefore, they are well aware of the customers’
future purchase plans, their reactions to market changes and their
perceptions for other competing products. They can provide an
approximate estimate of demand for the organisation’s products.
This method is quite simple and less expensive. However, the
main limitation of this method is that it provides estimates that are
dependent on the market skills of experts and their experience.
These skills differ from one individual to another. In such a case, it
becomes difficult to make accurate demand forecasts.
In this method, the relevant opinions of experts are taken and com-
bined, and results are derived. The forecast can be done either on
individual basis or on group basis provided they have the experience
and understanding of the scenario pertaining to the new product or
service. All the collected ideas are later evaluated in respect of feasi-
bility and profitability.

n o t e s
It is important to note that many companies use informed judgement

of the sales force because of their closeness with consumers. This
closeness helps them in forecasting future sales in their own territo-
ries in comparatively more accurate manner.
5. Whenever an organisation finds it difficult to obtain historical

data, the quantitative method is used to retrieve the forecasted
results. (True/False)
6. In ______, the tools such as surveys, product testing and focus
groups are used to assess the viability of a new product or
service.
S
Activity
With the help of Internet, find information on which of the

above-mentioned methods telecom firms generally use the most
IM
for forecasting.
QUANTITATIVE FORECASTING
8.5
METHODS
Unlike the qualitative method, this method makes use of complex
M
mathematical and statistical modelling to forecast results. Following

are few quantitative methods that are used widely:
TIME SERIES FORECASTING METHOD

N
A time series refers to the collection of data observed at fixed time in-
tervals over a timespan. These time intervals may be minutes, hours,
days, weeks, months or years. Methods in time series use historical
demand and carry out a statistical analysis of the past data to develop
forecasts for the future. Time series methods are best suited in the
scenarios where the basic demand pattern does not vary significantly
from one time period to the next. In the analysis of a time series, a firm
needs to consider the following time-related factors:
Trends: These relate to long-term persistent changes in data like
price increases, population growth and decline in market shares.
Seasonal factor: This could be periodic or repetitive in time series
that occurs because of buying patterns and social habits during
different times of a year. For example, the demand of woollen
clothes in winters.
Cyclical variations: These are variations in time series that take
place because of business cycles.

n o t e s
Random variations: All the remaining fluctuations that do not fall

under any of the three categories above falls under this category. A
wide range of factors are covered by this category such as sudden
weather changes, strikes or communal clashes. All these factors
are random in nature; therefore, the future occurrence of these
factors is difficult to predict. Smoothening of time series data will
help in eliminating the effects of these events. Time series fore-
casting uses the methods such as simple moving average method
and weighted average method. Let us discuss the two:
Simple moving average method: This method is used when
demand for a product is neither growing nor declining rapidly,
and it does not have seasonal characteristics.
The formula for a simple moving average is:
At −1 + At −2 + At −3 + ..... + At − n
S
Ft =
n
Where Ft denotes the forecast value for the coming period,

IM
n denotes the number of averaged period,
At-1, At-2, At-3, …….., At-n are the actual occurrences in the past
such as two periods ago, three periods ago and so on respec-
tively.
Weighted moving average: This method is used when a spe-
cial consideration is associated with a particular component.
M
According to this method, the weight is assigned to all the vari-

ables based on their importance to forecasting, provided that
the sum of all weights equals 1. The following formula is used
for calculating the weighted moving average:
N
Ft = W1 At −1 + W2 At −2 + W3 At −3 + ...... + Wn At − n
Where Ft denotes the forecast value for the coming period,

n denotes the number of averaged period,
wi denotes the weight to be assigned to the actual occurrence
for the period ti
Ai = the value of actual occurrence for the period ti
CAUSAL METHOD
Cause-and-effect relationships are studied under these methods. Ca-

sual methods are based on the assumption that the demand of a par-
ticular product is always highly correlated with certain factors such
as state of economy and government policies. These methods analyse
the correlation the demand with environmental factors to estimate the
future values due to these factors. This estimation of environmental
factors is used to forecast the future demand. For example, price of
products is strongly correlated with demand. Hence, companies can

n o t e s
use casual methods to determine the impact of pricing policy on the

demand. These methods are used for conducting medium- to long-
term forecasting.
7. Unlike qualitative method, quantitative method makes use of

complex mathematical and statistical modelling to forecast
results. (True/False)
8. _______ relate to long-term persistent changes in data like
price increases, population growth and decline in market
shares.
Activity
S
Collect data of any manufacturing company for research. Estimate
the demand for the next 5 years using the simple moving average
method.
IM
8.6 MEASURES OF FORECAST ERROR
Any product or service has two components that affect their demand,
that is, systematic component and random component. It is import-
ant to note that forecasting would be beneficial for an organisation
M
if it considers only the systematic components and not the random

components. This is so because the random component is responsible
for the variation of the forecast from the actual output. Therefore, it
is termed a forecast error. To retrieve better results from the forecast,
N
it becomes necessary to analyse the error on the basis of valuable in-

formation.
Error analysis is done by managers so that they can determine the

efficiency of the current forecasting method in predicting the system-
atic component. For example, if the forecasting method consistently
produces a positive error, the method is overestimating the systematic
component and should be modified by the organisation.
All the contingency plans must account for forecast errors. For exam-
ple, consider a shoe shop with two suppliers. The first is in the Far
West and has a lead time of two months. The second is local and can fill
orders within a week. The local supplier is more expensive, whereas
the Far West one costs less. The shoe shop wants to contract a certain
amount of contingency capacity with the local supplier to be used if
the demand exceeds the quantity the Far West supplier provides. The
decision of arranging quantity by the local provider is closely linked
to forecast error.
The firm can continue to use its existing forecasting method till the
time the forecasted errors are within historical error estimates. It is

n o t e s
important to note that when the range of an error goes beyond the
historical estimates, the firm has to explore new forecasting methods
resulting in lesser value of the error. In addition, if the forecast of de-
mand by a firm is continuously resulting in an over- or underestimat-
ed demand, it could also be treated as another signal that the forecast-
ing method opted by the firm should be changed.
Forecast error for period t is given by
En = Fn - Dn
Where,
En denotes the error in period n
Fn denotes the forecasted value in period n
S
Dn denotes the actual demand in period n
It is important that a manager estimate the error of a forecast made in

advance. The advance time must be nearer the lead time so that the
IM
manager can take appropriate actions to minimise the error. For ex-
ample, if the manager of a firm is conducting forecast for determining
an order size and the lead time of the supplier is three months, it is
important for the manager to estimate the error for the forecast made
three months before the actual demand of the product arises.
M
One of the most opted measures of calculating forecast errors is the

Mean Squared Error (MSE).
MSEn ∑ Et
N
The MSE of an estimate value refers to the average of the squares of

errors. In other words, it considers the square value of the difference
between the estimator and what is estimated. It is important to note
that the randomness results in the difference in value. Moreover, this
difference can result when the estimator doesn’t account for informa-
tion producing comparatively more accurate estimates.
Other measures to forecast errors include the following:

Mean Absolute Error (MAE): It is an important measure for fore-
casting errors in time series analysis. It assumes time series to be
homogeneous and two time series to be equal in size. It is calcu-
lated using the following formula:
MAE = Sum of absolute errors/ non-missing data points
∑
N
ˆi
xi − x
i =1
MAE =
N
Where xi=actual observation time series
ˆ i =estimated or forecasted time series
x

n o t e s
Mean Absolute Percentage Error (MAPE): This measures the

percentage size of errors. This is the measure that is used in
large-volume data. It is calculated as:
1 Actual data − Forecast data
n
∑ Actual data
* 100
Mean Forecast Error (MFE): This measures the amount of bias

in the forecasted data. It is the mean of the difference between the
actual and forecasted demands. The formula is calculated as:
∑ ( Actual demand − Forecasted demand )

n
MFE = t =1
Number of periods
Let us take an example of MFE, shown in Table 8.1:
S
Table 8.1: Actual and Forecast Values
Period Actual Demand Forecast Forecast Error
1 200 180 20
IM
2 240 220 20
3 130 128 2
4 120 130 –10
MFE = 32/4 = 7.5

M
9. Any product or service has two components that affect their

demand, i.e., _____ and random component.
N
Activity
With the help of Internet, find out about an incident where the pro-
motional strategy of a big corporate house ended up in failure be-
cause of forecast error. Make a report on the measures that could
ensure the success rate of the promotional strategy.
8.7 ROLE OF IT IN FORECASTING

There will hardly be a corner of today’s global economy that will not
be affected by Information Technology (IT). For almost every business
activity nowadays, IT is a high requirement, and forecasting is no ex-
ception. The benefits of forecasting can be reaped only if it is done
systematically and timely, for which IT is a need because:
Forecasting requires a huge quantum of data
Forecasting is a continuous process, the frequency of which should
not get disrupted

n o t e s
Results out of forecasting are of very high importance, as the plan-

ning phase depends upon these results, and all the functioning of
an organisation is based on that planning
There are several advantages in utilising the capabilities of informa-

tion technology in forecasting. The commercial demand planning
module includes a variety of advance forecasting algorithms. These
algorithms often give a more accurate forecast than the forecast pro-
duced through the use of a general package, such as Excel. Most of the
demand planning applications make it easy to test various forecasting
algorithms against the past data so that the best fitting to the observed
demand patterns can be determined. A variety of forecasting options
are required because different forecasting algorithms provide differ-
ent levels of quality based on the actual demand patterns. The IT sys-
tem can thus be used to identify the best forecasting methods not just
for the firm overall but also by product categories and markets.
S
A forecasting package should be efficient enough to be used for a wide
range of products updated in real time by incorporating all informa-
IM
tion pertaining to the pattern of demand. The real-time update helps
firms to respond quickly to the changes in the marketplace and avoid
the costs of a delayed reaction. Good demand planning modules in-
tegrate the most current data in demand forecast, such as new prod-
ucts; current open, new product and back orders; sales’ histories; etc.
Much of the progress in areas such as collaborative planning has hap-
pened because of information technology innovations that allow the
M
exchange and incorporation of forecasts between enterprises.
Demand planning facilitates the shaping of a demand, and good de-

mand planning modules contain tools to perform the ‘what-if analy-
N
sis’ to estimate the impact of potential changes in prices on demand.

These tools help to analyse the impact of promotions. Further, these
tools can be used to determine the extent and timing of promotions.
Due to the uncertainty of future, the randomness of any event can-

not be determined fully, which leads to variation in the actual result.
Therefore, none of these tools can be foolproof. A good IT system
should provide the feature to track historical forecast errors so that
the same errors are not be repeated when taking future decisions.
A well-structured forecast with a measure of error can significantly
contribute in improving the decision-making process. In addition, the
element of human intuition should not be ignored fully because com-
bining it with sophisticated tools is believed to give rather better re-
sults. However, relying only on these tools for forecasting eliminates
the human intuition element that may turn out as a drawback because
firms cannot assess all of the significant qualitative aspects about the
future demand with the help of sophisticated tools only.
Some of the most important supply chain software used by firms in-
clude Oracle and SAP. There are several forecasting modules provid-

n o t e s
ed by supply chain players, such as i2 Technologies. In addition, sta-

tistical analysis software such as SAS is used by firms for forecasting.
10. It is important to not fully ignore the element of human

intuition as combining it with sophisticated tools is believed
to give rather better results. (True/False)
Activity
With the help of various sources, find information about the widely
used supply chain software used by the following companies:
1. Reliance
S
2. Pantaloons
3. Shoppers Stop
Make a report on your findings.

IM
8.8 RISK MANAGEMENT IN FORECASTING
As has been said a lot of times before, a forecast is done to predict the
future about which the only thing that is known is its being uncertain.
M
This uncertainty results in difference between the actual result and

the estimated result, obtained under forecasting. Also, a large number
of errors in forecasting can cause serious misallocation of the scarce
resources of a firm. Therefore, it is important for a firm to consider
the risks associated with forecast errors when planning for the future.
N
This future planning is always based on the results obtained in fore-

casting. Almost every strategy is based on forecast results that include
pricing strategies, promotion strategies and selling strategies. This
makes it important to consider risk management in forecasting so that
the obtained results may further boost up the strategies.
All the forecasted trends and values are considered at the planning
level. Therefore, the actual inventory, production capacity, transporta-
tion facility and pricing plans that a company follows depend upon the
data retrieved by forecasting. Since all the departments in an organ-
isation work in an integrated manner, a wrong forecast may hamper
the efficiency of each of them resulting in a chaos. For instance, the
demand is overestimated by a firm for the upcoming year. As a result,
the firm produces comparatively large quantum of the product. This
will affect the functioning of the operational department, finance de-
partment and sales department. How? Due to overestimation in re-
spect of demand, the firm would order for a huge quantum of raw
material that would not be used fully as the actual demand is low. The
storage of the excess material would affect the functioning of the op-

n o t e s
erational department. The money spent for the purchase of the excess
material could have been invested in some other profitable venture,
so this would impact the decision making of the finance department.
Moreover, the sales department would be pressurised to generate
more sales so that funds can be generated. Therefore, it is important
to take the measures of forecasting with due diligence.
There is a wide range of factors that can cause a forecast to be wrong

such as lead time and seasonality that occur frequently. A firm having
a long lead time would be making forecast in advance which would
further reduce the reliability of the forecast. Similarly, seasonality also
increases the chances of forecast errors because of the short life cycle
of products. Thus, forecast errors increase in case of short life cycle of
products due to the lesser availability of the historical data to build a
forecast.
S
Firms having comparatively small customer base usually experience
uneven demands that make it difficult for the firms to forecast the ac-
curate quantum of sales. It is also important to note that the forecast
IM
should be focussed on the demand made by end users rather than the
demand made by intermediaries. The telecommunication industry
faced the drawback of doing forecasting on the basis of the order size
placed by intermediaries in 2001. As a result, the forecasts done by the
manufacturers exceeded the customer demand by a huge quantum.
Therefore, a firm not considering the information pertaining to the
end user usually faces difficulty in producing reliable forecasts.
M
To mitigate the forecast risk, two strategies are used: one is associated
with the increasing responsiveness of the supply chain and the other
is associated with utilising opportunities for the pooling of demand.
N
Responsiveness is the ability of a supply chain to respond timely to

customer requirements or changes in the marketplace, whereas pool-
ing of demand refers to the aggregation of demands leading to more
consolidation and more standardisation on the buyers’ side. The first
strategy helps a firm in reducing forecasting errors, thereby reducing
the associated risks. The second strategy helps in smoothing out the
uneven demand by bringing together multiple sources of demand.
A firm employing these strategies needs resources and is bound to in-

cur costs in improving responsiveness and pooling. It includes the cost
incurred for enhanced investment and transportation mode.
Therefore, it is important for a firm to tailor the mitigation strategy

so the balance between risk mitigation and cost can be achieved. For
instance, when dealing with a commodity for which shortfalls can be
easily made up by spot market purchases, it is not advisable to spend
large amounts to increase the responsiveness of the supply chain. In
contrast, investment in enhancing responsiveness may be worth the
cost for a product having short life cycle. In addition, a product with
small forecast errors does not require an investment for pooling efforts.

n o t e s
11. To mitigate the forecast risk, two strategies are used: one is
associated with the increasing ______of the supply chain and
the other is associated with utilising opportunities for the
pooling of demand.
Activity
Prepare a report on the risk management mechanism of forecast-

ing used by Nokia.
8.9 SUMMARY
Future is uncertain, and to prepare organisations for this uncer-
S
tainty, there is a planning tool known as forecasting.
Broadly, there are there types of forecasting, namely short-term
forecasting, medium-term forecasting and long-term forecasting.
IM
The forecasting process includes several steps such as analyse the
objective of forecasting, integrate demand planning with forecast-
ing, identify customer segments, identify all major factors affecting
demand forecast, etc.
The role of demand forecasting in supply chain is satisfying cus-
M
tomers, preparing budget, stabilising production and evaluating

performance.
Qualitative forecasting methods are subjective in nature and based
on human expertise and judgements.
N
These methods include Delphi approach, market research, life cy-

cle analogy and informed judgement.
Unlike qualitative method, quantitative method makes use of com-
plex mathematical and statistical modelling to forecast results.
Two widely used qualitative methods are time series forecasting
method and causal method.
Everyproduct and service has two components that affect their
demand: systematic component and random component.
Itis important to note that forecasting would be beneficial for an
organisation if it considers only the systematic components and
not the random components.
IT plays an important role in forecasting because of many reasons,
such as: forecasting requires a huge quantum of data; it is a con-
tinuous process, the frequency of which should not get disrupted;
and results out of forecasting are of very high importance, as the
planning phase depends upon these results.

n o t e s
Due to the uncertainty of future, the randomness of any event

cannot be determined fully, which leads to variation in the actual
result.
Some of the most important supply chain software used by firms
include Oracle and SAP.
To mitigate the forecast risk, two strategies are used: one is asso-
ciated with the increasing responsiveness of the supply chain and
the other is associated with utilising opportunities for the pooling
of demand.
key words
Lead time: It is the time between the commencement and com-

pletion of a production process.
S
Pooling: It refers to the aggregation of individual units.
Responsiveness: It refers to that quality of an object that makes
it reactive in a quick manner.
IM
SAS (Statistical Analysis System): It is a software developed
by the SAS Institute for conducting several analyses used
during the forecasting process, such as advanced analytics,
multivariate analyses, business intelligence, data management
and predictive analytics.
M
Seasonality: It is a characteristic of a time series according to

which the data experiences regular modifications recurring ev-
ery calendar year.
N

1. Explain the concept of demand forecasting.
2. Discuss the role of demand forecasting in supply chain.
3. Delineate all the widely used qualitative forecasting methods.
4. Write a short note on measures of forecast error.
5. Explain the concept of risk management in forecasting.
Topic Q. No. Answer

Meaning of Demand Forecasting 1. Planning tool
2. Short-term
3. True

n o t e s
Topic Q. No. Answer

Role of Demand Forecasting in 4. Budget
Supply Chain
Qualitative Forecasting Methods 5. False
6. Market research
Quantitative Forecasting Methods 7. True

8. Trends
Measures of Forecast Error 9. Systematic component
Role of IT in Forecasting 10. True
Risk Management in Forecasting 11. Responsiveness
S
1. Future is uncertain, and to prepare organisations for this
uncertainty, there is a planning tool known as forecasting. Refer
to Section 8.2 Meaning of Demand Forecasting.
IM
2. The roles performed by demand forecasting include satisfying
customers, preparing budget, stabilising production and
evaluating performance. Refer to Section 8.3 Role of Demand
Forecasting in Supply Chain.
3. The widely used qualitative forecasting methods include Delphi
M
approach, market research, life cycle analogy and informed

judgement. Refer to Section 8.4 Qualitative Forecasting Methods.
4. The random component is responsible for the variation of a
forecast from the actual output. Therefore, it is termed a forecast
N
error. Refer to Section 8.6 Measures of Forecast Error.

5. Future uncertainty results in difference between the actual
result and the estimated result obtained under forecasting.
Therefore, it is important for a forecasting firm to consider
the risks associated with forecast errors when planning for the
future. Refer to Section 8.8 Risk Management in Forecasting.

8.12
REFERENCE
SUGGESTED READINGS
Geunes,Joseph, and P. M Pardalos. Supply Chain Optimization.
New York: Springer, 2005. Print.
Hugos,Michael H. Essentials Of Supply Chain Management.
Hoboken, N.J.: John Wiley & Sons, 2003. Print.
Mentzer, John T. Supply Chain Management. Thousand Oaks, Ca-
lif.: Sage Publications, 2001. Print.

n o t e s
E-REFERENCES
Esper, Terry, and T. Russell Crook. ‘Supply Chain Resources: Ad-
vancing Theoretical Foundations And Constructs’. J Supply Chain
Manag (2014): n/a-n/a. Web.
Priem, Richard L., and Morgan Swink. ‘A Demand-Side Perspec-
tive On Supply Chain Management’. J Supply Chain Manag 48.2
(2012): 7-13. Web.
S
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M
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C h a
9 p t e r
INFORMATION TECHNOLOGY IN
SUPPLY CHAIN MANAGEMENT
CONTENTS
S
9.1 Introduction
9.2 Role of IT in a Supply Chain
IM
Activity
9.3 Strategic Management Framework for IT Adoption in Supply Chain
Activity
9.4 Supply Chain Applications at Marketplace
M

Activity
9.5 Future Trends in Supply Chain
N
Activity
9.6 Summary

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SOLUTION FOR TRACKING OF SHIPMENTS BY AIRBUS
Airbus is an aerospace company that is headquartered in Bla-

gnac, France. It was facing problems in tracking the movement of
aircraft parts, components and other items from suppliers’ ware-
houses to manufacturing sites. This was due to the suppliers be-
ing located in different parts of the world.
Airbus wanted to improve the process of tracking of aircraft parts

and components. Therefore, the company developed a solution to
identify instances of divergence in inbound shipments from their
path to a manufacturing site. The inbound components and parts
are dispatched in smart containers that are retrofitted with radio
frequency identification (RFID) tags. At every juncture, these tags
are checked to ascertain whether or not the shipment has arrived
S
at the right place with the right materials. If this is not the case,
the system alerts personnel regarding any kind of disturbance in
the production process.
IM
The solution developed by Airbus was successful in greatly reduc-
ing the number and the extent of severity of mistakes in the de-
livery of components thereby, reducing the costs associated with
correcting them as well. Since Airbus is now aware of the loca-
tion of the parts and components in its supply chain, it has been
M
able to decrease the number of containers in circulation by 8 per

cent. Moreover, Airbus has been able to significantly reduce its
carrying costs at the same time augmenting the flow of parts and
components in the supply chain. This has firmly placed Airbus to
meet its cost and competitive challenges in the industry.
N

INFORMATION TECHNOLOGY IN SUPPLY CHAIN MANAGEMENT 189
n o t e s
learning objectives

>> Discuss the role of IT in a supply chain
>> Describe the strategic management framework for IT
adoption in supply chain
>> Explain the supply chain applications at marketplace
>> Discuss future trends in supply chain
9.1 INTRODUCTION
In the previous chapter, you have studied about the role of demand
forecasting in supply chain management and qualitative and quanti-
S
tative methods of demand forecasting.
A supply chain refers to a complex network of demand and supply. It

involves activities that facilitate the transfer of products or services
IM
from suppliers to end customers. Business parties that participate in
the delivery of a product or service are included in the supply chain
network of an organisation. The efficiency of a supply chain network
is directly related to customer satisfaction. This is because an effec-
tive supply chain leads to a short cycle time and on-time delivery of
products to customers. Thus, it is important for organisations to keep
M
a constant tab on supply chain performance.
Information Technology (IT) plays an important role in the supply

chain as it automates all supply chain processes of organisations. It
provides meaningful information that helps supply chain profession-
N
als to link different business parties (suppliers, manufacturers, dis-

tributors and customers), understand customer response, manage
inventory effectively and so on. This results in improved productivi-
ty, overall customer satisfaction and long-term relationships between
business parties.
In this chapter, you will study the role of IT in supply chain in detail.
The chapter further explains the strategic management framework
for IT adoption in the supply chain. In addition, it explains the supply
chain application in the marketplace. Lastly, it discusses future trends
in supply chain.
9.2 ROLE OF IT IN A SUPPLY CHAIN

A supply chain is a network of various businesses that are inter-
connected with each other in order to ensure effective delivery of a
product or service to the end customer. Information is a key driver to
maintain coordination between these different businesses. Accurate
and timely information helps supply chain personnel to take the right
decisions at the right time. These decisions can be related to produc-

n o t e s
tion and inventory levels, supplier selection, plant capacity, etc. In the
absence of adequate information, supply chain professionals will not
be able to make informed decisions, which may disrupt coordination
among various parties involved in a supply chain. Therefore, it is of
paramount importance for organisations to manage information in
the best possible manner.
Information Technology (IT) has played a crucial role in maintaining

a smooth flow of information in a supply chain. It helps organisations
in retrieving, storing, transmitting and handling data for making de-
cisions at different stages of a supply chain through the application of
computers. IT has enabled supply chain parties to access data from a
single source and take decisions accordingly. Apart from this, IT in a
supply chain serves the following objectives of organisations:
Customer satisfaction: It is the ultimate goal of a supply chain. In
S
order to fulfil customers’ requirements, organisations need to have
updated information regarding product availability, order status
and delivery schedules. IT helps in providing real-time data re-
lated to a supply chain to organisations. This information helps in
IM
making on-time deliveries and responding to the needs of custom-
ers quickly; thereby achieving customer loyalty and satisfaction.
Inventory management: IT provides access to inventory-related
information, such as current inventory levels, replenishment or-
ders, etc. to supply chain professionals. This further helps profes-
M
sionals to minimise inventory levels and prevent wastage.

Strategy development: IT provides information on different as-
pects such as customers’ needs and preferences, emerging mar-
kets and current economic conditions. As a result, organisations
N
can develop their supply chain strategies and plan effectively

for different operations such as manufacturing, distribution and
transportation.
The two main types of supply chain systems used in organisations

are inter-firm information system and intra-firm information system.
These system are discussed as follows:
Inter-firm information system: This system allows the flow of
information between an organisation and its customers and/or
suppliers. The increasingly unclear business environment has
compelled organisations to adopt this information system. An in-
ter-firm information system allows organisations in eliminating re-
dundant inventory pools at different stages of a supply chain.
Intra-firm information system: This system enables an informa-
tion flow across an organisation’s internal supply chain. The most
commonly used intra-firm information systems are Transporta-
tion Management System (TMS), Warehouse Management Sys-
tem (WMS), Enterprise Resource Planning (ERP) and Decision
Support System (DSS).

n o t e s
In the supply chain network of organisations, various cutting-edge

technologies are used such as digital imaging, bar coding, Global Po-
sitioning System (GPS), Electronic Data Interchange (EDI), Radio
Frequency Identification (RFID) and real-time location systems, etc.
These technologies help organisations in the following ways:
Processing of transactions: The movement of goods from the
point of origin to the point of consumption involves a number of
activities, such as processing of orders, dispatching goods, track-
ing the status of goods in transit, billing, etc. These activities can
be automated by using advanced technologies.
Better customer service: The basic aim of any business is to pro-
vide excellent services to their customers in order to achieve cus-
tomer loyalty. IT helps in achieving this objective by keeping track
of customers’ buying preferences, purchase history, buying trends
of customers (whether they are repeat customers or first-time cus-
S
tomers). Having such information in place helps organisations to
provide them a satisfying experience.
Reduction in cycle time: Cycle time refers to the time taken be-
IM
tween customer order and final delivery of the order to the cus-
tomer. Shorter the cycle time of an organisation, the higher will
be the level of customer satisfaction. An application of IT reduces
cycle time as it quickens all processes and prevents errors.
Effective collaboration: An application of IT helps different sup-
ply chain parties to have access to information related to the level
M
of stock, customer feedback, production capacity, demand fore-

casting, etc. A smooth flow of this information facilitates better co-
ordination between various parties.
Timely delivery: In this process, monitoring and coordination of
N
individual shipments with the help of modern technologies help in

making timely delivery to customers. This generates repeat busi-
ness for organisations and contract renewals for suppliers.
Here, it should be noted that applying advanced technologies in sup-

ply chain only once would not serve the purpose for organisations in
the long run. Organisations need to keep a contestant tab on updates
in technologies in order to stay ahead of competition.
1. A _______________ is a network of various businesses that are

interconnected with each other in order to ensure effective
delivery of a product or service to the end customer.
2. IT provides access to inventory-related information, such as
current inventory levels, replenishment orders, etc. to supply
chain professionals. (True/False)
3. The shorter the cycle time of an organisation, the lower will be
the level of customer satisfaction. (True/False)

n o t e s
Activity
Using the Internet, find out some real-life organisations that have
been receiving the benefits of implementing IT in their supply
chain networks.
STRATEGIC MANAGEMENT
9.3 FRAMEWORK FOR IT ADOPTION IN
SUPPLY CHAIN
To optimise their supply chains, organisations need to develop a
strategic framework for the adoption and integration of IT in supply
chains. This framework helps an organisation to determine what kind
of strategies should be formulated, when to be formulated and how to
S
be formulated for successful IT adoption. Figure 9.1 shows a strategic
management framework for IT adoption in the supply chain of an or-
ganisation:
IM
Technology Orientation
Reactive Proactive
M
First Move
Independent
Second Move
Technology competency
Technology investment
Resource-based
Knowledge barriers
Supply Chain Interdependence
Dominant position
Potential power
Exercising power
N
Value orientation
Champion orientation
Technology
Follow-Up
Opportunism
Dependent
Technology fundamental
Technology orientation
Resource deficiency
Environmental awareness
Sustainability of survival
Industrial pressure
Collective power
Response capability
Profit orientation
Flexibility
Figure 9.1: Strategic Framework for IT Adoption
In the above framework, the dimension of technology orientation de-

notes the capability of the organisation to implement technology for
the overall effectiveness of its supply chain. An organisation basically
adopts two strategies, namely proactive and reactive for the imple-

n o t e s
mentation of IT in its supply chain operations. In the proactive strate-

gy, there is a positive attitude towards the adoption and initiation of IT
in a supply chain, whereas in the reactive strategy, there is resistance
in IT adoption in the supply chain.
The dimension of supply chain interdependence denotes the mutual

sharing of knowledge and information along with coordination and
integration in the system. The supply chain interdependence has two
fields: independent and dependent. The independent field refers to
an organisation’s greater degree of influence and decision-making au-
thority on other supply chain partners. In addition, the organisation’s
resources, core beliefs and operations are not overly dependent upon
supply chain partners. The other field is dependent and denotes lim-
ited resources, strained capacities and narrow influences of an organ-
isation’s supply chain network.
S
This strategic framework makes use of four strategies for an organi-
sation for adoption of IT in its supply chain. These strategies are ex-
plained as follows:
IM
First-move strategy: This strategy is focused on self-motivation
and aggression. It is influenced by the demand for improvement in
order to create an advantage over the other supply chain partners.
Organisations that employ the first-move strategy have a strong
desire to become a leader and fully deploy their resources in the IT
adoption process. These organisations are able to influence other
M
supply chain partners in terms of strategic resources and advanced

technological capabilities. However, the drawback of this strategy
is that it is costly; requires a great degree of technological compe-
tence and resources; poses high risk and generates less return on
investment (ROI) as compared to other IT adoption strategies.
N
Second-move strategy: This strategy is conservative in nature and

implemented according to an organisation’s policies and leader-
ship approach. The advantage associated with the second-move
strategy is its value orientation. This implies that the organisation
refrains from investing in projects whose returns are uncertain in
nature and without any value increment. In this case, the organi-
sation would develop a positive attitude towards IT adoption only
if it is sure that the returns on investment in IT adoption will be
realised in the future. However, the drawback of this strategy is
that the organisation would not be able to achieve competitiveness
in the supply chain system and utilise strategic potential of IT.
Follow-up strategy: It is passive in nature and focuses on those
organisations that do not take an active part in IT adoption. This is
because these organisations operate on a small scale, do not have
adequate resources and have negligible influence on their supply
chain partners. Thus, organisations employing this strategy adopt
an almost outdated IT framework in order to support their busi-

n o t e s
ness operations and process essential business information need-

ed to operate and connect with dominant organisations.
Technology opportunism strategy: Technology opportunism has
two aspects: technology sensing and technology response capabil-
ity. Technology sensing refers to an organisation’s ability to obtain
updated information about new technology development as well as
changes in the internal and external business environment. Tech-
nology response capability, on the other hand, refers to an organi-
sation’s ability to adapt to new technologies, reinvent its business
strategy and explore new business opportunities. An organisation
that employs a technology opportunism strategy believes that the
implementation of a new IT framework can create opportunities
for the advancement of the organisation.
S
4. The dimension of ______________ denotes the mutual sharing
of knowledge and information along with coordination and
integration in the system.
IM
5. Which strategy is focused on self-motivation and aggression?
a. First-move strategy
b. Second-move strategy
c. Follow-up strategy
M
d. Technology opportunism strategy

6. _________________ refers to an organisation’s ability to obtain
updated information about new technology development
as well as changes in the internal and external business
N
environment.
Activity
Suppose you have been appointed as a supply chain manager in a

start-up company. Which supply chain strategy would you imple-
ment for the adoption of IT in your supply chain network?
SUPPLY CHAIN APPLICATIONS AT

9.4
MARKETPLACE
A supply chain management system is a computerised software appli-
cation that enables the assimilation of data associated with customers,
suppliers, partners, distributors and contract manufacturers. It en-
sures uninterrupted collaboration with purchasing, technical, supply
operations and supplier personnel.

n o t e s
Apart from this, a supply chain management system helps organisa-

tions in:
Easy procurement of raw materials
Effective management of inventory
Product order management
Monitoring and controlling of logistics
Estimation and planning of production
There are many efficient supply chain systems available in the market.
One such supply chain management software is ACG Infotech’s On-
line SCM software which helps in gathering information and making
decisions for purchases. This software solution balances the demand
and supply of products. Moreover, it fuses the supplier’s relationship
management processes in order to lower time delays and reduce func-
S
tional and geographical limitations. By applying this system, distribu-
tion and manufacturing companies can maintain a balance between
supply and demand. The software helps companies in:
IM
Improving customer and supplier relationships
Enhancing supply chain performance
Lowering the chances of delays in the completion of projects
Reducing the overall cost of operations
Reducing transport errors in consignment delivery
M
Reducing overall shipment costs

Offering improved and value-added customer service
N
7. A supply chain management system is a computerised

software application that enables the assimilation of data
associated with customers, suppliers, partners, distributors
and contract manufacturers. (True/False)
8. __________ software helps in gathering information and
making decisions for purchases.
Activity
Find information on the features and advantages of some latest

supply chain management software available in the Indian market.
9.5 FUTURE TRENDS IN SUPPLY CHAIN

An application of IT in supply chain is evolving with time. Some of
the recent trends in IT have enabled organisations to improve their

n o t e s
supply chains further and manage them in an effective manner. These

trends are discussed as follows:
Cloud computing: It can be defined as a technique of using com-
puting services, such as software and hardware as a service, over
a network. Cloud computing plays an important role in enhancing
the efficiency of a supply chain in the following ways:
Stores all data at a single location (centralisation of informa-
tion) from where it can be accessed by all supply chain part-
ners.
Increases collaboration between supply chain partners by en-
abling these partners to work on a common platform irrespec-
tive of their geographical locations. This helps everyone in the
chain to remain updated about recent developments.
Enables organisations to track the movement of their packages
S
and the persons/vehicles carrying them. This helps to resolve
many potential thefts and losses.
Provides a competitive edge in the market as organisations
IM
using cloud services can provide better and faster services to
their consumers.
Mobile applications: These are software applications that run on
smart phones and tablets having operating systems, such as iOS,
Windows OS, and Android. Software companies, like Oracle, have
M
developed a number of mobile applications to execute various sup-

ply chain functions. For example, Oracle Mobile Supply Chain is
capable of automating all supply chain process and generate re-
al-time supply chain information.
N
Analytics: It is a process of finding meaningful information pat-

terns from a large chunk of data. Organisations generally apply
analytics in a supply chain to predict and improve supply chain
performance. This ultimately leads to informed supply chain de-
cisions.
Business process convergence: In this process, organisations dis-
pose inefficient processes instead of improving them. For exam-
ple, manual billing has been replaced with computerised billing
systems.
Equalised global labour costs: Decline in labour arbitrage (which
is an economic phenomenon wherein jobs are outsourced to coun-
tries where inexpensive labour is available) is another emerging
trend in supply chain. This is happening due to increase in com-
petitiveness in labour costs of countries such as India, Indonesia,
Mexico, China and Ukraine.

n o t e s
Re-shoring: It means the return of outsourced production jobs

from overseas back into the domestic market from where they
were originally offshored. This trend of offshoring has recently be-
gun in the US as it had earlier outsourced its production jobs to
China where production was based on the cost per unit. However,
in the past decade, the average cost of labour has risen at a rate of
double digits, which has impelled the US to engage in re-shoring.
9. _________________ can be defined as a technique of using

computing services, such as software and hardware as a
service, over a network.
10. Business process convergence is a process of finding meaningful
information patterns from a large chunk of data. (True/False)
S
11. ___________ means the return of outsourced production jobs
from overseas back into the domestic market from where they
were originally offshored.
IM
Activity
Using the Internet, prepare a report on the phenomenon of re-shor-

ing that is currently on-going in some developed countries.
M
9.6 SUMMARY
Information Technology (IT) helps organisations in retrieving,
storing, transmitting and handling data for making decisions at
N
different stages of a supply chain through the application of com-

puters.
IT in a supply chain serves various objectives of organisations
such as customer satisfaction, inventory management and strate-
gy development.
A strategic framework makes use of four strategies for an organi-
sation for the adoption of IT in its supply chain namely, first-move
strategy, second-move strategy, follow-up strategy and technology
opportunism strategy.
A supply chain management system ensures uninterrupted collab-
oration with purchasing, technical, supply operations and supplier
personnel.
Applications of IT are evolving with time. Some of the future
trends in supply chain are cloud computing, mobile applications,
analytics, business process convergence, equalised global labour
costs and re-shoring.

n o t e s
key words
Decision Support System (DSS): It is a computer application

that is used for analysing and presenting business data to make
better and informed business decisions.
Enterprise Resource Planning (ERP): It refers to software that
integrates various business activities of an organisation by col-
lecting, storing, managing and handling business data.
Information Technology (IT): It is the application of computers
and telecommunications devices for the storage, transmission,
retrieval and manipulation of data for business purpose.
Inventory management: It refers to the practice of planning
and controlling stock, primarily its condition.
S
Warehouse Management System (WMS): It is a system that is
capable of controlling the movement and storage of resources
inside a warehouse.
IM
1. What role does information technology (IT) play in supply chain?
2. How do cutting-edge technologies help organisations in
improving supply chain performance?
M
3. Explain strategies adopted by organisations for implementing IT

in supply chain.
4. What are the benefits of a computerised supply chain management
system?
N
5. Discuss some future trends in supply chain.
ANSWERS for SELF ASSESSMENT QUESTIONS
Topic Q. No. Answer

Role of IT in a Supply Chain 1. Supply Chain
2. True
3. False
Strategic Management Framework 4. Supply chain interdepend-
for IT Adoption in Supply Chain ence
5. a. First-move strategy
6. Technology sensing
Supply Chain Applications at Mar- 7. True
ketplace

n o t e s
Topic Q. No. Answer

8. ACG Infotech’s Online
SCM
Future Trends in Supply Chain 9. Cloud computing
10. False
11. Re-shoring

1. Information Technology (IT) helps organisations in retrieving,
storing, transmitting and handling data for making decisions
at different stages of a supply chain through the application of
computers. Refer to Section 9.2 Role of IT in a Supply Chain.
2. The various cutting-edge technologies help organisations in the
S
processing of transactions, better customer service, reduction in
cycle time, effective collaboration and timely delivery. Refer to
Section 9.2 Role of IT in a Supply Chain.
IM
3. A strategic framework makes use of four strategies for an
organisation for the adoption of IT in its supply chain namely,
first-move strategy, second-move strategy, follow-up strategy and
technology opportunism strategy. Refer to Section 9.3 Strategic
Management Framework for IT Adoption in Supply Chain.
4. A supply chain management system is a computerised software
M
application that enables the assimilation of data associated

with customers, suppliers, partners, distributors and contract
manufacturers. Refer to Section 9.4 Supply Chain Applications
at Marketplace.
N
5. Applications of IT are evolving with time. Some of the future

trends in supply chain are cloud computing, mobile applications,
analytics, business process convergence, equalised global labour
costs and re-shoring. Refer to Section 9.5 Future Trends in
Supply Chain.

9.9
REFERENCE
SUGGESTED READINGS
Berger, A.J. and Gattorna, J.L. (2001). Supply chain cybermastery:
building high performance supply chains of the future. Gower Pub-
lishing Limited
Simchi-Levi, D. et al (2004). Managing the supply chain: definitive
guide. Tata-McGraw Hill Publishing Limited.
Ireland,
R.K. and Crum, C. (2005). Supply chain collaboration. J.
Ross Publishing.

n o t e s
E-REFERENCES
A, Bambo. ‘Supply Chain Management: Trends Of Future Supply
Chain Management’. Cmuscm.blogspot.in.
Beeline.com,.‘With Global Labor Costs Equalizing, A New Trend
Emerges: Reshoring.’.
MBA Skool-Study.Learn.Share.,. ‘Role Of Information Technology
In Supply Chain Optimization | Business Article | MBA Skool-
Study.Learn.Share.’
S
IM
M
N

C h
10 a p t e r
SUPPLY CHAIN INTEGRATION
CONTENTS
S
10.1 Introduction
10.2 Concept of Supply Chain Integration
IM
Activity
10.3 Model for Integrating Inbound and Outbound Networks
Activity
10.4 Global Supply Chain Design
M

Activity
10.5 Internal and External Integration of Supply Chain
N
Activity
10.6 Building Partnerships and Trust in Supply Chain
Activity
10.7 Collaborative Planning, Forecasting and Replenishment (CPFR)
Activity
10.8 Vendor-Managed Inventory (VMI)
Activity
10.9 Summary

n o t e s
GLOBAL SUPPLY CHAIN OF THE MANUFACTURING

OF FOOTBALL
Footballs are generally manufactured in Asia. The places in Asia

can providing expertise in manufacturing are logistically well-con-
nected and the cost of labour is relatively low. Some of the major
places are Sialkot in Pakistan and Shenzhen in China where more
than 60 million footballs are produced in a year. For example, Adi-
das carries out 67 per cent of its manufacturing in Pakistan, Viet-
nam and China. This enables it to keep its costs at a minimum as
the raw materials are procured from the nearby areas.
Components are shipped from across the world using various

modes of transportation like air, road or rail. After these compo-
nents have been assembled into a football, it is thoroughly test-
S
ed for quality. Then, it is shipped to the distributors’ warehouses.
These warehouses may be located within the same country where
the football has been produced or transported to the locations
IM
where they will eventually be sold via air, road or rail transport
networks.
In order to ship the goods to US and Europe, declarations have

to be filed under the US Importer Security Filing and EU Import
Control System. After the arrival of goods in these locations, they
are stored in warehouses. The distributor then hires trucks for
M
the distribution of footballs to regional distribution centres from

where they are finally delivered to retail stores, malls, etc., for
selling to customers.
N

SUPPLY CHAIN INTEGRATION 203
n o t e s
learning objectives

>> Describe the concept of supply chain integration
>> Explain the model for integrating inbound and outbound
networks
>> Discuss the global supply chain design
>> Describe internal and external integration of supply chain
>> Explain how to build partnerships and trust in supply chain
>> Describe collaborative planning, forecasting and replenish-
ment
>> Discuss the concept of vendor-managed inventory
S
10.1 INTRODUCTION
In the previous chapter, you studied about the role of information tech-
IM
nology in supply chain and how a strategic management framework is
employed for IT adoption in the supply chain of an organisation. Let
us discuss supply chain integration in this chapter.
Supply chain integration means coordination, interaction and infor-

mation flow linkage within a supply chain. Without a smooth and un-
M
interrupted flow of information, the integration of supply chain would

be ineffective. Weak integration may lead to ineffective processes.
Ineffective processes could potentially disrupt the supply chain net-

work of an organisation. In today’s times, organisations’ supply chains
N
are spread across the world. In order to take advantage of low-cost

labour, the manufacturing of goods is outsourced to countries such as
China. Organisations need to focus on enhancing their global supply
chain design so that they can benefit immensely from the practice of
global outsourcing.
It is necessary to have smooth flow of information between supply

chain partners so that strong partnerships and trust among supply
chain participants can be built. For building cooperation and trust
among supply chain members, organisations can use various formal
contracts to ensure effective cooperation.
This chapter explains the concept of supply chain integration and the
model for integrating inbound and outbound networks. It discusses
global supply chain design as well as internal and external integration
of supply chain. It also explains how to build partnerships and trust in
supply chain. Lastly, collaborative planning, forecasting and replen-
ishment, and vendor-managed inventory are discussed.

n o t e s
CONCEPT OF SUPPLY CHAIN

10.2
INTEGRATION
Supply chain integration refers to a close arrangement and coordina-
tion within a supply chain by employing shared information systems.
A supply chain is a network of various businesses interconnected with
each other in order to ensure the effective delivery of a product or
service to the end customer.
A supply chain basically refers to the requisite inputs needed to man-

ufacture a product and accomplish the objective of making a sale to a
customer. For example, an organisation in the business of assembling
computers would need to buy certain parts such as circuit boards.
Now, the organisation in the business of circuit boards would need
to purchase raw materials, such as silicon, to manufacture them. An
S
organisation’s supply chain comprises the gathering and assembling
of these raw materials in order to produce components needed to
manufacture a working computer, which is the end product. After the
IM
computer has been assembled, it may be sent to a warehouse by an
organisation that supplies trucks for the transportation of products.
Subsequently, it is delivered to a retailer where it is ultimately sold to
the customer. This entire process, beginning from the sourcing of raw
materials to the final delivery to the end user, is treated as an element
of the supply chain of the computer.
M
Supply chain integration consists of different levels implemented in

an organisation. Typically, the first step in the process is the selection
of vendors with whom an agreement is made with respect to provid-
ing a particular quantity of inputs at a set cost. This helps in ensuring
N
that the organisation has the requisite quantity of materials in order

to manufacture its projected output of goods for a particular year.
For example, the computer-manufacturing organisation might sign a
contract with a particular vendor who would supply circuit boards.
These supplies would be provided at a certain cost, which would be
mentioned in the contract and would be in effect for a particular time
period.
Supply chain integration would achieve a higher level if the organi-

sation that supplies circuit boards would make its plant in close prox-
imity to the plant of the computer manufacturer. As a result, the two
organisations can share their production software to better integrate
their operations.
An aspect of supply chain integration is vertical integration. It occurs

when the supply chain of an organisation is fully owned by the same
organisation. For example, the computer-manufacturing organisation
would purchase or own the circuit board organisation in order to en-
sure the supply of its components as and when needed by it.

n o t e s
Organisations not only need to integrate their supply chains but also
have to make decisions regarding the integration of the business
with different processes, the kind of technology to be used, etc., so
that they can be successful. This kind of integration and coordination
is achieved by promoting collaboration among the business entities,
suppliers and customers through supply chain management. This sys-
tem is beneficial for all the parties involved in the process of supply
chain integration.
It is a generally accepted fact that achieving integration in a supply

chain is not possible overnight. The different levels involved in a sup-
ply chain develop and evolve over a period of time. By integrating
the supply chain, customers benefit immensely as they experience
an improved sense of satisfaction due to the timely delivery of prod-
ucts. Moreover, loyalty is built among different business partners,
inventory levels are reduced and there is an augmentation in flexi-
S
bility so that any kind of disruptions in the supply chain can be eas-
ily dealt with. The benefits of supply chain integration are shown in
Figure 10.1:
IM
Formation of partnerships
Facilitating predication
M
Reduction in inventory needs
Flexibility
N
Figure 10.1: Benefits of Supply Chain Integration
Let us discuss these benefits in detail:

Formation of partnership: Sourcing materials for the produc-
tion of finished products and their subsequent sale to customers
encourage building of partnerships with business partners. This
helps in building a level of trust with them.
Facilitating prediction: Due to transfer and sharing of informa-
tion, the process of supply chain integration becomes more smooth
and easier to integrate. Organisations exchange data pertaining
to present and future plans in addition to the tracking of data in
real time with each other. In order to increase the efficiency lev-
els, organisations can plan and carry out inventory management,
production schedules and shipping functions with increased effec-
tiveness. For example, an organisation in the construction busi-
ness can relate information to one of its supply chain partners that

n o t e s
builds doors so that the partner can arrange sufficient resources to

handle the demand for new doors created due to the development
of a new housing project.
Reduction in inventory needs: Supply chain integration is benefi-
cial in reducing inventory needs and ensuring delivery of products
on time. A latest study conducted on supply chain management re-
vealed that organisations that have switched to an integrated sup-
ply chain system reported improvements in the on-time delivery of
products by 50 per cent, growth in sales by more than 50 per cent
and reduction in inventory levels by 35 per cent. This resulted in
considerable improvement in customer service.
Flexibility: Due to an integrated supply chain, organisations can
offer a great degree of flexibility in order to respond to adverse
conditions. For example, an organisation can give cross-training
S
to its employees so that they are better prepared to deal with any
unforeseen situation such as sudden shutdown of operations.

IM
1. _______________________ refers to a close arrangement and
coordination within a supply chain by employing shared
information systems.
2. A ___________ basically refers to the requisite inputs needed
to manufacture a product and accomplish the objective of
M
making a sale to a customer.
Activity
N
Suppose you are the supply chain manager of a company that man-
ufactures laptops. You have recently outsourced your company’s
manufacturing unit to a company in the Philippines. List the bene-
fits of making this decision.
MODEL FOR INTEGRATING INBOUND

10.3
AND OUTBOUND NETWORKS
In the context of a supply chain, an inbound network refers to the
delivery, transportation and storage of goods coming into a business.
On the other hand, an outbound network refers to the goods that are
going out of a business.
The main objective of a supply chain is to integrate and bring about

optimisation in the operational and business functions of an organisa-
tion. In order to achieve this objective, the Supply Chain Operations
Reference (SCOR) model is used by organisations. SCOR model helps
in facilitating interactions different entities in an organisation. It helps
in the coordination of the supply chain with the planning function for
inbound and outbound networks.

n o t e s
In this model, planning for the inbound and outbound networks is

combined together. This is done so that the activities involved in these
networks can be further examined. In the planning of an inbound net-
work, manufacturers have to coordinate with their suppliers for the
inbound materials. On the other hand, in the planning of an outbound
network, manufacturers have to collaborate and cooperate together to
develop an outbound strategy for the goods. This model is beneficial
for balancing and integration of the inbound and outbound networks.
Figure 10.2 depicts a SCOR model:
Plan
S
Deliver Source Make Deliver Source Make Deliver Source Make Deliver Source
Return Return Return Return Return Return Return Return

IM
Supplier's Supplier Your Company Customer Customer's
Supplier Customer
Internal or External Internal or External
SCOR Model
M
Figure 10.2: SCOR Model

(Source: http://www.supplychainquarterly.com/print/scq200802scor/ )

N
3. The main objective of a supply chain is to integrate and bring

about optimisation in the operational and business functions
of an organisation. (True/False)
4. ___________ helps in facilitating interactions among different
entities in an organisation.
Activity
Suppose you are the supply chain manager of an organisation that

manufactures televisions. Prepare a report on how you would uti-
lise the SCOR model for integrating your inbound and outbound
networks.
10.4 GLOBAL SUPPLY CHAIN DESIGN

A global supply chain refers to a network developed among various
organisations across the world for the purpose of production, distri-
bution and handling of goods. Organisations need to take advantage

n o t e s
of global sourcing in order to gain access to the foreign consumer mar-

ket. They need to spend more time and resources to develop their
global supply chain.
In the past, the supply chain networks were infrequently redesigned

by organisations, mostly due to a vital change in operations triggered
by a merger or acquisition, the introduction of a new product, or a
change in the sales profiles of the employees. However, due to the fre-
quently changing market dynamics, organisations often examine their
supply chain design. For example, in global sourcing, several organ-
isations carry out complex global sourcing initiatives. However, they
are not adequately supported with equally thorough network design
analyses.
Global sourcing helps in the development of a new global supply chain

design by taking into account several factors such as the effect of low-
S
cost labour, problems in visibility of inventory, political and cultural
barriers pertaining to the local government, impact of geographical
distances on the service and availability of products, issues related to
IM
customs clearance, and language barriers.
Several organisations operate in a multitude of markets on different

continents. However, they do not possess the ability to effectively or-
ganise and leverage global supply and demand. This situation pro-
vides both an opportunity and a challenge. A multinational organisa-
tion must implement an inherently global planning process with strict
M
rules for creating and aggregating forecasts around the world in order
to function in an effective manner. For example, organisations that
grow by acquiring or merging with other organisations maintain their
existing production capacity across the world. However, some of them
N
may be redundant or inefficient. In such a situation, the supply chain

networks of these organisations need to be optimised to function in
fewer sites that are able enough to serve global markets.
In order to design a global supply chain, an organisation needs to con-

sider some of the factors as shown in Figure 10.3:
Design of Total Landed Cost
Obsolescence Cost
Visibility
Mitigation of Risk
Decentralised Manufacturing
Figure 10.3: Factors Affecting Global Supply Chain Design

n o t e s
Let us discuss these factors in detail:

Design of total landed cost: The management and design of a
global supply chain from the viewpoint of the total landed cost re-
fers to the cost borne by an organisation for storing its inventory
over a period of time. Organisations who want to design their glob-
al supply chain, should focus on areas such as business survey,
predicting the direction of organisational growth, study of trade
flows and interpreting the reasons behind the success or failure of
trade partners. The organisations interpret and analyse these data
for finding out areas where improvements can be made. For exam-
ple, an organisation may want to enhance its customer service by
making available in-transit shipment visibility to its supply chain
partners.
Obsolescence cost: Organisations have to consider the obsoles-
S
cence cost and the cost of carrying inventory. For example, a high-
end laptop manufacturer’s product with an average life span of 6
months should not be transported via ship as it takes time to reach
the destination. At the time of the arrival of the product, there may
IM
be a possibility that the technology would be obsolete.
Visibility: It plays an important part in the success of a global
supply chain as organisations that track shipments in transit ef-
fectively can better manage their freight and make transportation
decisions quickly. For example, an organisation has the option to
either immediately release its goods for delivery to its intended
M
destination or choose to hold them in a warehouse.

Mitigation of risk: Due to the outsourcing of manufacturing to
other parts of the world where cheap labour is available, such as
Asia, Latin America, Eastern Europe and the Caribbean, there re-
N
mains a distinct possibility that supply chain disruptions continue

to occur and the frequency of their occurrence may even increase.
A failure in the supply can have severe consequences. It may ad-
versely affect the organisation’s market capitalisation, cause loss
of value of stocks and may even result in bankruptcy. According to
a recent study, only 5-25 per cent of Fortune 500 organisations can
handle any disruptions in their supply chains. For example, high-
tech consumer electronics markets are particularly at the risk of
supply chain failures. Sony has shifted its manufacturing plants
that produce digital cameras back to Japan from China.
Decentralised manufacturing: Organisations that have global
supply chains should not outsource their manufacturing needs to
a particular geographic region only, but rather disperse them in
different parts of the world. For example, a computer manufactur-
er has outsourced its manufacturing to China, Africa and Eastern
Europe. This would ensure that the organisation does not experi-
ence a total breakdown in its supply chain.

n o t e s
5. A _________________ refers to a network developed among

various organisations across the world for the purpose of
production, distribution and handling of goods.
6. Global sourcing helps in the development of a new global
supply chain design by taking into account several factors
such as the effect of low-cost labour, impact of geographical
distances on the service and availability of products, etc.
(True/False)
Activity
Using the Internet, prepare a report on the factors affecting the
S
design of the global supply chain of an organisation that manufac-
tures smartphones.
IM
INTERNAL AND EXTERNAL
10.5
INTEGRATION OF SUPPLY CHAIN
As discussed earlier, integration is a process of collaboration between
companies to arrive at the mutually acceptable outcomes. The key
components of supply chain integration are coordination, interaction
M
and information flow linkage. It is necessary that these components

are present outside as well as inside the supply chain. Weak integra-
tion may lead to ineffective processes. There are generally two types
of integration – internal integration and external integration.
N
Internal integration refers to the integration of functional areas in the

organisation that include purchasing and operations. It involves the
management of intra-organisational relationships. The collaboration
between the internal departments includes functional areas, such as
production marketing, sales, logistics and distribution. These function-
al areas need to be integrated well to enhance the customer service.
Thus, it is expected that the holistic performance of these functional
areas should be achieved. The important elements of internal integra-
tion are communication, coordination and strong relationships.
To achieve internal integration, the information systems used by dif-

ferent functions are linked together that help in accessing the real
time information from other functions. Internal integration reduces
cost, stockout and lead time. The internal integration mechanisms
used by organisations include the following:
Centralisation of decision making
Information systems

n o t e s
Cross-functional teams
Cross-functional job rotation
On the other hand, external integration manages the inter-organisa-

tional relationships through increased coordination among the sup-
pliers, retailers and distributors. This can be achieved with the help of
wireless wide area networks. For example, an organisation can view
the location and status of the shipment of suppliers with the help of
global positioning system. If the delivery of materials is late, then care-
ful planning should be done.
7. ___________ refers to the integration of functional areas in an

organisation that include purchasing and operations.
S
8. Internal integration increases cost, stockout and lead time.
(True/False)
IM
Activity
Using the Internet, make a report on the alignment of external in-

tegration with internal integration.
BUILDING PARTNERSHIPS AND TRUST

M
10.6
IN SUPPLY CHAIN
It is necessary to have a smooth flow of information among supply
chain partners. This ensures building strong partnerships and trust
N
among supply chain participants. Through accurate and timely infor-

mation sharing, organisations can better match supply and demand
throughout the supply chain. There should be harmonious relation-
ships between all the parties so that they can work in an integrated
manner. For building cooperation and trust among supply chain mem-
bers, organisations can adopt either of the following two ways:
Making contracts: Parties involved in a supply chain can use vari-
ous formal contracts to ensure effective cooperation. Through con-
tracts, parties gain each other’s trust for self-interest.
Holding meetings: Trust and cooperation can be built among par-
ties due to a series of interactions over time. Cooperation among
parties is strengthened through positive interactions.
The following are the major advantages of building partnerships and

trust among supply chain partners:
Results in unified decisions in the network. By building trust, one
party becomes more considerate towards the objectives of the oth-
er parties involved in the supply chain.

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Information sharing becomes a reliable source of decision making

among parties due to trust and long-term partnerships.
With trust, it is easy to implement operational improvements and
design appropriate pricing schemes.
Eliminates the duplication of efforts at every stage when each party
trusts the action of the other parties involved in the supply chain.
9. Through accurate and timely information sharing,

organisations can better match supply and demand throughout
the supply chain. (True/False)
10. For building cooperation and trust among supply chain
members, organisations can make contacts and refrain from
S
holding meetings. (True/False)
Activity
IM
What will be the effects on the supply chain in the absence of trust
among channel partners? Make a report on the basis of your find-
ings.
COLLABORATIVE PLANNING,
M
10.7 FORECASTING AND REPLENISHMENT

(CPFR)
According to the Voluntary Interindustry Commerce Standards
N
(VICS) Association, CPFR is a business practice that combines the in-

telligence of multiple partners in the planning and fulfilment of custom-
er demand. It is an approach to supply chain management in which
the planning skills of trading partners are combined with common
metrics and agreements to fulfil customers’ demand and improve the
efficiency of the supply chain. CPFR increases the availability of prod-
ucts to customers at reduced inventory, transportation and logistics
costs. It is the basic framework for the flow of information, goods and
services in a supply chain. The benefits of CPFR model are as follows:
Forecasting becomes more reliable. This helps in planning the
production capacity accordingly.
It helps in making accurate predictions for consumer demands
that provide a better understanding of production needs.
Material flow is improved between various stages in a supply chain.
The effective use of CPFR techniques helps in creating an under-

standing among all partners, such as manufacturers, suppliers,
distributors and retailers.

n o t e s
Figure 10.4 shows the CPFR model used in a supply chain:
Str
ate
is Manufacturer gy
lys &
a
Pl
An
Performance Collaboration
an
assessment Arrangement
nin
Retailer Joint
Exception
g
Management Business
Plan
Consumer
Order Sales
Fulfillment Forecasting
S
Order Order
Generation Planning/
n
Forecasting
io
t
IM
u
xec
E
Figure 10.4: CPFR Model

M
(Source: http://www.socialsupplychains.com/what-is-collaborative-planning-
forecasting-and-replenishment-cpfr/)
In the above figure, the customer is placed at the centre of the model,
followed by retailer (buyer) in the middle ring, then the manufacturer
N
(seller) in the outer ring. In a supply chain, the demand for products
generates from customers, whereas the retailer provides the products
demanded. The manufacturer becomes the supplier of customers’ de-
manded products to the retail channels/stores.
Figure 10.4 shows the four phases of CPFR, which are discussed as
follows:
Strategy and planning: In this phase, the ground rules for collabo-
rative relationships to be formed and are defined, such as business
goals, scope of collaboration; assignment of roles; responsibilities,
checkpoints and escalation procedures. These rules are deter-
mined by partners involved in a supply chain.
Demand and supply management: In this phase, collaborative
sales are projected by the partners to estimate consumer demand
at the point of sale. Based on the projection, a collaborative order
plan is created to determine future orders, delivery requirements,
replenishment lead times, etc.

n o t e s
Execution: In this phase, orders are generated on the basis of fore-

casts. After that, partners involved in a supply chain begin work-
ing on various activities for the fulfilment of orders, such as pro-
duction, shipping and storage of products.
Analysis: In this phase, focus is laid on identifying exceptions and
assessing performance to uncover trends and develop alternative
strategies for further improvements.
By implementing CPFR, the overall profits of a supply chain can be

achieved through better coordination among all trade partners.
11. ____________ is an approach to supply chain management in

which the planning skills of trading partners are combined
S
with common metrics and agreements to fulfil customers’
demands and improve the efficiency of a supply chain.
12. CPFR increases the availability of products to customers
IM
at reduced inventory, transportation and logistics costs.
(True/False)
Activity
List the benefits achieved by any manufacturing organisation that

M
uses CPFR.
10.8 VENDOR-MANAGED INVENTORY (VMI)

N
A system in which a vendor provides or supplies items to a customer

on the basis of the order specified by him/her is called Vendor-Man-
aged inventory (VMI). This entire supply and demand is based on a
signed contract or an agreement between the supplier or the vendor
and the customer.
In VMI, organisations store their stock at the customer’s warehouse,

store or any other location as per the agreed terms and conditions. The
customer communicates the consumption of the stock to the vendor
on a regular basis. The stock levels in the VMI organisations are fixed
at the rate of consumption of the customer. Further, the cost manag-
er determines the cost of the consumed items and records it. Next,
the cost manager creates bill-only sales orders that are further used
for the preparation of invoices. The VMI organisations thus generate
intraunit transfers to stock the customer location to the appropriate
stock levels. The main features of VMI are as follows:
The vendor is responsible for the supply of inventory items as
and when the customer demands or makes a requisition. This ap-
proach makes the customer free from the need to maintain a min-
imum inventory and a safety stock.

n o t e s
The customer benefits from the reduced purchasing costs, as the

materials are at the cost level based on the agreement between the
vendor and customer.
The manufacturers gain from this approach, as they have the ac-
cess to the trends and data generated and are able to plan ahead
and take decisions and actions appropriately.
VMI supports the business objectives and reorganise the supply chain
functions for both suppliers and their customers. Leading manufac-
turers are determined to become more receptive to the demands of the
customers for a wide range of products, without holding huge invento-
ries. Many manufacturers are striving to extend their demand-driven
supply systems, where they can promptly ‘sense and respond’ to the
actual demand. Some organisations are even using this methodology
to shape the demand on the basis of the incessant visibility of market
S
commotion.
VMI is an organised process for managing inventory and fulfilling an

order. It includes an association between suppliers and customers (for
IM
example, distributors, retailers, OEM and product end users), which
changes the conventional ordering process.
Exhibit
Implementation of Vmi
M
The following figure depicts the implementation of VMI:

N
Figure: Implementation of VMI

(Source: https://docs.oracle.com/cd/E16365_01/fscm91pbr0/eng/psbooks/sinv/img/graph-
ic_The_process_flow_for_Vendor_Managed_Inventory_when_nonconsigned_items_are_
stored_at_your_customers_l.png)

n o t e s
The implementation of VMI involves the following processes:

Fulfilment: It is used to process sales orders based on the or-
ders received from customers.
Receiving: It provides customers the option of giving receipt
confirmation of the consigned goods.
Consumption: It is used to depict the rate of consumption of
materials by customers.
Return: It is used to keep a track of the items returned by cus-
tomers.
Physical count: It is used to keep a track of the count of the in-
ventory items physically.
S
13. A system in which a vendor provides or supplies items to a

customer on the basis of the order specified by him/her is
IM
called _____________________.
14. VMI is a forecasting process for managing inventory and
fulfilling an order. (True/False)
Activity
M
How is CPFR model different from VMI? Prepare a report on it.
10.9 SUMMARY
N
Supply chain integration refers to a close arrangement and coor-

dination within a supply chain by employing shared information
systems.
A supply chain basically refers to the requisite inputs needed to
manufacture a product and accomplish the objective of making a
sale to a customer.
The benefits of supply chain integration are formation of partner-
ships, facilitating prediction, reduction in inventory needs and
flexibility.
The main objective of a supply chain is to integrate and bring
about optimisation in the operational and business functions of an
organisation. In order to achieve this objective, the SCOR model is
used by organisations.
SCOR model helps in facilitating interactions among different en-
tities in an organisation. It helps in the coordination of the supply
chain with the planning function for inbound and outbound net-
works.

n o t e s
A global supply chain refers to a network developed among vari-

ous organisations across the world for the purpose of production,
distribution and handling of goods.
In order to design a global supply chain, an organisation needs to
consider factors such as design of total landed cost, obsolescence
cost, visibility, mitigation of risk and decentralised manufacturing.
Internalintegration refers to the integration of functional areas in
the organisation that include purchasing and operations.
External integration manages the inter-organisational relation-
ships through increased coordination among the suppliers, retail-
ers and distributors.
For building cooperation and trust among supply chain members,
organisations can adopt two ways, namely making contracts and
S
holding meetings.
CPFR is an approach to supply chain management in which the
planning skills of trading partners are combined with common
IM
metrics and agreements to fulfil customers’ demands and improve
the efficiency of a supply chain.
A system in which a vendor provides or supplies items to a cus-
tomer on the basis of the order specified by him/her is called ven-
dor-managed inventory.
M
key words
Collaborative Planning, Forecasting and Replenishment

(CPFR): This approach makes a supply chain more efficient in
N
fulfilling customer demands by combining the planing skills of

trading partners and common metrics and agreements.
Global supply chain: It refers to a network developed among
various organisations across the world for the purpose of pro-
duction, distribution and handling of goods.
Obsolescence cost: It is referred to as a cost borne by an organ-
isation when a product is no longer wanted even though it may
still be in good working condition due to advancements made in
technology.
Total landed cost: It refers to the cost borne by an organisation
for storing its inventory over a period of time.
Vendor-Managed Inventory (VMI): It is a system in which a
vendor provides or supplies items to customers on the basis of
the order specified by them.

n o t e s

1. What is supply chain integration? List its benefits.
2. Write a short note on the model for integrating inbound and
outbound networks.
3. What is global supply chain design? Discuss the factors that an
organisation needs to consider for designing a global supply
chain network.
4. Describe internal and external integration in a supply chain.
5. Explain collaborative planning, forecasting and replenishment
(CPFR).
6. Discuss the concept of vendor-managed inventory.
S

IM
Topic Q. No. Answer
Concept of Supply Chain 1. Supply chain integration
Integration
2. Supply chain
M
Model for Integrating Inbound 3. True

and Outbound Networks
4. SCOR model
Global Supply Chain Design 5. Global supply chain
N
6. True
Internal and External 7. Internal integration
Integration of Supply Chain
8. False
Building Partnerships and 9. True
Trust in Supply Chain
10. False
Collaborative Planning, 11. Collaborative Planning, Fore-
Forecasting and Replenishment casting and Replenishment
(CPFR) (CPFR)
12. True
Vendor-Managed Inventory 13. Vendor-Managed Inventory
(VMI) (VMI)
14. False

n o t e s

1. Supply chain integration refers to a close arrangement and
coordination within a supply chain by employing shared
information systems. Please refer to Section 10.2 Concept of
Supply Chain Integration.
2. The SCOR model is used by organisations for integrating
inbound and outbound networks. Please refer to Section
10.3 Model for Integrating Inbound and Outbound Networks.
3. A global supply chain refers to a network developed among
various organisations across the world for the purpose of
production, distribution and handling of goods. Please refer to
Section 10.4 Global Supply Chain Design.
4. Internal integration refers to the integration of functional areas in
S
an organisation that include purchasing and operations. External
integration manages the inter-organisational relationships
through increased coordination among the suppliers, retailers
and distributors. Please refer to Section 10.5 Internal and
IM
External Integration of Supply Chain.
5. CPFR is an approach to supply chain management in which the
planning skills of trading partners are combined with common
metrics and agreements to fulfil customers’ demands and
improve the efficiency of a supply chain. Please refer to Section
10.7 Collaborative Planning, Forecasting and Replenishment
M
(CPFR).
6. VMI is a system in which a vendor provides or supplies items
to customers on the basis of the order specified by them. Please
refer to Section 10.8 Vendor-Managed Inventory (VMI).
N

10.12
REFERENCE
SUGGESTED READINGS
Simchi-Levi, D. et al. (2004). Managing the supply chain: definitive
guide. Tata-McGraw Hill Publishing Limited.
Sadler, I.( 2007). Logistics and supply chain integration. SAGE Pub-
lications.
Schary,P.B., et al. Managing the global supply chain. Copenhagen
Business School Press.
E-REFERENCES
Karsten Horn, Supply Chain 24/7. ‘The Amazing Supply Chain
of The 2014 World Cup Soccer Ball - Supply Chain 24/7’. Supply-
chain247.com.

n o t e s
Study.com. ‘What Is Supply Chain Integration? - Definition &

Overview - Video & Lesson Transcript | Study.Com’.
From A-Z, Kewill. ‘From A-Z, How A Soccer Ball Reaches A Con-
sumer’s Doorstep, By Kewill’. Supplychaindigital.com.
S
IM
M
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C h
11 a p t e r
Supply Chain Restructuring
CONTENTS
S
11.1 Introduction
11.2 Supply Chain Mapping
IM
Activity
11.3 Supply Chain Process Restructuring
Activity
11.4 Postponing the Point of Differentiation
M

Activity
11.5 Changes in the Shape of the Value-addition Curve and Improvement
in Supply Chain Management
N

Activity
11.6 Summary

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Hewlett Packard’s POSTPONEMENT STRATEGY
Hewlett Packard (HP) is a multinational company that provides

IT hardware and software solutions along with IT and Informa-
tion Technology Enabled Services (ITES) to individuals and big
and small businesses. It has global presence including USA and
India and it is headquartered at Palo Alto, California, USA. It was
founded in 1939 by Bill Hewlett and Dave Packard. It employs
more than 10,000 individuals worldwide. It was incorporated in
August 1947 and went public in November 1957. The major com-
petitors of HP are CSC, Dell, Gateway and HTC Corp.
In the late 1980s, the company was facing dual problem. Firstly, its
inventory was mounting and billions of dollars were blocked in the
inventory. Secondly, the customers were becoming increasingly
S
dissatisfied with the order fulfilment process of HP. The company
was looking for a possible solution to address these problems.
IM
(Source: http://www.theoldcomputer.com/)
At that time, the products of HP were manufactured in its Vancou-

M
ver factory, USA and the products were sold in Europe and North
America. Each European country had its own set of specifications
regarding the hardware components such as voltage, plug size
etc. Due to these specifications, it was required that each product
N
must be customised for each European country separately.
Initially, the company followed the strategy to differentiate the

products for each market segment according to specific require-
ments such as products that require 110 volt supply or products
that require 220 volts supply within its Vancouver factory. The dif-
ferentiation was decided before the manufacturing process had
started. HP carefully thought about this practice and resolved to
postpone this differentiation at later stage in the supply chain.
This would help in reducing inventory and increasing customer
service by improving the order fulfilment process. HP developed
a new design of universal power supply that was built into the
products and could work in all the countries.
Due to this, HP was able to shift its differentiation at time, it re-

ceived customer order. HP also benefited because of this as the
products were not made for any specific country and in case of de-
mand and supply imbalances, the products could be easily trans-
shipped from one country to another. This postponement strategy
is a part of a bigger strategy known as supply chain restructuring.

Supply Chain Restructuring 223
n o t e s
learning objectives

>> Explain the concept of supply chain mapping
>> Describe the concept of supply chain process restructuring
>> State the importance of postponing the point of differentiation
>> Explain how changing the shape of the value-addition curve
can lead to improvement in supply chain management
11.1 INTRODUCTION
In the previous chapter, you studied the concepts of supply chain in-
tegration including the Supply Chain Operations Reference (SCORE)
S
model for integrating inbound and outbound networks; designing
the global supply chains; internal and external integration of sup-
ply chains; Collaborative Planning, Forecasting and Replenishment
IM
(CPFR) system; and the concept of Vendor Managed Inventory (VIM).
The chapter discussed how the flow of information is increased and
smoothened among all the supply chain partners.
Supply chain activities start from the very point when the manufactur-
er acquires the raw materials and ends when the products are bought
by the end customers. During this entire time, it is required that there
M
is perfect co-ordination and flow of information among the supply

chain partners. It is important that any gaps or imbalances in the sup-
ply chain must be detected as early as possible. It is the duty of the
supply chain managers to identify any gaps and resolve the same. For
N
this purpose, supply chain managers usually resort to two techniques,

namely, supply chain integration and supply chain optimisation. You
have already studied supply chain integration in the previous chapter
and you will study supply chain optimisation in upcoming chapters
(Chapter 13). These two concepts help in improving the supply chain
performance and reducing costs. However, today the organisations
are under tremendous pressure to relentlessly improve their supply
chain performance to sustain their competitive advantage. To facili-
tate this, organisations now use supply chain restructuring.
Supply chain restructuring is a methodology that involves activities

which help in significantly changing and restructuring the supply
chain processes and architecture. It may involve closer integration be-
tween the marketing process and supply chain process, process rede-
signing, redesigning the network structures and offering more value
to the customers. Supply chain restructuring is accomplished by three
major strategies viz. postponing the point of differentiation, altering
the shape of the value addition curve and advancing the customer or-
dering point. The details of these strategies will be discussed in the
chapter.

n o t e s
In this chapter you will study supply chain mapping. Further you will
study supply chain process restructuring. In addition postponing the
point of differentiation will be discussed. Towards the end you will
study about changes in the shape of the value-addition curve and im-
provement in supply chain management.
11.2 SUPPLY CHAIN MAPPING

Before you study how a firm may restructure its supply chain; it is es-
sential to find a method that can capture and evaluate all supply chain
processes. Supply chain mapping is a method of identifying existing
supply chain processes. This can be done on the basis of three dimen-
sions, which are as follows:
Shape of the value-addition curve
Point of differentiation
S
Customer entry point in a supply chain
These dimensions are shown in Figure 11.1:

IM
Order Placed by
Customer
Point of Differentiation
M Cost
N
Shape of value addition curve
Time
Figure 11.1: Three Dimensions of Supply Chain Processes
Restructuring the supply chain process involves altering the supply

chain on at least one of these three dimensions. It may also involve
altering more than one of these dimensions or altering all the three.
Let us now discuss each dimension separately and see what kind of
restructuring can be undertaken in each of these dimensions.
Value-addition Curve
A typical supply chain begins with raw material and information,

which are transformed into finished goods and finally delivered to

n o t e s
customers. This transformation comprises a number of activities and

each activity incurs costs and time. Moreover, value addition for each
activity also takes place. Here, it has been assumed that all non-value
adding activities have been removed by an organisation during the
supply chain optimisation process. Refer to Figure 11.1, the time is
shown on the x-axis while the total cost (cumulative) in the supply
chain is shown on the y-axis.
To map the value-addition curve, a reverse route (backward) from

the point where the value is delivered to the end customer is taken
and all activities that were performed to make the end product and
service available are traced back. All these activities are mapped in
two dimensions: time and cost. That means the value addition curve
mainly captures the way cost is added over a period of time in supply
chain processes. For example, a bus manufacturer receives engines
(an important component for making the bus) from an engine sup-
S
plier; the received engines have to wait till the machining operation
(and engine assembly) is scheduled in the machine shop (production
area). The whole production process is divided into various stages.
IM
First, machined castings are made which then go to the WIP (work-
in-progress) store. This WIP inventory is then taken to the engine as-
sembly stage. At this stage, the engine is mounted over the chassis in
the bus assembly line. After this, certain other activities such as fitting
and paint are completed and the assembled bus is ready for dispatch
to the dealer.
M
After completing a particular number of buses, they are transport-

ed to a dealer. The bus remains in the inventory or showroom of the
dealer until a customer buys it. It means that the material in different
forms (raw/WIP/finished goods) waits at various stages. If all these op-
N
erations are added, we will get a curve as shown in Figure 11.1. Also,
since costs are also getting added with every subsequent activity in
the supply chain process, the y-axis is also showing an increase with
time.
Different organisations offer different products to consumers. How-

ever, an organisation may choose to differentiate a particular product
also so as to offer more variety to consumers. Other organisations may
choose not to differentiate products. The concept of point of differ-
entiation (second dimension) is valid only for organisations that offer
product differentiation.
Products are manufactured in a supply chain comprising multiple

stages. As the product progresses through the supply chain, it assumes
an identity that is closer to the end product. The point of differentia-
tion refers to the stage at which the product is modified or differenti-
ated and becomes a specific variant of the end product. For example,

n o t e s
a toothpaste manufacturer offers one variety of toothpaste in varying

pack sizes (such as 50 grams, 100 grams, and 200 grams). In this case,
the point of differentiation is the time of packing.
Similarly, a garment manufacturer produces different sizes and styles

of garment using the same material (fabric). Here, differentiation oc-
curs at stitching stage. An automobile manufacturer produces a par-
ticular type of car having the pre-defined set of features and functions.
However, the differentiation demanded by customers is based on the
colour of automobiles. This differentiation in colour is introduced at
the painting stage. All the examples described above reflect one point
of differentiation only. However, in practice, the organisation can in-
troduce differentiation in products at various stages. For example, be-
fore sending the fabric for stitching, the garment manufacturer has to
decide which colour fabrics will be used. The colour decision is taken
at the drying stage.
S
After this, the size and design decision is made at the cutting stage.
Now, you are aware that a product can have more than one point of
IM
differentiation. However, here, you will study about only one main
point of differentiation.
You have studied the concept of demand forecasting earlier in this

book. We discussed the demand forecasting along with all its meth-
ods. While doing so, we were mainly concerned about forecasting the
aggregate demand for a particular product. However, we never did
M
any forecasting for different product variants. It is so because demand

forecasting at the aggregate level is relatively simple whereas demand
forecasting at the variant level is quite difficult. For example, an auto-
mobile manufacturer may easily forecast the demand for total num-
N
ber of cars for its next financial period with a great degree of certain-
ty. However, the automobile manufacturer would face difficulty if he
wants to predict the demand for a particular car having a particular
colour. In addition, as the variation increases, the chances of error in
forecasting also increase.
Therefore, the firm has to forecast demand at the aggregate level be-
fore the point of differentiation. The organisation has to forecast de-
mand at a variant level after the point of differentiation. It means that
the point of differentiation forces the firm to forecast at the variant
level. The probability of forecasting errors is higher for a longer time
period. Therefore, if the point of differentiation occurs early in the
supply chain, the firm will have to forecast demand at the variant level
for a longer horizon.
Customer Entry Point in the Supply Chain
The dotted line in Figure 11.1 shows the time or point (see that this
line is parallel to y-axis) at which a customer places an order. In the

n o t e s
case of most of the industries, customers expect products on shelves

in nearby stores. It means that the customers’ entry point in the sup-
ply chain is at the end of the value addition curve and coincides with
delivery time of the product. In some other industries, customers do
give some lead time to the firm to deliver the product. In such cases,
the customer’s entry point is ahead of the delivery time. This is similar
to the CTO (configure to order) supply chain situation. The customer’s
entry point captures the order to delivery lead time. The importance
of this dimension lies in the fact that all previous activities were car-
ried out on the basis of forecasts, whereas after the order placement
by the customer, all the activities are done based on order. However,
how perfect a forecast may be, there is a scope of errors in it. So a lot of
certainty comes to the entire operations if most activities are carried
out based on order rather than forecast.
S
1. Supply chain restructuring is a method that captures the

existing supply chain processes. (True/False)
IM
2. Supply chain processes can be identified on the basis of three
dimensions namely ______, ______ and _______.
3. During the value-addition mapping, activities are mapped in
two dimensions which include ________ and ________.
4. The differentiation in automobiles demanded by customers is
M
based on ______ of automobiles.

5. We can forecast demand at an aggregate level or at variant
level. Which is a preferred and better forecast?
N
6. Usually, a customer entry point falls at the beginning of the

value-addition curve. (True/False)
Activity
Using the Internet, find information on organisations using the

CTO (configure to order) model in India.
Supply Chain PROCESS

11.3
RESTRucTuRING
Whenever the best supply chain practices, such as supply chain opti-
misation and integration, fail to achieve the desired changes, supply
chain managers may require resorting to supply chain restructuring.
Supply chain restructuring is all about integrating product and pro-
cess engineering with supply chain functions. Additionally, it may also
involve integrating the supply chain functions with marketing. Supply
chain restructuring also involves taking into consideration existing

n o t e s
supply chain processes and architecture. In addition, it also involves

introducing innovative concepts, such as product redesign, process
redesign and network redesign, in the supply chain to improve cus-
tomer service. Supply chain process restructuring involves making
changes in one or more dimensions of the supply chain by adopting
any of the following three approaches:
Postpone the point of differentiation: According to this approach,
the point of differentiation should be as close as possible to the
end of the value curve. It means that all changes that are made
to introduce differentiation in a product should be made near the
customer delivery point. It is important because in this way, ma-
jority of activities of supply chain can be carried out at the aggre-
gate level instead of carrying them at a variant level. For example,
paint companies produce paints of different varieties in different
colours. They usually postpone the point of differentiation till the
S
far end of the value addition curve. For example, Asian Paints of-
fers four types of emulsion brands. All emulsions comprise a base
and a stainer. Paints comprise 99 percent of the base and 1 percent
IM
of strainers. The stainer is the element which when added to the
base produces an emulsion of the desired colour. The base for all
emulsions remains same whereas the stainer is manufactured in
various colours. Strainers are available in about 150–250 shades.
The process of mixing the base with the stainer is called as tinting
operation. Now, Asian Paints has shifted its tinting operation at the
retail level. It means that the retailer produces emulsion having a
M
particular colour in tinting machines (paint mixing machines) only

after getting an order from a customer. By doing this, Asian paints
has been able to changes its MTS (made to stock) model to CTO
(configure to order) model, saving billions of rupees by reducing
N
the inventory level at the variant level.

Alteration in the shape of the value-addition curve: Most cost
addition in products should be shifted to the end of the supply
chain. This helps in decreasing the level of inventory required to
be maintained by the organisation. Shifting majority of cost ad-
dition towards the end of the supply chain is important because
if any unpredictable changes occur, the organisation can incorpo-
rate those changes with the least cost.
Advancement in the customer ordering point: It involves shifting
the customer ordering point or customer entry point as early as
possible, as near to the start of the value-addition curve as possi-
ble. By this, the organisation moves from the MTS (make to stock)
model to CTO (configure to order) model of the supply chain. The
advantage of the CTO model is that most activities can be done
against an order. When activities are done on the basis of order, the
level of forecasting reduces. In a supply chain based on the CTO

n o t e s
model, the point of differentiation occurs after receiving the cus-

tomer order. Therefore, in such a scenario, there is no requirement
of preparing the variant-level forecasts.
At this stage, it is important to differentiate between supply chain

restructuring and supply chain integration/optimisation. This differ-
ence can be explained by using a figure, as follows:
Order Placed by
Customer
S
Cost
IM
New point of Differentiation
Time
M
Figure 11.2: Impact of Supply Chain Restructuring and Supply

Chain Optimisation on the Shape of Value-Addition Curve
In Figure 11.2, supply chain integration and optimisation lower the

N
value-addition curve, which means that there is overall reduction in

cost and time involved in the supply chain. Additionally, there is also
an absolute shift in the point of differentiation; however, the relative
position of the point of differentiation does not change. Please note
that supply chain integration and optimisation only lower the val-
ue-addition curve; they do not affect its shape. On the contrary, supply
chain restructuring may have one or more of the following impacts:
Affecting the shape of the value-addition curve
Shifting customer order (entry) point
Shifting the point of differentiation
These changes may be reflected in terms of changing product design

or product service bundle offered to customers. Supply chain restruc-
turing involves making major changes in the supply chain such as
moving from the MTS model to the CTO model of the supply chain.
All these changes lead to the increased efficiency of the supply chain
along with reduced costs for an organisation.

n o t e s
7. Supply chain restructuring involves taking into consideration

existing supply chain processes and architecture. (True/False)
8. List any two approaches used for supply chain restructuring.
9. An organisation can move from the MTS (make to stock)
model to CTO (configure to order) model of the supply chain
by _________.
10. In the case of supply chain integration and optimisation, the
value-addition curve is lowered and there is a relative shift in
the point of differentiation. However, the absolute position of
the point of differentiation does not change. (True/False)
S
Activity
Prepare a report on any two Indian companies that have recently

restructured their supply chains. Include in your report the prob-
IM
lems faced by these companies and the possible solutions imple-
mented by them.
POSTPONING THE POINT OF

11.4
DIFFERENTIATION
M
As discussed above, postponing the point of differentiation involves

shifting the point of differentiation towards the end of the value-addi-
tion curve. This can be achieved in reality by deferring the operational
process (differentiation process) to a later stage in the supply chain. A
N
differentiation process is an activity that results in producing differen-

tiated products using the base products. For example, an organisation
manufactures potato chips in various flavours. The process to produce
chips in different flavours remains same till the flavouring agents and
spices are added to the produced chips. In this case, the usual process
of chips manufacturing includes the following steps:
1. Collecting and cleaning the required quantity of potatoes
2. Inspecting and making temperature checks
3. Peeling the skin
4. Washing the starch
5. Frying the chips
6. Adding additives (spices and flavouring mixtures)
7. Packaging
However, the differentiation takes place in Step 6 where spices and

flavouring mixtures are added. The advantage of postponing the point

n o t e s
of differentiation is that it helps in reducing inventories. Additionally,

the time period for which a firm has to carry out forecasting at the
variant level is also reduced. These lead to improved customer service
and reduced product obsolescence. The postponement of the point of
differentiation can also help in reducing transportation costs. Let us
now discuss how the postponement of the point of difference helps in
reducing transportation costs.
Postponement for Reducing Transportation Cost
Usually, the differentiation process is postponed for producing cus-

tomised products as per the requirements of customers. However, or-
ganisations may also use the postponement strategy for delaying the
operational process to a later stage in the supply chain with an aim to
reduce transportation cost. There are organisations that achieve this
S
reduction in transportation cost by shifting the assembly of the final
(bulky) finished products towards the customers’ end. This practice
is generally followed in cases where the product can be transported
IM
as a kit consisting of various parts, which can be easily assembled by
the customer after he/she purchases it. In such a case, transportation
costs are significantly reduced because transporting kits is easier and
cheaper as compared to the transportation of a finished product.
Organisations that manufacture bicycles in India have been quite

successful in implementing the postponement strategy. Bicycle
M
manufacturers usually manufacture cycle frames, handles and trans-

mission parts in-house whereas all other parts such as tyres, tubes,
seats, brakes, etc. are sourced through their respective suppliers. Re-
tail dealers of bicycles stock frames and other components separately.
N
When a customer arrives, he/she chooses a particular bicycle (from

catalogue or display) and finalises his/her order. After this, the deal-
er instructs his/her technician to assemble the demanded bicycle us-
ing the frame and other components. This assembly time takes about
15–30 minutes. After the completion of assembly, the bicycle is hand-
ed over to the customer. The advantage to the bicycle manufactur-
er is that the kits are less prone to damage as compared to the fully
assembled bicycles. Also, kits require less space as compared to the
fully assembled bicycles; therefore, more kits can be transported in
a transporting vehicle as compared to the number of fully assembled
bicycles.
Bicycle manufacturers initially used this strategy to lower their costs.

However, this strategy can also be used to offer a number of variants
to customers, which is an added advantage for bicycle manufacturers.
The bicycle industry can introduce mass customisation by designing
modular components and allowing customers to choose a combina-
tion of modules, which the dealer can assemble as per customers’ re-
quirements.

n o t e s
Problems with Implementing the Postponement

Strategy
The postpone strategy is helpful in the following cases:

Mass product customisation
Modular product designs
Large fluctuations or variability in demand
Large transportation lead time
Small value addition during transportation
Small lead time in postponed operation
Large value addition in the postponed operation
As discussed above, the postponement strategy brings various ad-
S
vantages such as reduced inventory, warehousing and transportation
costs and increased responsiveness to customers. However, there are
some problems associated with the postponement strategy. These
IM
problems are as follows:
Economies of scale are reduced due to mass customisation
Product quality may be affected (in certain cases) when a manu-
facturer shifts the final assembling processes to the dealers’ end
Relationship with other members of the supply chain may get af-
M
fected
11. Postponing the point of differentiation involves shifting the

N
point of differentiation towards the end of the value-addition

curve. This can be achieved in reality by deferring the ________
to a later stage in the supply chain.
12. Due to postponement of the point of differentiation, the time
period in which a firm has to carry out forecasting at the
variant level is also reduced. (True/False)
Activity
Using the Internet, find information on benefits received by organ-

isations by postponing the point of differentiation.
ChangES in the Shape of the Value-

11.5 addition Curve AND IMPROVEMENT
IN Supply Chain MANAGEMENT
A firm usually tends to alter the shape of the value-addition curve
so that maximum cost addition takes place as late as possible in the

n o t e s
supply chain. This is shown in Figure 11.3 (given below), which pres-
ents two curves namely the existing value-addition curve and the pro-
posed value-addition curve. For analysing these curves, the organisa-
tion needs to differentiate between cost-intensive and time-intensive
activities. Activities which can be completed in short time but require
high cost are cost-intensive activities; whereas activities that require a
lot of time but only small cost are time-intensive activities.
To shift cost addition at the later stages of the supply chain, a manu-
facturer should rearrange all activities in such a way that maximum
time-intensive activities are carried out during the initial period of
supply chain whereas cost-intensive activities are carried out during
the later stages of supply chain. To accomplish the rearrangement of
activities, cost per unit of time can be used as a parameter of activities
to arrange activities in an ascending order.
S
IM
Cost
M
N
Time
Figure 11.3: Change in the Shape of Value Addition Curve
You have already studied the significance of postponing the point of

differentiation. Here, you will study the cost and time related param-
eters of the postponement process. Let us understand this with the
help of an example. Reliance Infocomm is a large telecommunications
company in India. It keeps on extending its telecommunications net-
work which requires the company to lay down the fibre optic network.
Most telecommunication companies usually follow a pre-determined
sequence to lay down their network, which is as follows:
a. Procuring optical cable
b. Obtaining the right of way
c. Trenching

n o t e s
d. Laying of cable
e. Starting the network
Step a. (procuring optical cable) is a cost-intensive activity and in-

volves huge capital expenditure whereas trenching is a time-inten-
sive activity. This usual sequence involved initial cost outlays and time
outlays at the end of the value-addition curve. Due to this, the shape
of the value-addition curve remained similar to the original value-ad-
dition curve.
Reliance Infocomm found that something was wrong with the existing
sequence of activities and restructured the sequence in such a way
that it was able to modify the shape of the value-addition curve. Re-
liance shifted the activity of buying optical cables after the trenching
activity was over. The activity of trenching involved laying of a conduit
S
within which the optical cable could be laid later. After the trenching
activity (time intensive) was over, Reliance purchased the optical ca-
ble which was laid in the conduit. Now, after this restructuring the Re-
liance Infocomm’s value-addition curve looked like the dotted curve
IM
as shown in Figure 11.3.
13. To shift cost addition to the later stages of the supply chain,
a manufacturer should rearrange all activities in such a way
M
that maximum time-intensive activities are carried out during

the ___________.
14. Rearrangement of activities according to time-intensive and
cost-intensive activities can be done by using cost per unit of
N
time as a parameter of activities to arrange activities in an

ascending order. (True/False)
Activity
Using various sources, find information on companies whose sup-

ply chain management performance has been improved by making
changes in the shape of the value-addition curve.
11.6 SUMMARY
Supply chain mapping is a method that captures existing supply
chain processes.
Three dimensions of supply chain processes based on which re-
structuring of supply chain is done includes: value addition curve,
point of differentiation and customer entry point.
To map the value-addition curve, a reverse route (backward) from
the point where the value is delivered to the end customer is taken
and all activities are mapped in two dimensions: time and cost.

n o t e s
Pointof differentiation refers to the stage at which the product is

modified or differentiated and becomes a specific variant of the
end product.
The customers’ entry point in the supply chain is at the end of
the value addition curve and coincides with delivery time of the
product.
Supply chain restructuring is all about integrating product and
process engineering with supply chain functions.
Supply chain restructuring also involves taking into consideration
existing supply chain processes and architecture.
Supply chain restructuring involves introducing innovative con-
cepts, such as product redesign, process redesign and network re-
design, in the supply chain to improve customer service.
S
A differentiation process is an activity that results in producing
differentiated products using the base products.
The advantage of postponing the point of differentiation is that it
IM
helps in reducing inventories.
The postponement of the point of differentiation can also help in
reducing transportation costs.
There are organisations that achieve reduction in transportation
cost by shifting the assembly of the final (bulky) finished products
M
towards the customers’ end.

Organisations that manufacture bicycles in India have been quite
successful in implementing the postponement strategy.
Problems with Implementing the Postponement Strategy include:
N
economies of scale are reduced due to mass customisation; rela-

tionship with other members of the supply chain may get affected.
To shift cost addition at the later stages of the supply chain, a man-
ufacturer should rearrange all activities in such a way that max-
imum time-intensive activities are carried out during the initial
period of supply chain whereas cost-intensive activities are carried
out during the later stages of supply chain.
key words
Customisation: It refers to the process of making a product as

per the requirements of the customer.
Customer entry point: It refers to that point in the value addi-
tion curve at which a customer places an order.
Point of differentiation: It refers to the stage at which the prod-
uct is modified or differentiated and becomes a specific variant
of the end product.

n o t e s
Restructuring: It refers to any process or activity that brings

about drastic changes in the process/procedure/entity to which
it is applied.
Value-addition curve: It is a curve that can be obtained by plot-
ting the time on the x-axis and the total cost (cumulative) on the
y-axis in the supply chain graph.

1. Discuss the concept of supply chain mapping.
2. Explain the three dimensions of supply chain mapping in detail.
3. Discuss how postponing the point of differentiation helps an
organisation.
S
4. Explain why is it beneficial for an organisation to advance the
point of entry.
5. Explain the process of shifting the point of differentiation
IM
towards the end of the value-addition curve in case of a potato
chips manufacturer.
6. Explain how altering the shape of the value-addition curve can
be used for improving the supply chain management.

M
Topic Q. No. Answer

N
Supply Chain Mapping 1. False

2. Shape of the value-addition curve,
point of differentiation, customer
entry point in the supply chain
3. Time, Cost
4. Colour
5. Aggregate level forecast is better
6. False
Supply Chain Process 7. True
Restructuring
8. Postponing the point of differentia-
tion, altering the shape of the val-
ue-addition curve
9. Advancing in the customer ordering
point.
10. False

n o t e s
Topic Q. No. Answer

Postponing the Point of 11. Operational process (differentiation
Differentiation process)
12. True
Changes in the Shape 13. Initial period of supply chain
of the Value-Addition
Curve and Improve-
ment in Supply Chain
Management
14. True

1. Supply chain mapping is a method that captures existing supply
chain processes. Refer to Section 11.2 Supply Chain Mapping.
S
2. Supply chain processes can be identified on the basis of
three dimensions: shape of the value-addition curve, point of
differentiation and customer entry point in the supply chain. To
IM
map the value-addition curve, a reverse route (backward) from
the point where the value is delivered to the end customer is
taken and all activities that were performed to make the end
product and service available are traced back. Refer to Section
11.2 Supply Chain Mapping.
3. By postponing the point of differentiation, organisations can
M
move from MTS (made to stock) model to CTO (configure to

order) model which leads to cost reduction. Refer to Section
11.3 Supply Chain Process Restructuring.
4. It is beneficial for an organisation to advance the point of entry
N
because by doing so most of the activities can be accomplished

against an order. When activities are done on the basis of order,
the level and importance of forecasting reduces. Refer to Section
11.3 Supply Chain Process Restructuring.
5. Potato chips manufacturer produces chips in various flavours.
The process to produce chips in different flavours remains
same till the flavouring agents and spices are added to the
produced chips. Refer to Section 11.4 Postponing the Point of
Differentiation.
6. Shifting cost addition at the later stages of the supply chain, a
manufacturer should rearrange all activities in such a way that
maximum time-intensive activities are carried out during the
initial period of supply chain whereas cost-intensive activities
are carried out during the later stages of supply chain. Refer to
Section 11.5 Changes in the Shape of the Value-Addition Curve
and Improvement in Supply Chain Management.

n o t e s

11.9
REFERENCE
SUGGESTED READINGS
Shah, J. (2009). Supply chain management. Upper Saddle River,
N.J.: Pearson Education.
Blackwell, R., & Blackwell, K. (1999). The century of the
consumer. Columbus, Ohio: Fisher College of Business, Ohio State
University.
Vrat, P. (2014). Materials Management. New Delhi: Springer India.
E-REFERENCES
S
Harvard Business Review,. (2004). Leading a Supply Chain Turn-
around. Retrieved 9 December 2015, from https://hbr.org/2004/10/
leading-a-supply-chain-turnaround
IM
us, D. (2015). Green Packaging & Shipping. Dell. Retrieved 9 De-
cember 2015, from http://www.dell.com/learn/us/en/uscorp1/corp-
comm/earth-transportation-logistics?c=us&l=en&s=corp
Jhconline.com,. (2015). Supply Chain Restructuring: Considerations
for Change. Retrieved 9 December 2015, from http://www.jhcon-
line.com/supply-chain-restructuring-considerations-for-change.
M
html
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C h
12 a p t e r
METRICS AND DRIVERS OF SUPPLY CHAIN
CONTENTS
S
12.1 Introduction
12.2 Framework for Supply Chain Drivers
IM
12.2.1 Facilities
12.2.2 Inventory
12.2.3 Transportation
12.2.4 Information
12.2.5 Sourcing
12.2.6 Pricing
M

Activity
12.3 Managing Performance with Metrics
12.3.1 Performance Measure
N
12.3.2 Different Metrics

12.3.3 Next Generation Performance Management
Activity
12.4 Supply Chain Operations Reference (SCOR) Model
Activity
12.5 Summary

n o t e s
RESPONSIVE SUPPLY CHAIN IN OLD DUTCH FOODS
(Source: roadstories.ca)
S
Old Dutch Foods is an US-based food manufacturer that primari-
ly supplies potato chips and other snack items in the Mid-western
IM
US and Canada. Founded in 1934, the company has always served
its customers with delicious and high quality snack food items.
In 2000, Old Dutch Foods acquired a competitive organisation

named Humpty Dumpty Snack Foods Limited. The objectives of
the acquisition were to:
Maintain its leadership position in the market with increased
M
efficiency and accuracy

Create a streamlined organisation with higher productivity
levels among the existing staff
N
Eliminate inventory shrinkage

Serve customers with a wide variety of options while main-
taining product quality
Improve distribution centres’ throughput and process order
on time
To achieve the above objectives, Old Dutch Foods decided to re-

design its distribution centres according to its requirements and
implement Warehouse Control System (WCS) successfully. For
this purpose, the company hired a logistics organisation named
Invata Intralogistics to provide customised distribution centres.
Invata Intralogistics created a distribution centre that enabled

Old Dutch Foods to receive products from manufacturing facili-
ties and deliver orders on time. The distribution centre transport-
ed manufactured products to warehouses and organised them in
a forward pick area. Invata categorised cartons in serial numbers
according to the lot to ensure first in, first out (FIFO) picking and
tracking system. The company also integrated the Enterprise Re-

METRICS AND DRIVERS OF SUPPLY CHAIN 241
n o t e s
source Planning (ERP) software with WCS to process multiple

orders simultaneously.
With the new technology development, Old Dutch Foods success-

fully created a leaner and more streamlined distribution centre in
the Atlantic regional market. This helped the company to reduce,
and in some cases, eliminate shipping errors remarkably. It also
made the process from manufacturing to retailing and beyond
more transparent and visible. As a result, the throughput of the
organisation increased considerably.
S
IM
M
N

n o t e s
learning objectives

>> Explain the framework for supply chain drivers
>> Describe how to manage performance with metrics
>> Discuss the Supply Chain Operations Reference (SCOR)
model
12.1 INTRODUCTION
In the previous chapter, you have studied about the supply chain pro-
cess restructuring. However, a successful supply chain consists of cer-
tain drivers that govern the responsiveness and competitiveness of an
S
organisation with regard to its supply chain network. In an organisa-
tion, these drivers serve as metrics that measure the performance of
its supply chain network.
IM
There are six main supply chain drivers. While three of them are lo-
gistical drivers, the rest are cross-functional drivers. Logistical drivers
are involved in the movement of products from a supply centre or an
organisation to a demand centre or end users.
On the other hand, cross-functional drivers help in making a supply

M
chain effective by aligning it with other organisational functions, such

as marketing, sales and manufacturing. Logistical drivers include fa-
cilities, inventory and transportation, while cross-functional drivers
include information, sourcing and pricing.
N
In this chapter, you will study the framework for supply chain drivers
in detail. You will also study how to manage performance with met-
rics. Towards the end, you will study the SCOR model.
FRAMEWORK FOR SUPPLY CHAIN

12.2
DRIVERS
In the present dynamic business scenario, every organisation needs
to have a competitive edge over the rest. To achieve this, organisa-
tions are adopting different processes and technologies for aligning
the capabilities of their supply chains with their business strategies.
This has enabled organisations to maintain a balance between supply
chain efficiency and responsiveness. For this, organisations require
examining different supply chain drivers and utilising them appro-
priately. A supply chain driver is a factor that enables a supply chain
to operate efficiently and responsively. There are six key supply chain
drivers, as listed in Figure 12.1:

n o t e s
Facilities
Inventory
Transportation
Information
Sourcing
Pricing
Figure 12.1: Key Supply Chain Drivers
S
A supply chain’s performance depends on the interaction among
these six key supply chain drivers. Let us first discuss the framework
for structuring these drivers. The supply chain of each organisation
IM
targets at aligning its competitive strategy with its supply chain strat-
egy for increased efficiency and responsiveness. To achieve this, or-
ganisations require structuring a suitable combination of all these six
drivers of a supply chain. These drivers interact with one another to
determine the supply chain’s responsiveness. Figure 12.2 shows the
framework for structuring these drivers:
M
Competitive Strategy
N
Supply Chain Strategy
Efficiency Responsiveness
Supply Chain Structure
Logistical Drivers
Facilities Inventory Transportation
Information Sourcing Pricing
Cross-Functional Drivers
Figure 12.2: Framework of Interactions between Supply Chain Drivers

(Source: Supply Chain Management (Strategy, Planning, And Operation)
by Sunil Chopra and Peter Meindl)

n o t e s
Figure 12.2 shows that it is important for an organisation’s supply chain

strategy to support its competitive strategy. A supply chain strategy
seeks to achieve efficiency and responsiveness. To accomplish supply
chain activities effectively, both logistical drivers (inventory, facilities
and transportation) and cross-functional drivers (sourcing, informa-
tion and pricing) are used.
Let us consider an example to understand this framework. ABC Lim-

ited is a retail organisation with a competitive strategy that intends
to achieve efficiency and responsiveness through its supply chain. To
accomplish this, ABC can include both logistical as well as cross-func-
tional drivers in its supply chain in the following manner:
The organisation can maintain low levels of inventory to maintain
supply chain efficiency.
It can employ its own fleet to increase awareness and ensure bet-
S
ter product availability.
It can use its central distribution centres to enhance efficiency
with fewer facilities.
IM
It can ensure a smooth flow of information throughout its supply
chain network to improve responsiveness.
It can define valid criteria for selecting suppliers to determine reli-
able and efficient sources for selling their products.
It can adopt the Everyday Low Pricing (EDLP) scheme to confirm
M
a steady demand for its products.
Therefore, by utilising a structured framework of supply chain, ABC

can synchronise its supply chain strategies.
N
12.2.1 FACILITIES
Facilities are the physical locations in a supply chain network that are
used for manufacturing, storing and transporting products. There are
different types of facilities in a supply chain, such as:
Plant sites
Factories
Warehouses
Distribution centres
The efficiency and responsiveness of a supply chain depends on the

capacity, location and flexibility of facilities. For example, a distributor
who wants to respond quickly to customers should choose a facility
that is located near the consumption centre.
An organisation usually makes long-term decisions related to facilities

in its supply chain. Therefore, it considers various factors before de-
ciding on facilities, including:

n o t e s
Transportation costs
Production capacity
Customer demand
Market uncertainties
12.2.2 INVENTORY
Inventory refers to the stock of materials or goods owned by a busi-

ness with an aim of production and sale. It includes the following:
Raw materials that are used to manufacture products
Work-in-progress or goods in semi-finished stage
Finished goods or final outputs
S
It is essential to maintain an appropriate level of inventory in an or-
ganistion to meet the increasing demands of customers and avoid un-
der-stocking or over-stocking of products.
IM
Based on their role in the entire process of customer satisfaction, there
are five main types of inventories held by an organisation. Figure 12.3
shows these categories:
M
Cycle
Inventory
N
Obsolete Transit
Inventory Inventory
Types of
Inventories
Seasonal Safety
Inventory Inventory
Figure 12.3: Types of Inventories
Let us now discuss these different types of inventories in detail.

Cycle inventory: This type of inventory is available or is planned
to be made available to meet the normal demand of customers
during a given period. If supply lead times and customer demands
are known, then the cycle inventory is only required to meet the
regular demand.

n o t e s
Transit inventory: This refers to the inventory that is dispatched

by the seller, but is still not received by the respective purchaser.
Its level depends on the distance between the manufacturing fa-
cility and consumption centres. If the distance is large, then the
transit inventory level increases.
Safety inventory: This refers to the extra inventory stored by an
organisation to deal with any unintended and unanticipated situ-
ations, such as stock-outs. The level of safety inventory is higher
than that of the regular cycle inventory because it helps the organ-
isation to deal with uncertainties in product demand or supply.
Seasonal inventory: This inventory is held by an organisation to
meet its seasonal demand. For example, the demand for raincoats
and umbrellas increases during the rainy season. Seasonal inven-
tory helps an organisation to meet fluctuations in demand caused
S
by unstable production during a specific season.
Obsolete inventory: This inventory includes only non-moving
items, which are expected to have low demand in future.
IM
An organisation can make its supply chain more efficient and respon-
sive by managing its inventories effectively. For example, if a large
amount of inventory is stocked near the consumption centres, then it
will help the organisation to meet the customer demand on time.
12.2.3 TRANSPORTATION
M
Transportation refers to the movement of products from one location

to another, such as from a supplier to a manufacturer. It directly im-
pacts the product delivery schedules of an organisation. Therefore, it
N
plays a crucial role in ensuring the effectiveness and responsiveness

of a supply chain.
A supply chain becomes more responsive with faster transportation

means. For example, 7-Eleven is a world-renowned supply chain
based in Japan. To move its products across the various geographical
stores, it uses a responsive transportation system to refill its stocks
several times a day. This transportation system has also reduced the
transportation costs of the company.
An organisation needs to take various strategic decisions to make its

transportation responsive and cost-effective. These decisions are de-
scribed as follows:
Long-term decisions: These decisions determine the availability
and appropriateness of various transportation modes to be used
for a long duration. The organisation selects a primary mode of
transportation for an appropriate inbound or outbound movement
of inventory among various facilities. It also needs to decide the
level of outsourcing required for the chosen mode of transporta-
tion. For example, an organisation can use contractual transport-

n o t e s
ers to move products from centralised stock locations to regional

cross-dock facilities for packaging, sorting and delivering small
batches to customers.
Lane operation decisions: These decisions determine the daily
operational freight transactions. The organisation uses real-time
information to coordinate the movement of products along in-
bound and outbound shipping lanes among facilities to meet the
customer demands. Lane operation decisions include the follow-
ing areas for consideration:
Temporal consolidation
Inbound/outbound consolidation
Carrier consolidation
Vehicle consolidation
S
Transportation mode decisions: These decisions are related to the
carrier and mode for the movement of goods in a specific freight
transaction. For example:
IM
Rail container services can be used for long distances in an
economical way.
Truck load carriers are used for overnight freight movements
to deliver within 24 hours at reasonable rates.
M
12.2.4 INFORMATION
Information refers to the consolidated data associated with various

facets of a supply chain, such as transportation, facilities, prices, costs,
customers and suppliers. The efficiency and responsiveness of a sup-
N
ply chain depends on timely and accurate information. If suitable in-

formation are not provided, then various supply chain activities may
suffer, including:
Warehouse management
Inventory control
Transportation planning
Development of customer service standards
Design procurement
Operation of supply and distribution systems.
Information also impact other supply chain drivers. For example, a

pharmaceutical company can produce suitable quantities of a product
using demand forecasting techniques, provided it has adequate infor-
mation about customer demand patterns.
Information determines all the decisions related to supply chain

activities. If information are correct, then they improve coordination

n o t e s
among various units of the supply chain and thus maximises total
profitability.
12.2.5 SOURCING
Sourcing is an array of business processes used to purchase and deliv-

er products and services. It includes the selection of suppliers for var-
ious supply chain activities, such as production, storage, information
management and transportation. It determines whether a particular
supply chain activity should be performed in-house or outsourced.
These decisions impact the efficiency and responsiveness of a supply
chain considerably. For example, efficiency of Motorola improved con-
siderably when it outsourced a major part of its production to China.
However, its responsiveness suffered because of the increased trans-
portation costs and delivery schedules.
S
While designing the sourcing process, an organistaion should consid-
er the following steps:
Decide which tasks should be outsourced.
IM
Decide whether to source these tasks from one supplier or multi-
ple suppliers.
In case of multiple suppliers, create a portfolio that defines the role
of each supplier.
M
Define appropriate criteria for the selection and measurement of

the performance of suppliers.
Choose suitable suppliers based on the criteria.
Negotiate contracts with the selected suppliers.
N
This sourcing process may help the organisation to maintain a con-

sistent and accurate information flow across the various stages of a
supply chain and improve its performance.
12.2.6 PRICING
Pricing is a process used to determine the amount charged by an or-

ganisation for making its products and services available to custom-
ers. This process impacts the purchase decisions of the customers to
a large extent. It also plays a critical role in matching the supply and
demand of products in the market. For example, an organisation can
offer short-term discounts to customers to reduce excess supply.
Consider an example to understand the signficance of pricing in a

supply chain. Cotsco Wholesale Corporation is a membership-based
warehouse company located in the US. It follows a policy for main-
taining a stable but low prices for its products. Due to stable prices, its
products have a consistent demand as customers are ready to wait for
the products. As a result, Cotsco can target a broad range of custom-

n o t e s
ers, while maintaining its existing customer base. It has reshaped its
supply chain according to its pricing policies and customer demands.
1. _______________ are the physical locations in a supply

chain network that are used for manufacturing, storing and
transporting products.
2. Finished goods or final outputs come under which of the
following:
a. Facilities
b. Transportation
c. Inventory
S
d. Sourcing
3. Sourcing determines whether a particular supply chain
activity should be performed in-house or outsourced.
IM
(True/False)
4. ________ refers to the consolidated data associated with
various facets of a supply chain.
5. Stable prices may help an organisation in maintaining
consistent demand for its products by customers. (True/False)
M
Activity
Suppose you run a wafer manufacturing company. Create a frame-

work for utilising different supply chain drivers appropriately to
N
achieve maximum efficiency with high responsiveness.
MANAGING PERFORMANCE WITH

12.3
METRICS
It is crucial for organisations to improve their supply chain perfor-
mance to meet increased customer demands on time. They should
regularly evaluate the performance of their supply chains using vari-
ous metrics.
There are different metrics for measuring supply chain performance.

An organisation should choose a metric based on its need and usage.
For example, some organisations use metrics that can be easily ap-
plied, but these metrics fail to provide an accurate picture of the sup-
ply chain performance. On the other hand, some organisations use
metrics that focus on the performance of logistics only. These metrics
may negatively impact other parts of the supply chain. Therefore, an
organisation should consider some basic requirements while choosing
a metric.

n o t e s
The requirements are as follows:

The metric should be simple to decipher.
The metric should use an objective value to express the results of
measurement.
The metric should provide consistent results after each measure-
ment process.
Metric should accurately measure processes in the appropriate
business context.
The metric should be retrievable at reasonable costs.
In the next section, you will study about the different metrics used for
evaluating supply chain performance.
S
12.3.1 PERFORMANCE MEASURE
Supply chain is a significant element in the development of logistics

for any industry. It can enhance the effectiveness and efficiency of not
IM
only inventory relocation, but also information sharing between the
various levels. The performance measure in a supply chain refers to
an assessment of the performance of the following aspects of the sup-
ply chain:
General operation level in the supply chain
M
Node enterprises in the supply chain

Mutual relations between the various node enterprises
Therefore, performance measure is basically a framework of perfor-

N
mance measurement related to various business processes in the sup-

ply chain.
12.3.2 DIFFERENT METRICS
Performance measure of a supply chain is a complicated process. It

includes different activities, which are follows:
Monitoring inventory levels
Tracking the current status of shipments
Ensuring that the right orders are dispatched to right places
Therefore, different performance metrics are used for measuring the

performance of a supply chain. Some common metrics are described
as follows:
Inventory carrying cost: This is the cost incurred by an organi-
sation to store its inventory over a given duration. It enables the
organisation to determine the expected profits on its current in-
ventory. It also enables suppliers to map their cycles of production.

n o t e s
The formula for calculating the inventory carrying cost is as fol-

lows:
Inventory carrying cost = Inventory carrying rate × A
verage inven-
tory value
Inventory turnover: This metric determines the number of times
an organisation sells its entire inventory. It indicates the demand
and quality of the inventory carried by the organisation. The for-
mula to calculate this metric is as follows:
Inventory turnover = Cost of goods sold/Average inventory
If the inventory turnover is high, then the supply chain is efficient.
If it is low, then the supply chain is inefficient, leading to low reve-
nue generation.
Inventory to sales ratio: This metric determines the level of in-
S
ventory carried by an organisation as compared to the number of
completed sales orders. Its formula is as follows:
Inventory to sales ratio = Inventory value/Sales value
IM
Cash-to-cash cycle time: This metric calculates the amount of
time for which the operating capital is occupied. The formula used
for calculating cash-to-cash cycle time is as follows:
Cash-to-cash cycle time = Materials payment date – C
ustomer order
payment date
M
If the cash-to-cash cycle time is fast, then the supply chain is effec-
tive for the organisation.
Rate of return: This metric determines the rate at which the dis-
patched items are returned to an organisation. It helps the organ-
N
isation to determine the reasons and ways by which it can reduce

the amount of products returned by the customers.
Back order rate: This metric determines the number of orders
that could not be processed at the time of placing the order. If the
back order rate is high, then it implies that the customers are com-
pelled to wait while the organisation tries to process the order, re-
sulting in customer dissatisfaction. Therefore, every organisation
should aim for a low back order rate.
Perfect order rate: This metric determines the orders that are dis-
patched without any incident of inaccuracy, damaged goods or late
delivery. If the perfect order rate is high, then the organisation is
efficient and customers are highly satisfied.
Fill rate: This metric calculates the percentage of orders processed
in the first shipment. It is calculated using the following formula:
Fill rate = {1 – [(Total items – Shipped items)/Total items]} × 100
Average payment period for production materials: This metric
estimates the average time from the receipt of materials to their

n o t e s
payment. It helps the organisation to determine the efficiency of

its supply chain. It can be computed using the following formula:
Average payment period for production materials
= (Materials payables/Total cost of materials) × Days
12.3.3 NEXT GENERATION PERFORMANCE MANAGEMENT
Supply chain management is a complicated process, as it may con-

sist of several unpredictable macroeconomic cycles, which are char-
acterised by various disruptions. To adapt to such a challenging en-
vironment, organisations are aggressively administering their supply
chains using various strategic and operational means. They are focus-
ing on three main drivers to sustain and improve their supply chains’
efficiency and responsiveness:
S
Perfect-order delivery
Cost reduction
IM
Supply chain flexibility
In addition, today, organisations are investing in new technologies

and tools to build wide-ranging supply chain networks that are highly
flexible and responsive, yet simple. All these initiatives help contem-
porary organisations in responding proactively to the increasing de-
mands of the customers.
M
6. In an organistaion, the supply chain drivers serve as __________

that measure the performance of its supply chain network.
N
7. The metric should use an objective value to express the results

of measurement.(True/False)
8. __________is basically a framework of performance
measurement related to various business processes in the
supply chain.
Activity
Using the Internet, find any five organisations that are aggressive-
ly administering their supply chains by using ‘cost reduction’ as a
driver to sustain and improve their supply chains’ efficiency.
SUPPLY CHAIN OPERATIONS

12.4
REFERENCE (SCOR) MODEL
To help organisations in improving the effectiveness of their supply
chains, the Supply-Chain Council (SCC) designed a Supply Chain

n o t e s
Operations Reference (SCOR) model. The SCOR model provides a

process-based methodology to supply chain management. It helps an
organisation to address, improve and convey supply chain manage-
ment decisions related to various entities within and outside the or-
ganisation. It illustrates the processes in the entire supply chain and
also offers an outline to improve them.
This model incorporates business concepts for process re-engineer-

ing, standardisation and measurement in its framework. The SCOR
model focuses on the five stages of the supply chain, which are shown
in Figure 12.4:
Plan
S
Source
IM
Make
Deliver
M
Return
N
Figure 12.4: Stages Involved in the SCOR Model
Let us discuss each stage in detail.

1. Plan: This is the first stage in a supply chain, which includes the
following activities:
Planning and management of demand and supply
Balancing various resources with respect to requirements
Establishing communication throughout the entire chain
Designing the following business rules for enhancing and
measuring supply chain effectiveness:
99 Inventory rules
99 Shipping rules
99 Assets rules
99 Authoritarian compliance rules

n o t e s
2. Source: At this stage, organisation sources the required

infrastructure and acquires the material. This stage explains the
following activities:
How to handle inventory, the supplier system, supplier con-
tracts and competence
How to deal with supplier payments
When to receive, authenticate and transfer products
3. Make: This stage focuses on manufacturing and production. It
involves the following activities:
Production
Packaging
Staging
S
Releasing
Handling the production system, equipment, facilities and

shipment
IM
4. Deliver: This stage focuses on the administration of final
inventories, assets, shipment, product life cycle and import and
export prerequisites. It includes the following activities:
Order management
Storage
M
Shipment
Receiving orders from different customers

Invoicing customers after they receive products
N
5. Return: This is the final stage in a supply chain, where an

organisation manages the return of packaging, containers or
faulty products. It consists of the administration of the following:
Business rules
Return products
Assets
Shipment
Regulatory prerequisites
There are numerous benefits of the SCOR model, such as:

It helps the organisation to identify the efficiency of its supply
chain.
It enables the organisation to understand how the five stages of
the SCOR model are consistent and repetitive among the organi-

n o t e s
sation, its suppliers and customers. Each stage acts as a linkage in

the supply chain, which is crucial for a product to successfully pass
through each level.
It helps to evaluate various supply chain problems.
It provides full impact of capital investment, development of a
supply chain roadmap, configuration of business operations and
a standard range of two to six times return on investment (ROI).
9. The __________provides a process-based methodology to

supply chain management.
10. Packaging comes under which of the following stages of the
SCOR model?
S
a. Plan
b. Source
IM
c. Make
d. Deliver
11. Each stage in the SCOR model acts as a separate element in
the supply chain. (True/False)
M
Activity
Find information on the implementation of the SCOR model in a

famous manufacturing organisation. Prepare a report on your find-
ings.
N
12.5 SUMMARY
A supply chain driver is a factor that enables a supply chain to op-
erate efficiently and responsively.
The six key supply chain drivers include the following:
Facilities
Inventory
Transportation
Information
Sourcing
Pricing

n o t e s
Facilitiesare the physical locations in a supply chain network

which are used for manufacturing, storing and transporting prod-
ucts.
Inventory refers to the stock of materials or goods owned by a
business with an aim of production and sale.
Based on the role in the entire process of customer satisfaction,
there are five main types of inventories held by an organisation:
Cycle inventory
Transit inventory
Safety inventory
Seasonal inventory
Obsolete inventory
S
Transportation refers to the movement of products from one loca-
tion to another, such as from a supplier to a manufacturer.
An organisation needs to take various strategic decisions to make
IM
its transportation responsive and cost-effective. These decisions
are classified as follows:
Long-term decisions
Lane operation decisions
Transportation mode decisions
M
Information refers to the consolidated data associated with vari-

ous facets of a supply chain, such as transportation, facilities, pric-
es, costs, customers and suppliers.
N
Sourcing is an array of business processes used to purchase and

deliver products and services.
Pricing is a process used to determine the amount charged by an
organisation for making its products and services available to cus-
tomers.
There are different metrics for measuring supply chain perfor-
mance. An organisation should choose a metric based on its need
and usage.
The performance measurement in a supply chain is an assessment
on the performance comprising general operation level, the node
enterprises in the supply chain, the mutual relations between the
various node enterprises and so on.
To help organisations in improving the effectiveness of their sup-
ply chains, the Supply-Chain Council (SCC) designed a Supply
Chain Operations Reference (SCOR) model.
The SCOR model helps an organisation to address, improve and
convey supply chain management decisions related to various en-
tities within and outside the organisation.

n o t e s
key words
Core competencies: An essential mix of knowledge, skills and

abilities of an organisation that makes it a leader in the market.
Inventory control: A process of administering and managing
storage, supply and accessibility of materials to keep an ade-
quate supply chain level for meeting customer demand.
Lead time: A period between the beginning and execution of a
process.
Stock-out: A situation of inventory shortfall that occurs due to
inefficient management of inventory, unexpected demand, dis-
ruptions in replenishment or delays in production.
Temporal consolidation: A process of combining different or-
S
ders at a definite time for managing batch transactions.
Warehouse management: A process of controlling the storage
and movement of materials within a warehouse.
IM
1. What do you understand by supply chain drivers? Discuss the
framework for structuring these drivers.
2. Discuss facilities as a key supply chain driver.
M
3. Explain the major types of inventories held by an organisation.

4. Explain the role of performance measure as a metric used for
evaluating supply chain performance.
N
5. Write a short note on the SCOR model.
Topic Q. No. Answer

Framework for Supply Chain 1. Facilities
Drivers
2. c. Inventory
3. True
4. Information
5. True
Managing Performance with 6. Metrics
Metrics
7. True
8. Performance measure

n o t e s
Topic Q. No. Answer

Supply Chain Operations Ref- 9. SCOR model
erence (SCOR) Model
10. c. Make
11. False
Hints for Descriptive Questions

1. A supply chain driver is a factor that enables a supply chain
to operate efficiently and responsively. Refer to Section
12.2 Framework for Supply Chain Drivers.
2. Facilities are the physical locations in a supply chain network,
which are used for manufacturing, storing and transporting
products. Refer to Section 12.2 Framework for Supply Chain
S
Drivers.
3. Based on the role in the entire process of customer satisfaction,
there are five main types of inventories held by an organisation,
IM
which include cycle inventory, transit inventory, safety inventory,
seasonal inventory and obsolete inventory. Refer to Section
12.2 Framework for Supply Chain Drivers.
4. The performance measure is a framework for assessing the
performance of various business processes in the supply chain.
Refer to Section 12.3 Managing Performance with Metrics.
M
5. The SCOR model helps an organisation to address, improve and

convey supply chain management decisions related to various
entities within and outside the organisation. Refer to Section
12.4 Supply Chain Operations Reference (SCOR) Model.
N

12.8
REFERENCE
SUGGESTED READINGS
BolstorffP., Rosenbaum R. (2007). Supply chain excellence. New
York: AMACOM.
Springer.
erence.
shey, PA: Idea Group Pub., (an imprint of Idea Group).

n o t e s
E-REFERENCES
Apics.org. (2015). SCOR Framework - The APICS Supply Chain
Council. Retrieved 30 November, 2015, from http://www.apics.org/
sites/apics-supply-chain-council/frameworks/scor.
Performance Drivers. (2015). Retrieved 30 November, 2015, from
http://www.performancedrivers.com.au/knowledge-centre/techni-
cal/what-is-scor-model.shtml.
Scm.ncsu.edu. (2015). The SCOR Model for Supply Chain Strate-
gic Decisions - SCM | Supply Chain Resource Cooperative (SCRC)
| North Carolina State University. Retrieved 30 November, 2015,
from https://scm.ncsu.edu/scm-articles/article/the-scor-model-for-
supply-chain-strategic-decisions.
Slideshare.net.(2013). Supply chain drivers & metrics. Re-
S
trieved 30 November, 2015, from http://www.slideshare.net/
ujjmishra/supply-chain-drivers-metrics.
IM
M
N

N
M
IM
S
C h
13 a p t e r
SUPPLY CHAIN STRATEGIES

AND PERFORMANCE MEASURES
CONTENTS
S
13.1 Introduction
13.2 Customer Service and Cost Trade-off
IM
Activity
13.3 Internal and External Performance Measures
13.3.1 Benchmarking Supply Chain Performance Using Financial Data
Activity
M
13.4 Linking Supply Chain and Business Performance

Activity
13.5 Improvement in Supply Chain Performance
N
13.5.1 Supply Chain Optimisation

13.5.2 Supply Chain Integration
13.5.3 Supply Chain Restructuring
Activity
13.6 Summary

n o t e s
SUPPLY CHAIN STRATEGIES AT DELL COMPUTER
S
(Source: mindsetcomputerrepairs.com)
In 1995, Dell Computers adopted ‘Dell Direct Model’ after realis-

IM
ing the benefit of collaborative supply chain. This model includes
a high velocity and cheaper distribution system with direct cus-
tomer relationships and build–to–order manufacturing. Dell has
been able to save significant cost and time after implementing col-
laborative supplier relationships. In addition, it has been able to
maintain a competitive edge in the market for several years.
M
The Just-in-Time (JIT) inventory system was a major part of the

collaborative supply chain of Dell. In order to implement JIT,
Dell first trimmed down the number of its suppliers from 204 to
47. Dell’s suppliers were required to have their warehouses at a
N
maximum of 15 minutes’ distance from Dell’s manufacturing fa-

cilities. The JIT system at Dell had reduced the inventory costs
of the organisation. This enabled the organisation to reduce the
delivery time of products to end customers from 30 to 13 days. In
addition, the JIT system led to easy customisation of Dell prod-
ucts, reduced wastage of inventory, and improved ability to adjust
production levels.
The collaborative supply chain had enabled Dell to manage its

product orders effectively by sharing information, costs, risks,
and joint decision-making. As a result, the inventory turnover of
the organisation had reduced by 57% and the production space
had increased due to the decreased inventory storage area. Con-
sequently, the growth rate of Dell reached as high as 50% in the
next two years and its annual sales reached $12 billion by 1997.

SUPPLY CHAIN STRATEGIES AND PERFORMANCE MEASURES 263
n o t e s
learning objectives

>> Discuss the trade-off between customer service and operat-
ing cost
>> Explain the internal and external performance measures
>> Describe benchmarking supply chain performance using fi-
nancial data
>> Discuss how supply chain is linked to business performance
>> Explain how supply chain performance can be improved in
an organisation
13.1 introduction
S
In the previous chapter, you studied the metrics and drivers of sup-
ply chain. Now, let us move forward and study business performance
IM
measures vis-à-vis supply chain strategies.
In simple words, strategy refers to a plan of action formulated to

achieve certain goals. Supply chain strategy refers to the plan of ac-
tion organisations take regarding the execution of their supply chain
cycle to achieve business goals, such as reduction in manufacturing
cost or cycle time, gaining competitive advantage, providing better
M
and timely services to the customers, etc. A well-formulated and ef-

fective supply chain strategy leads to efficient logistics, which helps
to reduce the costs of the overall business and increase the customer
service levels, thus increasing profitability.
N
In order to assess the effectiveness of any strategy, organisations take

cognisance of various internal as well as external performance mea-
sures. One tried-and-tested measure to ensure and evaluate the ef-
fectiveness of a supply chain strategy is benchmarking supply chain
performance using financial data. Supply chain strategies cannot be
considered effective, if these strategies cannot result in improved busi-
ness performance, such as improvement in distribution system, incre-
ment in market share, etc. Therefore, linking supply chain with the
overall business performance is very crucial for measuring the effec-
tiveness of the supply chain cycle. In case supply chain strategies are
not able to increase business performance, the organisation needs to
improve its supply chain performance. Improvement in supply chain
can take place with the help of techniques, such as supply chain op-
timisation, supply chain integration, and supply chain restructuring.
The chapter begins with a discussion on customer service and cost

trade off. Next, you will study various internal and external perfor-
mance measures. In addition, the chapter discusses how a supply
chain is linked to the business performance of an organisation. To-

n o t e s
wards the end, the chapter elaborates on improvement in supply

chain performance.
CUSTOMER SERVICE AND COST

13.2
TRADE-OFF
In a modern and highly competitive business environment, an organ-
isation can hardly be successful without being highly efficient. How-
ever, being and remaining efficient is a tight-rope walk for an organ-
isation, as it has to continuously face many trade-offs. For example,
one of the most important trade-offs faced by manufacturing organi-
sations is customer service and cost trade-off. Let us understand how
this trade-off works.
If a manufacturer maintains too much inventory, it has to incur high
S
amounts of inventory costs. Therefore, to reduce overall costs, a man-
ufacturer would like to keep minimum possible inventory. However,
low inventory expose the manufacturer to the risk of stock out sit-
IM
uation, in which it fails to supply goods to customers, as and when
demanded. Therefore, to improve customer service, a manufacturer
would like to keep high inventory. Now, you can see the dilemma of
the manufacturer in keeping the right inventory level while trying to
maintain a balance between low cost and effective customer service.
Lowering costs results in ineffective service and effective customer
service comes at a higher cost. In such a circumstance, a trade-off bal-
M
ance between cost and customer service level is maintained, in which

inventory levels are maintained at a relatively lower level and custom-
er service is maintained at a relatively higher level. When the custom-
er service level and supply chain cost trade-off is plotted in the graph,
N
it is called the supply chain’s ‘efficiency frontier’. Figure 13.1 shows

the supply chain’s efficiency frontier:
Total Supply Chain Cost
Starting Point
Current
Efficient Frontier
New
Efficient Frontier
Optimized Strategy
Service Level
Figure 13.1: Supply Chain’s Efficiency Frontier

n o t e s
As can be seen in Figure 13.1, a manufacturer cannot increase cus-

tomer service level without increasing the supply chain cost while be-
ing in the current efficient frontier. The figure also shows that a man-
ufacturer can achieve the goal of lower supply chain cost and higher
customer service level by moving up to a higher efficiency frontier.
The service level and supply chain cost trade-off points towards the
importance of managing inventory levels to achieve competitive ad-
vantage. Most organisations consider inventory mainly as a cost head.
However, inventory can be managed to reduce costs, provide better
customer service and increase revenue. This notion leads to the con-
cept of Inventory Optimisation (IO). A large number of organisations
have been benefitted by adopting IO. It is very common for companies
to reduce upto 30% of inventory after implementing IO. For example,
Hewlett Packard (HP) saved more than $130 million, Microsoft in-
creased inventory turn by 18-20% while increasing fill rates by 6-7%
S
and Procter & Gamble reduced inventory level by $100 million (Effi-
cient Frontier: A Moving Target)
IM
IO intends to achieve balance between customer service level and
supply chain by considering the following factors:
Order delivery lead time and supply chain lead time: It refers
to the time taken by a manufacturer to deliver the finished prod-
uct after receiving an order. The main objective of modern ‘lean’
manufacturing is to reduce the lead time so that customer satisfac-
M
tion can be increased. For example, if e-retailing giant promises to

deliver products within 48 hours of receiving the order, its order
delivery cannot exceed 48 hours; else, it will result in customer
dissatisfaction.
N
Supply chain lead time refers to the total time starting from the
procurement of raw materials to delivery of the finished goods to
the customers. Therefore, supply chain lead time includes the or-
der delivery lead time as well as sourcing and manufacturing time.
This is shown in Figure 13.2:
Customer order
Order penetrations point
(decoupling point) Order delivery lead time
Source Make components Assembly Delivery
Supply chain lead time
Figure 13.2: Supply Chain Lead Time and Order Delivery Lead Time

n o t e s
As can be seen in Figure 13.2, a typical firm sources material from

suppliers, manufactures components, assembles the products, and
delivers the finished products to the end users. IO aims at optimis-
ing the order delivery lead time and supply chain lead time to cre-
ate the balance between supply chain cost and customer service.
Push-pull boundary of a supply chain: All activities in a supply
chain can be categorised into push or pull depending upon wheth-
er the activity is being conducted in anticipation of a customer or-
der (push) or because a customer order has already been placed
(pull). The push-pull boundary separates these two processes, as
shown in Figure 13.3:
Push-pull
Boundary
S
Push Pull
IM
Supply chain lead time
Figure 13.3: Push-Pull Boundary

Apple follows the push strategy in which it anticipates a huge de-
mand for its products from the market and strives to expedite the
M
manufacturing process to meet these demands. On the other hand,

Dell computers start assembling a product only when they receive
an order. This means Dell computers adopts the pull strategy.
The balance between customer service and supply chain cost is
N
established on the basis of the position of the push-pull boundary;

that is whether the organisation is pursuing pull strategy or push
strategy.
Supply chain responsiveness: It refers to the capability of the sup-
ply chain of an organisation to meet the market demands in a giv-
en period of time. A highly responsive supply chain possesses the
following abilities:
Ability to handle supply uncertainty
Ability to deal with a large assortment of products
Ability to deliver in short lead times
Ability to cater to wide fluctuations in market demand
Ability to provide high level of customer service

n o t e s
Delivery reliability: Delivery reliability is a crucial aspect of cus-

tomer service and it reflects the extent to which a firm is able to
provide service to its customers within the promised delivery time.
Delivery reliability is measured by the fraction of customer de-
mand that is fulfilled within the specified delivery lead time.
Product variety: The assortment of products or service offered by
a firm is a crucial aspect of customer service. In the last two de-
cades, an explosion of product assortment has taken place in most
product categories. Higher product assortment offers a wide vari-
ety of choice to the customer who is willing to get a product that
fits closest to his or her real requirement.
1. Customer service and inventory cost has a trade-off
S
relationship (True/False)
2. A manufacturer can achieve the goal of lower supply chain cost
and higher customer service level by shifting to a _________
IM
efficiency frontier.
3. Under the pull strategy, supply chain functions are carried out
only after receiving customer orders. (True/False)
M
Activity
With the help of the Internet, conduct a research on how large man-
ufacturers or retailers balance the supply chain and customer ser-
vice trade off.
N
INTERNAL AND EXTERNAL

13.3
PERFORMANCE MEASURES
In the last section, we discussed the trade-off between supply chain
cost and the level of customer service. We also learned that how this
trade-off is one of the most important factors in designing supply chain
strategy of an organisation. Now, let us study how the performance of
the supply chain strategy of a firm can be measured.
The effectiveness of supply chain strategies is measured on the basis

of certain performance measures. These performance measures can
be both external and internal to an organisation and are shown in
Figure 13.4:

n o t e s
INTERNAL LEVELS
Cycle time or lead time
Inventory levels
Resource utilisation level
EXTERNAL LEVELS
Customer satisfaction level
S
Figure 13.4: Internal and External Performance
Measures of Supply Chain
Let us now study each of these measures in detail:

IM
Cycle time or lead time: Lead time or the cycle time of any busi-
ness process refers to the end-to-end time of any process. While
measuring the efficiency of a supply chain, two important lead
times are taken into consideration. These measures are supply
chain lead time and order-to-delivery lead time. We have already
M
defined both these types of lead times in the last section. The ef-
ficiency level of the supply chain strategies of two organisations
can be compared with the help of the lead time of these two or-
ganisations. For example, suppose A and B are two close compet-
ing automobile companies and the supply chain lead time of the
N
organisations are 15 days and 21 days, respectively. From this, we

can conclude that company A has a more efficient supply chain.
Inventory levels: High inventory levels make organisations incur
additional inventory carrying costs. Therefore, to achieve sup-
ply chain efficiency, an organisation should maintain just about
as much inventory as required. Generally, there are four types of
inventory hold in the supply chain of an organisation. These are
raw materials, work-in-process (including semi-finished and un-
finished goods), finished goods, and spare parts. An organisation
holds different levels of each of these types as different types of in-
ventory serve different purposes. An efficient supply chain main-
tains the optimal levels of these four types of inventory. Therefore,
as you can see, the efficiency of a supply chain is reflected by the
level of inventory it maintains.
Resource utilisation level: The supply chain of an organisation
deploys various types of resources, such as manufacturing re-
sources (equipment), warehousing resources (storage facilities),
logistics resources (cargo carriers), human resource (knowledge,
skills, experience, etc.), financial resources (working capital). The

n o t e s
efficiency of a supply chain is reflected by how these resources are

utilised to achieve the supply chain objectives, such as minimising
lead time, optimising inventory level, and providing best customer
services.
Customer satisfaction level: Customer satisfaction level is a sub-
jective factor and it depends upon a number of indices, such as:
Delivery lead time: It refers to the time span between the
placement of an order by a customer and delivery of the goods
to the customer.
Order fill rate: It refers to the fraction of customer demands
met by the available stock.
Stockout rate: It refers the fractions of orders cancelled due to
unavailability of goods in stock. As you can see, stockout rate is
S
complementary to order fill rate.
Backorder level: It refers to the number of orders that are yet
to be filled.
IM
Probability of on-time delivery: It refers to the fraction of or-
ders fulfilled within the promised delivery time.
If the customer satisfaction level is high, the supply chain of a compa-

ny can be said to be efficient.
M
13.3.1 BENCHMARKING SUPPLY CHAIN PERFORMANCE

USING FINANCIAL DATA
Measuring the performance of a business function against financial

N
metrics is one of the most traditional forms of performance measure-

ment. Organisations exist because they earn profits; therefore, ‘what
is the contribution of the supply chain of an organisation towards its
bottom line?’ becomes a critical strategic question. Various regulatory
norms mandate organisations to periodically publish their financial
reports. This data reflects the effectiveness of business decisions of
the organisations.
Supply chain managers take decisions that have high potential impact
on the financial performance of the organisation. In such cases, man-
agers can evaluate the performance of the supply chain or the effec-
tiveness of their decisions by linking the supply chain functions with
the financial performance of the organisation. Let us study how the
financial performance of a firm can be linked with the supply chain
performance.
INCOME STATEMENT
An income statement is a document that shows the earnings of an

organisation within a particular period. The main components of a

n o t e s
supply chain are revenue, products costs, sales, general and admin-
istrative costs. Table 13.1 shows how the various components of an
income statement are affected by the supply chain performance of an
organisation:
Table 13.1: Effects of supply chain performance

on the income statement
Income Statement Supply Chain Issues that Affects the
Component Component
Revenues zz Supply chain
zz Order delivery lead time
zz New product development time (time-to-
market)
zz Stock-out rate
S
zz On-time delivery rate
zz Product quality
zz Order cancellation rate
IM
zz Product return rate
zz Fill rates
zz Order fill rate
Product Costs zz Procurement costs
zz Transportation costs
M
zz Inventory costs
zz Storage costs
zz Packaging costs
zz Waste
N
zz Stockouts
zz Accuracy of demand forecast
Sales, General, and Admin- zz Warranty costs
istrative Costs zz Selling costs
zz Transaction accuracy and error rate (in-
voices, shipping documents, export doc-
umentation)
Source: scmr.com
BALANCE SHEET
A balance sheet provides the snapshot of the assets and liability po-
sition of a firm at a given date. Working capital is a key component of
the balance sheet of an organisation, and refers to the current assets
less current liability.

n o t e s
Table 13.2 shows the effects of the functions of supply chain of an or-
ganisation on its working capital:
Table 13.2: Working Capital and Supply Chain

Performance
Working Capital Supply Chain Issues that Affect Working
Component Capital
Inventory Days zz Holding costs – financing, warehousing,
tracking, moving, insurance
zz Obsolescence
zz Theft
zz Accuracy of demand forecast
zz Sourcing and delivery time
Accounts Receivable Days zz Bad debt
Follow-up calls to receive payments
S
zz
zz Unable to ship due to non-payment

zz Exchange rate changes
zz Correct invoicing terms
IM
zz Proof of receipt
Accounts Payable Days zz Discounts not taken
zz Late payments, subsequent orders delayed
zz Correct invoicing terms
zz Payment penalties
M
(Source: scmr.com)
As we can see, supply chain functions affect the financial performance

of a firm and we can measure supply chain performance by linking sup-
ply chain functions with the financial performance of the organisation.
N
4. _______ refers to the time span between the placement of an

order by a customer and delivery of the goods to the customer.
5. Stockout rate refers to the fractions of orders cancelled due to
unavailability of goods in stock. (True/False)
6. Mention the four types of inventory maintained by the supply
chain of an organisation.
7. Time-to-market does not have any effect on the income
statement of a business organisation. (True/False)
Activity
With the help of the Internet, conduct a research on the financial

reports and supply chain performance of three leading retailers.
Discuss your findings with those of your friends.

n o t e s
LINKING SUPPLY CHAIN AND BUSINESS

13.4
PERFORMANCE
In the previous section, we studied how supply chain performance
can be measured with the help of a number of internal and external
performance measures. We also linked financial performance of a firm
with its supply chain functions. Now, let us see how the supply chain
function is related to the business performance of a firm.
Business performance refers to the extent to which an organisation

achieves its different goals, such as market share, new product de-
velopment, revenue, competiveness, cost reduction, quality improve-
ment, lead time reduction, attrition rate reduction, etc. Supply chain
of an organisation impacts its performance in different areas. For
example, Walmart would hardly be able to achieve its business goal
S
of assuming a cost leadership position in the retail industry without
having one of the most efficient supply chain infrastructures across
industries.
IM
An important indicator of business performance is Return on Assets
(ROA), and two of its critical components are cost reduction and in-
crement in revenue and profitability. Let us study how the goals of
increasing ROA can be accomplished by an efficient supply chain in
the following points:
M
Cost reduction: This objective can be accomplished by:

Decreasing indirect material expenditures
Decreasing logistics expenditures
N
Decreasing stocks
Decreasing direct material expenditures
Increase in revenue and profitability: This goal can be accom-
plished by:
Reducing time-to-market
Decreasing backorder and forfeiture sales
Selling higher profit and revenue giving goods and services
Penetrating into a new markets
Reducing delivery time to market
Utilising supply chain assets efficiently
Decreasing souring of procurement expenditures
Decreasing stocks
Decreasing accounts receivables

n o t e s
8. Decreasing stock level can result in reduction of supply chain

cost of an organisation. (True/False)
9. Revenue can be increased by increasing the time-to-market.
(True/False)
Activity
Make a group of your friends and discuss the importance of linking

business performance with supply chain of a firm.
IMPROVEMENT IN SUPPLY CHAIN
S
13.5
PERFORMANCE
In the first section of the chapter, we made the conclusion that a firm
IM
cannot meet the dual goal of reducing cost and improving customer
service without shifting to a more efficient frontier. In other words, im-
provement in supply chain performance is necessary to reduce supply
chain costs and achieve customer satisfaction.
In real life, most organisations are usually not able to manage their
M
supply chain procedures smoothly. As a result, the position of their

supply chain efficiency frontiers is always at some distance from the
optimal efficiency frontier. The only way organisations can meet their
goals is by moving to a higher efficiency frontier. Going to a higher
efficiency frontier requires organisations to optimise, integrate and
N
restructure their supply chain cycles.
Let us next study how organisations can improve their business per-
formance by implementing optimisation, integration and restructur-
ing of supply chain.
13.5.1 SUPPLY CHAIN OPTIMISATION
In simple words, optimisation of supply chain refers to reaching the

optimal performance level of the manufacturing and distribution sup-
ply chain of an organisation. Optimisation of supply chain involves
extensive application of mathematical models and computer software
to determine optimal inventory level and minimise supply chain cost.
The following are some of the important steps taken towards optimis-
ing the supply chain of an organisation:
Localise: In the highly globalised market place, ‘think globally,
act locally’ has become the mantra of success for business organ-
isations. Therefore, while looking for growth opportunities in the
global market, an organisation also needs to look for sourcing op-

n o t e s
portunities in the local market. Business organisations can also

consider developing multiple sourcing channels to optimise the
supply chain.
Focus on the strengths: Organisations need to focus on the busi-
ness functions in which they have competency and outsource ac-
tivities that can be outsourced at lower cost.
Collaborate for better forecasting: Increased collaboration with
suppliers and retailer puts organisations in a better position to
forecast demand and maintain an optimal inventory level. Collab-
oration also helps in increasing customer satisfaction as customer
demands are met more efficiently and stockouts are reduced.
Use innovative technology: Technology plays a very crucial role
in supply chain optimisation as technology enables integration,
coloration, information sharing, etc. An organisation needs to
S
have access to innovative supply chain technologies to optimise its
supply chain. Walmart is a noteworthy example of an organisation
that made revolutionary changes in its supply chain with the help
IM
of technological products such as Radio-Frequency Identification
(RFID) and EDI (Electronic Data Interchange).
Build responsive supply chain: In order to optimise the supply
chain, an organisation needs to use information such as point of
sale (POS) data, market trends, etc. This information enables sup-
ply chains to respond more efficiently to demand fluctuations.
M
13.5.2 SUPPLY CHAIN INTEGRATION
In simple words, supply chain integration refers to close alignment or

N
coordination within a supply chain. An inefficient supply chain con-

sists of connected but uncoordinated set of activities that extends to
various organisational functions, where every individual function has
its own budget and set of priorities and measurements. Some compa-
nies have discovered that total distribution costs can be reduced by
integrating such distribution related activities.
Integrated supply chain is the system that coordinates among the

various supply chain functions and the parties involved. Integrated
logistics is especially useful for the manufacturing businesses. Manu-
facturing organisations are under constant pressure to produce goods
at a lower cost. Price is an important aspect on the basis of which com-
petition among various manufacturers take place. Integrated supply
chain helps in reducing supply chain costs which in turn increases
their competitiveness.

n o t e s
Figure 13.5 shows an integrated supply chain system:
Inventory Flow
Physical Manufacturing
Customer Procurement Suppliers
Distribution Support
Information Flow
Figure 13.5: Integrated Supply Chain
A successful integrated supply chain ties all supply chain activities in

a system, which minimises the total costs and maintains the desired
customer service level. It is necessary to state that the total cost in-
S
cludes the following five major cost categories of a supply chain:
1. Customer service level achievement costs
IM
2. Transportation costs
3. Warehousing costs
4. Lot quantity costs
5. Inventory carrying costs
M
Logistical integration
Information flow plays a vital role in the process of supply chain in-
tegration. Effective supply chain is perceived as a competency that
associates an organisation with its customers and suppliers. As men-
N
tioned previously, the information about the customers flows through

the organisation in the form of sales activity, estimate and orders.
13.5.3 SUPPLY CHAIN RESTRUCTURING
At times, integrating the supply chain is not enough to achieve the

desired results and the level of optimality. In such cases, major trans-
formations may be required in the structure of the supply chain. The
need of supply chain restructuring may be triggered by a number of
factors, such as internationalisation of business, high demand fluctua-
tions, structural loopholes in the supply chain, etc.
Supply chain restructuring includes critical changes in the supply

chain structure in the way material and information flows are man-
aged. Restructuring of supply chains helps organisations move the en-
tire efficiency frontier downwards and in the right direction, resulting
in lower costs and higher customer service.

n o t e s
A few ways in which supply chains can be restructured are:

Decreasing the quantity of stock in distribution
Separating fast moving and slow moving products in terms of ma-
terial in chain
Redesigning products and procedures
By restructuring its supply chain, an organisation moves the whole

frontier downwards.
Some of the benefits of supply chain restructuring include:

Integrating with new business areas
Lowering process and personnel costs
Increasing efficiency all over the organisation
S
Improving process quality
Providing better customer service
IM
10. Restructuring of supply chain refers to reaching the optimal

performance level of the manufacturing and distribution
supply chain of an organisation. (True/False)
M
11. Better coordination with parties involved in a supply chain

helps in better demand forecasting. (True/False)
Activity
N
With the help of the Internet, find out a case of supply chain re-
structuring, study the case, and make a report on your findings.
13.6 SUMMARY
In a modern and highly competitive business environment, an or-
ganisation can hardly be successful without being highly efficient.
However, being and remaining efficient is a tight-rope walk for an
organisation, as it has to continuously face many trade-offs.
Lowering costs results in ineffective service and effective custom-
er service comes at a higher cost.
When the customer service level and supply chain cost trade-off is
plotted in the graph, it is called supply chain’s ‘efficiency frontier’.
A manufacturer can achieve the goal of low supply chain cost and
high customer service level by moving up towards a higher effi-
ciency frontier.

n o t e s
IO intends to achieve a balance between customer service level and

supply chain by considering a number of factors, such as order de-
livery lead time and supply chain lead time, push-pull boundary of
supply chain, supply chain responsiveness, and delivery reliability.
The effectiveness of supply chain strategies is measured on the
basis of certain performance measures. These performance mea-
sures can be both external and internal to an organization.
Some of the measures of supply chain performance include cycle
time or lead time, customer satisfaction level, inventory levels, and
resource utilisation levels.
Supply chain managers take decisions that have high potential
impact on the financial performance of the organisation. In such
cases, managers can evaluate the performance of the supply chain
or the effectiveness of their decisions by linking the supply chain
S
functions with the financial performance of the organisation.
Business performance refers to the extent to which an organisa-
tion achieves its different goals, such as market share, new prod-
IM
uct development, revenue, competiveness, cost reduction, quality
improvement, lead time reduction, attrition rate reduction, etc.
Supply chain of an organisation can be improved with the help
of supply chain optimisation, supply chain integration and supply
chain restructuring.
M
Optimisation of supply chain refers to reaching the optimal perfor-

mance level of the manufacturing and distribution supply chain of
an organisation. Optimisation of supply chain involves extensive
application of mathematical models and computer software to de-
termine optimal inventory level and minimise supply chain cost.
N
Supply chain integration refers to close alignment or coordination

within a supply chain. An inefficient supply chain consists of con-
nected but uncoordinated set of activities that extends to various
organisational functions, where every individual function has its
own budget and set of priorities and measurements. Some compa-
nies have discovered that total distribution costs can be reduced
by integrating such distribution related activities.
Supply chain restructuring includes critical changes in the supply
chain structure in the way material and information flows are man-
aged. Restructuring of supply chains helps organisations move the
entire efficiency frontier downwards and in the right direction, re-
sulting in lower costs and higher customer service.

n o t e s
key words
Bottom line: The line in a financial statement showing net prof-

it or loss of the organisation in a given time period.
EDI: The system of transferring data from one computer sys-
tem to another computer system.
Lean manufacturing: A systematic method that intends to
eliminate all wastes in a manufacturing system.
Receivables: Monetary obligations owed to an organisation by
its debtors, customers, etc.
RFID: An information technology tool used for identifying and
tracking objects attached with tags.
Time-to-market: The time span between concept generation of
S
a product and its introduction in the market.
Work-in-process: Inventory goods that are currently in differ-
ent stages of production.
IM
1. Explain the trade-off between customer service and supply chain

M
cost.
2. What do you mean by inventory optimisation? List the factors
that are considered in inventory optimisation.
3. Discuss why is it important to link supply chain efficiency of an
N
organisation to its financial performance.

4. Elaborate on the linkage of supply chain and business
performance.
5. What do you mean by supply chain optimisation? How can this
be achieved?
ANSWERS FOR SELF-ASSESSMENT QUESTIONS
Topic Q. No. Answer

Customer Service and Cost 1. True
Trade-Off
2 Higher
3 True
Internal and External Perfor- 4 Delivery lead time
mance Measures

n o t e s
Topic Q. No. Answer

5 True
6 Raw materials, work-in-process,
finished goods, and spare parts
7 False
Linking Supply Chain and 8 True
Business Performance
9 False
Improvement in Supply Chain 10 False
Performance
11 True
S
1. IO intends to achieve a balance between customer service level
IM
and supply chain by considering a number of factors, such as
order delivery lead time and supply chain lead time; push-pull
boundary of supply chain, supply chain responsiveness, and
delivery reliability. Refer to Section 13.2 Customer Service and
Cost Trade-off.
2. If a manufacturer maintains too much inventory, it has to incur
M
high amount of inventory costs. Therefore, to reduce overall

costs, a manufacturer would like to keep minimum possible
inventory. However, low inventory expose to manufacturer to the
risk of stock out, in which it fails to supply goods to customers as
N
and when demanded. Therefore, to improve customer service, a

manufacturer would like to keep high inventory. Refer to Section
13.2 Customer Service and Cost Trade-off.
3. Supply chain managers take decisions that have high potential
impact on the financial performance of the organisation. In
such cases, managers can evaluate the performance of the
supply chain or the effectiveness of their decisions by linking
the supply chain functions with the financial performance of
the organisation. Refer to Section 13.3 Internal and External
Performance Measures.
4. Supply chain of an organisation impacts its performance in
different areas. Refer to Section 13.4 Linking Supply Chain and
Business Performance.
5. In simple words, optimisation of supply chain refers to reaching
the optimal performance level of the manufacturing and
distribution supply chain of an organization. Refer to Section
13.5 Improvement in Supply Chain Performance.

n o t e s

13.9
REFERENCE
SUGGESTED READINGS
Sadler, I. (2007). Logistics and supply chain integration. Los Ange-
les: SAGE. Roh, J. (2009). From responsiveness strategy to market
responsiveness. Toledo, Ohio: University of Toledo.
Wang, J. (2011). Supply chain optimization, management and inte-
gration. Hershey, PA: Business Science Reference.
E-REFERENCES
Europeanbusinessreview.com,. ‘Efficient Frontier: A Moving Tar-
S
get | The European Business Review | Empowering Communica-
tions Globally’. N.p., 2015. Web. 8 Dec. 2015.
Academia.edu,. (2015). Push and pull strategy in supply chain
IM
management. Retrieved 8 December 2015, from http://www.ac-
ademia.edu/6081016/Push_and_pull_strategy_in_supply_chain_
management
Lcm.csa.iisc.ernet.in,. (2015).
Customer Service Level. Retrieved 8
December 2015, from http://lcm.csa.iisc.ernet.in/scm/coimbatore/
node14.html
M
Scmr.com,. (2015). Linking Supply Chain Performance to a

Firm’s Financial Performance - Article from Supply Chain
Management Review. Retrieved 8 December 2015, from http://
www.scmr.com/article/linking_supply_chain_performance_to_a_
N
firms_financial_performance
4flow.de,. (2015). Restructuring: 4flow – Supply Chain Consulting,
Supply Chain Software, Supply Chain Services. Retrieved 8 De-
cember 2015, from http://www.4flow.de/en/supply-chain-consult-
ing/strategy/restructuring.html
Jhconline.com,. (2015). Supply Chain Restructuring: Consid-
erations for Change. Retrieved 8 December 2015, from http://
www.jhconline.com/supply- chain-restructuring- consider-
ations-for-change.html

C h
14 a p t e r
CASE STUDIES
CONTENTS
S
Case Study 1 Walmart’s Advanced Scm
Case Study 2 Implementation of the Scor Model by ExpressPoint
IM
Case Study 3 Increasing Growth by Implementing IT Sourcing Strategy
Case Study 4 Inventory Management Solution by Infosys
Case Study 5 Shift Towards Ocean Freight for the Transportation of Goods
Case Study 6 Modelling the Distribution Network Design of a British Energy Firm
by Logistics Bureau
Case Study 7 Yeeld’s Revenue Management Solution for Abc Hotel
M
Case Study 8 New and Improved E-Retail Business

Case Study 9 Internet of Things and Smart Supply Chain
Case Study 10 Global Supply Chain Hit by Terror Threats
Case Study 11 Long Grove Confectionery Co.
N
Case Study 12 Application of Big Data and Analytics in Effective Supply Chain
Strategy Formulation

Case study 1
n o t e s
WALMART’S ADVANCED SCM
This Case Study discusses the supply chain management strategies

at Walmart. It is with respect to Chapter 1 of the book.
Walmart has one of the largest and most efficient supply chains
in the world with strong logistical and operational infrastructure.
According to a recent report by Supply Chain Digest, the company
operates in more than 11,000 stores in more than 27 countries. The
total amount of inventory managed by the company is worth USD
32 billion.
Walmart is the most powerful retailer in the world with the high-
est sales per square foot, inventory turnover, and operating profit.
I don’t believe there is a university in the world that doesn’t talk
S
about Walmart and the supply chain, said James Crowell, Director
of the Supply Chain Management Research Center at the Walton
College of Business. They are just so well respected because they do
IM
it so well.
From the very beginning, Walmart’s strategy has been to offer

low prices to the customers by developing an advanced supply
chain. It is not surprising that Walmart was named the retailer
of the decade in 1989. In the 1980s, Walmart began innovation in
the supply chain by directly dealing with the manufacturers in
M
order to cut costs and manage the supply chain more efficiently.
It introduced the concept of Vendor-managed Inventory (VMI),
which made manufacturers responsible for managing their prod-
ucts in the company’s warehouses. Consequently, Walmart was
N
able to expect close to 100 per cent order fulfilment on merchan-

dise. In addition, to improve material flow with lower inventories,
Walmart improved its supply chain management by constructing
communication and relationship networks with suppliers.
Technology at Walmart plays a key role in forecasting demand,

predicting inventory levels and identifying efficient transporta-
tion routes. Walmart has also implemented Universal Product
Code bar codes, which helped it to immediately collect and analyse
store-level information. In addition, it developed and used Retail
Link, an Internet-based tool to help suppliers access point-of-sale
data and other important information. Apart from this, Walmart
also uses Radio Frequency Identification (RFID) technology for
scanning and keeping track of merchandise as it moves along the
supply chain.
Walmart also entered into collaboration with Procter & Gamble

(P&G) for maintaining the inventory in its stores and to develop
an automated re-ordering system. With the help of this system, all

Case study 1: WALMART’S ADVANCED SCM 283
Case study 1
n o t e s
the computers between the P&G factory were linked through a

satellite communication system.
Walmart’s innovative supply chain strategy has helped it to be-

come a leading force in a highly competitive global market. As
technology evolves, Walmart continues to focus on innovative
processes and systems to improve its supply chain and achieve
greater efficiency.
Walmart’s supply chain provides valuable learning points that

other organisations can take and apply to their own operations.
According to Army Col. Vernon L. Beatty, who commanded the
Defense Distribution Depot in Kuwait and spent a year with
Walmart as part of the military’s Training with Industry Program,
supply chain management is moving the right items to the right cus-
S
tomer at the right time by the most efficient means. No one does that
better than Walmart.
IM
questions
1. Discuss the SCM strategy that has helped Walmart to

develop competitive advantage and assume the leadership
position in the market.
(Hint: Fewer links in the supply chain, strategic vendor
partnerships.)
M
2. Mention the IT applications used by Walmart to manage

its supply chain network.
(Hint: Universal Product Code, Radio Frequency
N
Identification (RFID) technology, etc.)

Case study 2
n o t e s
IMPLEMENTATION OF the SCOR MODEL BY

EXPRESSPOINT
This Case Study discusses the implementation of a SCOR model by

ExpressPoint in order to enhance its supply chain and achieve its
organisational objectives. It is with respect to Chapter 12 of the book.
ExpressPoint is a company that provides supply chain and

high quality repair solutions to equipment manufacturers and
third-party logistics providers. The company’s leadership team is
aware of the fact that collaboration, undergoing continuous im-
provement and flexibility in conducting business are essential
for satisfying customers. The company’s main business goal is
to make on-time delivery of products and services to customers
along with high quality and at relatively economical costs. For
S
this, the leadership team has to strategically analyse and enhance
the company’s supply chain processes.
The organization structure had become disjointed, explains Susan

IM
Buttner, the Director of Finance at ExpressPoint. Through em-
ployee attrition, responsibilities were assigned to others who lacked
expertise with supply chain strategy. Departments became siloed
and vertical-thinking, focusing on their specific tasks rather than
the holistic, end-to-end supply chain.
M
ExpressPoint executives designed a three-year strategy to imple-

ment changes in separate phases. They also wanted to balance in-
dustry cost and improve service, quality and reporting standards.
In order to achieve these objectives, the executives selected the
Supply Chain Operations Reference (SCOR) model.
N
These tools were chosen because they demonstrate a proven ap-

proach, says Kelly Dudek, Chief Operating Officer at Expres-
sPoint. In addition, they teach employees to carry out day-to-day
principles, the technique demands team ownership, and SCOR is a
cross-industry standard.
ExpressPoint’s team members employed SCOR metric defini-

tions in order to define their scorecard. They also collected a set
of sample data and decided the baseline data over a fiscal year. In
order to determine and analyse metric failures, lean and six sigma
training was employed. This helped to uncover faults that were
the reason behind the failure of metrics. In the meantime, SCOR-
mark, which is a benchmark survey, was completed. This helped
to furnish a statistical evaluation of ExpressPoint with respect to
comparable businesses.
A SCOR process maturity map was developed by ExpressPoint’s

executives that rated and outlined activities as broken or missing,
which were in need of improvement or were working effectively.

Case study 2: IMPLEMENTATION OF the SCOR MODEL BY EXPRESSPOINT 285
Case study 2
n o t e s
This analysis helped to establish certain measures for identifying

strategic process steps and system transactions. The team dis-
covered that the company’s planning processes and system capa-
bilities were not fully integrated and several of them were either
broken or missing.
In present times, ExpressPoint is reaping benefits by having

a more comprehensive understanding of its supply chain. The
SCOR model helped us better understand our supply chain and the
competitive requirements, Buttner says. Refining our metrics gives
us increased visibility and helps balance our customers’ require-
ments with our financial objectives.
questions
S
1. Mention objectives that ExpressPoint’s executives wanted
to achieve by implementing the SCOR model.
(Hint: Balanced industry cost, improved customer service,
IM
high-quality of products and services and compliance
with reporting standards.)
2. How did the SCOR model help ExpressPoint in integrating
its supply chain?
(Hint: Understanding supply chain process and
M
competitive requirements, aligning customers’

requirements with financial objectives, etc.)
N

Case study 3
n o t e s
increasing growth by implementing it

sourcing strategy
This Case Study discusses the development and implementation of

an IT sourcing strategy at a pharmaceutical company to help ex-
pand its growth. It is with respect to Chapter 3 of the book.
A global pharmaceutical company developed an internal strategy

in order to double its revenues in a period of seven years. It want-
ed to analyse its IT service department to provide support for the
expectant growth in the new emerging markets.
This pharmaceutical company enlisted the help of Everest Group

to develop a company-wide IT sourcing strategy. This strategy fo-
cused on the economic, governance and organisational networks
S
in order to manage, select and integrate structure and application
services. This newly developed structure was implemented in or-
der to integrate global IT service providers in a more economical
IM
and efficient manner.
The pharmaceutical company was facing several challenges in

the implementation of its new strategy. These challenges were as
follows:
Developing a flexible solution in order to fulfil demands on IT
M
services
Addressing and identifying the areas where IT services would
be required
Developing a solution that would benefit the organisation to
N
cultivate cost advantages over the current expenditures in-

curred by the company for rendering services
Everest Group organised combined sessions with the business

unit and the IT department executives. The purpose of these ses-
sions was to identify changes in IT services with respect to the
delivery location, performance, regulatory compliances and costs
which would enable the company to support its global expansion
strategy. The group worked with the IT department in order to
determine various sourcing strategies. It also worked with the
pharmaceutical company in order to create guidelines for the
selection and management of multi-sourcing (it refers to an ap-
proach of outsourcing wherein IT operations are outsourced to
multiple vendors) environment.
Everest Group was successful in creating an effective strategy for

the pharmaceutical company to accelerate its growth. Moreover,
it helped the company to avoid adopting the conventional meth-
ods of splitting sourcing solutions. Moreover, the pharmaceutical
company was able to discover lasting solutions for the manage-

Case study 3: increasing growth by implementing it sourcing strategy 287
Case study 3
n o t e s
ment of its financial services with respect to a multi-provider

solution. The final outcome was the creation of an IT sourcing
solution structure which provided the company with flexibility in
its operations due to its evolving sourcing needs.
questions
1. What were the challenges faced by the pharmaceutical

company in the implementation of its new IT sourcing
strategy?
(Hint: Developing a flexible solution in order to fulfil
demands on IT services, addressing and identifying the
areas where IT services would be required.)
2. How did the pharmaceutical company benefit from the
S
services provided by the Everest Group?
(Hint: An IT sourcing solution structure was developed
which provided the company with comprehensive
IM
flexibility due to its evolving sourcing needs).
M
N

Case study 4
n o t e s
INVENTORY MANAGEMENT SOLUTION BY INFOSYS
This Case Study focuses on the in-store inventory management solu-

tion by Infosys. It is with respect to Chapter 4 of the book.
(Source: www.infosys.com)
S
BACKGROUND
A leading European pharmacy retailer required the services of an

IM
external provider to manage its inventory. It selected Infosys, a
global consultancy services provider, to address its inventory and
operational issues. Infosys is a reputed service provider with high
success rate in inventory management solutions.
CHALLENGES
M
The pharmacy retailer incurred high operational costs to manage

its inventory. Further, the pharmacy retailer faced issues of stock
picking and counting errors in its processes. Thus, the retailer
needed an efficient technology transformation without heavy cap-
N
ital expenses. Some of the major business challenges that Infosys

needed to address were as follows:
Goods in-tracking to record all stocks received and goods
out-tracking to monitor the outflow of goods
Noting the status of store shelves to collect the sales floor shelf
quantity and product fill quantity
Tracking excess inventory
Movement of goods from the store to shelf
Managing prices of products
Store space planning and management
SOLUTION
The solution provided by Infosys ensured real-time and offline

data verification and validation with Electronic Point of Sale
(EPOS), a system which helps to maintain a record of stocks and

Case study 4: INVENTORY MANAGEMENT SOLUTION BY INFOSYS 289
Case study 4
n o t e s
ensure accurate re-orders. This system was applied by Infosys to

support sales and customer service staff using handheld devices.
Experts at Infosys provided multi-hardware device support to the

pharmacy retailer via scalable and robust architecture, which ab-
stracted the hardware-level dependency.
BENEFITS
The solution provided by Infosys helped the pharmacy retailer in

the following ways:
Reduced inventory management costs
Enhanced stock file accuracy by approximately 10 per cent
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Reduced stock room units and increased customer facing time
Reduced overall workload by 15 to 20 per cent

Alignment between sales patterns and customer trends
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Efficient technology transformation
Efficient store inventory management and operations han-
dling
(Source: https://www.infosys.com/engineering-services/case-studies/
Pages/inventory-management.aspx)
M
questions
1. What types of inventory were managed by the pharmacy

retailer through the use of Infosys’s solution?
N
(Hint: Cycle inventory, safety stock, decoupling stock, etc.)

2. What could be the different types of inventory-related
costs that the experts at Infosys must have considered to
provide an effective solution to the retailer?
(Hint: Ordering costs, inventory-carrying costs, stock-out
costs, etc.)

Case study 5
n o t e s
shift towards ocean freight for the

transportation of goods
This Case Study discusses the shift towards ocean freight from air
freight for the transportation of goods by companies. It is with re-
spect to Chapter 5 of the book.
S
IM
(source: dhlexpress.com)
The dramatic decline in ocean freight spot market rates has served
to widen the pricing differential to air rates to record levels, an an-
alyst at Drewry Supply Chain Advisors has observed.
M
Analysts at Drewry Supply Chain Advisors, a sea freight market

intelligence and benchmarking firm, has highlighted the fact that
spot market ocean freight prices are plunging down quickly. The
average prices for shipping containers in the month of October,
2015 on the route for Europe to Asia trade were more expensive
N
than they were for the far larger Asia to Europe trade route.
This situation has happened for the first time since Drewry start-
ed benchmarking the cumulative trade rate indices in 2011. Air
freight spot rates have been considerably more stable than ocean
rates in spite of stagnant demand.
Chuck Clowdis, Managing Director of Transportation Advisory

Services for IHS Global Insight, is in agreement with this obser-
vation, however, warns that, Air cargo will see last moderate rise in
November, 2015 and maybe in December, 2015, he says. But it may
not be sustainable, as there was no real peak season this year.
Moreover, the pricing differential between the two modes of sup-

ply chain transportation, namely air and ocean, has reached a
record high. The move towards more economical ocean freight
for the transportation of goods has gathered force in the past few
years due to the fact that more sophisticated IT systems are being
used by them. Additionally, container service reliability has been

Case study 5: shift towards ocean freight for the transportation of goods 291
Case study 5
n o t e s
increased and simple inventory strategies have been implement-

ed by shippers.
questions
1. Why has pricing differential for air rates widened?

(Hint: Dramatic decline of ocean freight spot market
rates.)
2. Why are companies using ocean freight for the
transportation of goods?
(Hint: Usage of more sophisticated IT systems, increased
container service reliability, etc.)
S
IM
M
N

Case study 6
n o t e s
MODELLING THE DISTRIBUTION NETWORK DESIGN

OF A BRITISH ENERGY FIRM BY LOGISTICS BUREAU
This Case Study focuses on the usefulness of the modelling of dis-

tribution network design as done by Logistics Bureau for a British
energy firm. It is with respect to Chapter 6 of the book.
(Source: www.logisticsbureau.com/)
Logistics Bureau offers supply chain consulting services across
S
various industrial sectors; for example, retail, healthcare, FMCG,
mining, construction, energy, IT and telecom, etc. It provides a
range of consulting assignments across various geographies,
IM
which includes Latin American countries, Asia-Pacific zones, Eu-
ropean countries, African nations, etc. It is a renowned market
leader for local, national and international clients.
The business needs of an organisation’s distribution network

change with time due to mergers and acquisitions, expansions,
M
entry in new markets, legal changes, etc. In view of this, a British

energy firm sought the services of Logistics Bureau to model its
existing distribution network. The firm was facing issues such as:
Network costs higher by 10-15% than expected norms
N
Longer service lead times

Impact on its energy distribution
Excessive inventory investment
Lack of availability of resources
The distribution strategy consultants at Logistics Bureau mod-

elled the distribution network design of the firm in such a manner
that it satisfies customer demands at specified service levels at
optimal costs. They used specialist distribution network model-
ling software to allow cost and service optimisation of the net-
work to be established. Networks were modelled from the firm’s
energy plant to the consumer considering all relevant cost and
service drivers like transport costs, transport modes, service lev-
el requirements, plant and supplier locations, distribution centre
size, location, resources, costs, etc.
In addition, Logistics Bureau conducted a fast track network

test that used market-based warehouse and transport costs. The

Case study 6: MODELLING THE DISTRIBUTION NETWORK DESIGN OF
A BRITISH ENERGY FIRM BY LOGISTICS BUREAU 293
Case study 6
n o t e s
trained consultants and experts at Logistics Bureau modelled the

distribution network design of the firm and immediate benefits
were obtained. The benefits from the specialist distribution net-
work modelling software were as follows:
Distribution costs were reduced.
Customer service requirements were better understood.
Service costs were better understood.
Storage, inventory and transport costs were appropriately
balanced.
Graphical mapping of customer demand and density became
possible.
Further access to leading distribution network modelling tools
S
and techniques became possible.
Graphic outputs enabled an effective cost-benefit analysis.
(Source: www.logisticsbureau.com/)
IM
questions
1. What factors affected the British energy firm’s distribution

network? Discuss.
(Hint: Structure of distribution network, government
M
regulations, infrastructure utility costs, etc.)

2. What challenges were faced by the decision makers of
Logistics Bureau in modelling the distribution network
design of the British firm?
N
(Hint: Technological factors, political factors, competitive

factors, etc., are some of the challenges that rose before
Logistics Bureau while decision making.)

Case study 7
n o t e s
YEELD’S REVENUE MANAGEMENT SOLUTION FOR

ABC HOTEL
This Case Study discusses how Yeeld Solutions, a revenue manage-

ment consultant solved ABC Hotel’s revenue management problems.
It is with respect to Chapter 7 of the book.
Yeeld Solutions is a consultancy organisation that provides rev-

enue management consultancy services along with distribution
services for hotels. It is located in Berlin, Germany. The consul-
tancy was founded by David Turnbell in 2006. David is also the
current Director of the company. It uses Yeeld Solutions Central
Reservations System developed by Sabre Hospitality Solutions.
Through this system, the consultant provides integrated distri-
bution solutions and hotel reservation services. It caters to the
S
revenue management needs of various hotels located throughout
Europe. It provides high value and cost-effective reservations and
revenue management services.
IM
During the late 2000s, a client ABC Hotel consulted Yeeld Solu-
tions. The client was a mid-size European hotel. ABC Hotel want-
ed a total review and overhauling of its revenue management and
distribution. The reason why ABC consulted Yeeld was that its
sales remained stagnant for the past three years and the annual
occupancy of hotel was only 65%. Also, the Average Daily Reve-
M
nue (ADR) was only about 125 Euros.
Yeeld devised a strategy to identify the problems with the existing

revenue management practices and accordingly recommended
for an Internet Distribution Strategy (IDS) for increasing reve-
N
nues. For this, Yeeld had to evaluate the Global Distribution Strat-
egy (GDS) share and Market Penetration Index (MPI) and recom-
mend future growth strategies.
The consultant started its evaluation with an audit by collecting

data from the hotel by conducting interviews. After the audit was
over, Yeeld presented its findings and recommendations.
The audit revealed that there were certain challenges and prob-
lem areas faced by the hotel, as follows:
Erroneous pricing
Ineffective forecasting
Problems with inventory management and planning
Ineffective revenue management decision making
Ageing market segment
Reservation department using old techniques and resources

Case study 7: YEELD’S REVENUE MANAGEMENT SOLUTION FOR ABC HOTEL 295
Case study 7
n o t e s
No formal criteria were prescribed for the IDS partners

ABC Hotel did not select its competitor set effectively
In order to provide a feasible solution for these challenges, Yeeld

suggested a plan that was to be implemented in three phases over
a period of 12 months. The hotel was given an option to imple-
ment this solution either itself or with the assistance of Yeeld. The
hotel retained Yeeld for implementation of the plan for the first six
months and for the remaining six months; Yeeld provided strate-
gic support to ABC. The three phases of the plan were as follows:
1. Immediate corrections (month 1 to month 2): Under this
phase, the existing market and channel segment structures
were revised; the staff was given extensive training on
pricing, inventory management and forecasting.
S
2. New revenue management infrastructure (month 3
to month 6): Under this phase, a centralised business
development department was created. This department was
IM
having new Standard Operating Procedures along with daily
and weekly checklists. New revenue management tools were
introduced that were updated daily, weekly, or monthly. The
important revenue and financial statistics were mapped
against the new and effective set of competitors.
3. Long-term business development planning (month 6 to
M
month 12): This phase allowed the consolidation of the new

business development department. Company introduced a
dynamic pricing matrix.
As a result of these practices, the hotel was able to achieve
N
6% increase in the occupancy along with 5% increase in

ADR. The cost of implementing the plan suggested by Yeeld
costed approximately EUR 60,000 whereas the revenue of
the hotel increased by EUR 600,000.
(Source: Adapted from, Yeeld.com,. (2015). Hotel Revenue Management Case Study |
Revenue Management Consultancy | Hotel Benchmarking – Yeeld Solutions. Retrieved 10
December 2015, from http://www.yeeld.com/intelligence/case_study.)
questions
1. What was the relevance of the third phase of the plan

suggested by Yeeld?
(Hint: The third phase was essential for the consolidation
of the new business development department.)
2. How did Yeeld unearth the problems related to revenue
management at ABC Hotel?
(Hint: Yeeld unearthed the problems by conducting an
audit which involved collecting data from the hotel by
conducting interviews.)

Case study 8
n o t e s
New and improved e-retail business
This Case Study discusses the role of demand forecasting in e-retail

business. It is with respect to Chapter 8 of the book.
Snapdeal e-commerce platform handled 30 orders per second in

2014 during Diwali sale. In addition, 300 orders per second were
handled by the company in its weekly festive sales. A range of
forecasting models and analytics tools were used by the compa-
ny for handling huge traffic. It resulted in quick forecasting of
demand for products, which further led to the availability of suf-
ficient stocks with its sellers. The company has a team of 1,500
engineers to deal with the huge surge in traffic during sales time.
Snapdeal is one of the most growing e-commerce players in India
S
that is leveraging technology to create its competitive edge. On
the other hand, Flipkart, which had to issue an apology in 2014 for
the unavailability of products during the Big Billion Day, run the
IM
show successfully in 2015. Ankit Nagori, Chief Business Officer at
Flipkart, says compared to last year, the number of customers has
more than doubled. There is also a huge increase in our seller num-
bers. We have ramped up across the board – be it our warehouses, call
centres, our delivery mechanism and technology stacks – and this
has paid rich dividends. We have definitely done better than 2014.
M
Unlike 2014, the Big Billion Day 2015 was run for over five days
through mobile apps. Organising such large sales events online
requires matching consumer demand patterns with supply-chain
logistics. Indranil Mukherjee, Vice-President & Global Practice
Lead for Systems at SapientNitro, says Before going into big-ticket
N
sale event, e-commerce players must use analytics to understand

the typical customer journey from evaluation through consideration
and purchase on different channels (website and mobile app) and
then accordingly determine demand patterns across categories.
Amazon, which is known for using data analytics and technology

in managing massive sales events like Black Friday, Cyber Mon-
day and more recent Prime Day in the US, has started incorporat-
ing its global learning in its India operations. Samir Kumar, Vice
President, Category Management, Amazon India said, the Great
Indian Freedom Sale, in August, 2015. Given our expertise in web
services and hosting, we are prepared to handle enormous traffic in
a manner that enables a seamless and frictionless shopping experi-
ence for millions of customers in a sale event.
It is important for an e-commerce company to work on a user

interface as it is the only thing that is seen by a consumer. Entire
interaction between customers and the e-commerce company
takes by this interface only. Therefore, if the site of e-commerce

Case study 8: New and improved e-retail business 297
Case study 8
n o t e s
players gets freeze during the sale or fails to load, the whole idea
of organising a big sale event can be lost. Snapdeal refreshed its
user interface in July 2015, across all platforms that includes Web,
Wireless Application Protocol (WAP) and mobile applications. Ro-
hit Bansal, Co-Founder & COO, Snapdeal said, the refreshed inter-
face has been designed to give our products an uncluttered look, to
make navigation easier and create more focus on visual elements,
especially during a sale. We recorded a 99.99 per cent uptime on
the website, WAP and App during our October 13-October 17 Di-
wali sale. It invested a $300 million for strengthening its supply
chain and logistics. We have already invested a large portion of this
money into our supply chain and logistics, including Gojavas - to
enhance our reach. Along with the introduction of services like less
than four hour delivery for exclusive launches, card on delivery ser-
vice in over 100 cities and 90 minute returns pick-up across 70 cit-
S
ies, it has resulted in 70 per cent improvement in delivery time over
the last six months, says Bansal.
IM
Now Snapdeal has 1.3 million square feet additional warehouse
space across 63 fulfilment centres in 25 cities. All are located near
the majority of seller and buyer locations. We rely heavily on ana-
lytical tools to plan volumes on different shipment routes according
to the load capacity on a real-time basis, says Bansal.
Bansal says Snapdeal has set up a remote control-and-command

M
centre to facilitate real-time monitoring and spot fixing. We monitor

load across centres to identify bottlenecks. We have early warning
systems for shipping legs allowing us to plan shipment volumes. This
enabled 98.6 per cent on-time deliveries during the October 13-Oc-
N
tober 17 Diwali sale and 98.9 per cent orders dispatched within 24
hours of order placement.
Moreover, ShopClues introduced a new feature for increasing in-

frastructure capability and architecture optimisation to handle
20X traffic. With the help of this, Web chats can be initiated be-
tween customers and sellers, thereby customers can negotiate di-
rectly with sellers. We have also introduced image search solutions
so that customers get recommendations based on visual appearance
of products. This is very important in fashion and other unstruc-
tured categories, especially during a sale. A deal discovery platform
for faster discovery of the best available deals on a single page, has
made navigation faster says Gyanesh Sharma, AVP, Engineering,
ShopClues.
Supply chain logistics should be effectively managed for making

the big sale event successful during festivals. This is because the
number of first-time users placing orders online is comparative-
ly quite huge during the festive season sales. Poor experience
in terms of the cancellation of orders, out-of-stock issues, price

Case study 8
n o t e s
changes and delay in delivery can severely dent an e-retailer’s

image.
A vast delivery network was installed by Amazon in the past

few months to ensure fast and reliable delivery in remote areas
during the festive season. It made expansion in the Amazon Lo-
gistics footprint three times and opened eight new fulfilment cen-
tres (FCs). Till now, it has 21 FCs operational across 10 states cov-
ering a total of over 2 million-square-feet of space with a storage
capacity of over 5 million cubic feet. In addition, Amazon started
working with NGOs in rural India so that it can establish rural
distribution centres. We pioneered morning delivery service in In-
dia during the Great Indian Festive Sale wherein customers can
place orders as late as midnight and get the items delivered at their
doorstep by 11:00 am. During the Great Indian Festive Sale, over
S
65 per cent orders came from Tier-II and Tier-III cities and towns.
We are shipping 60 per cent of the customer orders in less than six
hours, says Samir Kumar, Vice President, Category Management,
IM
Amazon India.
The use of big data analytics is done by Flipkart to understand

people’s preferences so that customer engagement can be en-
hanced. Through the data collected from the various interactions
with our customers on the app, we have been able to offer customers
various benefits: personalised category recommendations, fashion
M
taste and preferences and location-based recommendations, says

Ankit Nagori, Chief Business Officer, Flipkart. More than 8 mil-
lion units are sold by Flipkart during the recently concluded Big
Billion sale with a total of 5 million app downloads.
N
The number of FCs was ramped-up from 13 to 17 this year so that

customers from smaller cities could shop with us too. In order to
smoothen the backend process, we increased investments in auto-
mation technology. We also started implementing the automation
technology to pick and move packages to designated pick-up sta-
tions, among several other applications which made our warehouse
processes quicker and smoother, says Nagori.
Flipkart has built a team of 20,000 delivery boys by 2015 as com-

pared with 9,000 in 2014 for ensuring efficient delivery. In addi-
tion, Turbo Charge Campaign was launched for preparing its
small sellers for the sale so that they can streamline back-end pro-
cesses handling massive customer demands during this period.
Special packages on inventory and enterprise management are
provided to sellers for handling peak season sales.
The latest search technologies are used for making the search
simple, fast and contextual in the online retail industry. The use of
personalisation technologies are done so that the past behaviour

Case study 8: New and improved e-retail business 299
Case study 8
n o t e s
can be reminded to the visitor such as abandoned shopping carts.

The applications of cloud-based hosting infrastructure ensure
guaranteed uptime and scaling on demand. This technique also
supports latest navigation tools. After all, it is overall customer
experience on the e-commerce platform and mobile app during
the event that helps in cracking deals for e-commerce players.
(Source: Adapted from: http://www.business-standard.com/article/management/new-and-
improved-e-retail-business-115102500562_1.html.)
questions
1. Explain the significance of forecasting for e-commerce

players.
(Hint: A range of forecasting models and analytics tools
were used by the company for handling huge traffic.)
S
2. Discuss the importance of big data in the online industry.
(Hint: Big data is used for enhancing customer
engagement.)
IM
M
N

Case study 9
n o t e s
INTERNET OF THINGS AND SMART SUPPLY CHAIN
This Case Study discusses how Internet of Things (IoT) is bringing

revolutionary changes in supply chain practices. It is with respect
to Chapter 9 of the book.
S
IM
(Source: supplychain247.com )
Supply chains of organisations are becoming more intelligent

M
and efficient because of the Internet of Things (IoT)—the latest

technological phenomenon that is revamping many supply chain
functions. In simple words, IoT refers to a network of physical
objects connected over the Internet using software, sensors, net-
work connections, etc. IoT facilitates the collection and exchange
N
of data among these connected objects.
Organisations like General Motors (GM) and Whirlpool have al-

ready started using IoT in their supply chains to make them more
effective. These companies are replacing the passive sensors in-
stalled in their supply chain by more intelligent sensors to gain
better control over their external environment and make more
informed decisions. In addition, by enabling IoT in the factory
equipment, these companies are in a better position to keep track
of machine utilisation, optimise process flow and raise the overall
performance and efficiency of the supply chain.
IOT in the warehouse and on the factory floor
GM’s Plant Floors Control Network, which used Cisco’s IoT sys-
tem is an example of application of IoT in the warehouse and the
factory floor. GM has installed sensors in its manufacturing plants,
which measure the humidity in the plants and make necessary
adjustments in the assembly line. This arrangement ensures that

Case study 9: INTERNET OF THINGS AND SMART SUPPLY CHAIN 301
Case study 9
n o t e s
cars are not painted in a humid condition, which in turn improves

paint quality and eliminates the risk of repainting. According to
Cisco, after installing the IoT-enabled sensors, GM has been able
to save millions of dollars by reducing repainting.
An injection molding company, a client of xTuple ERP, sets up

‘crib’ parts on its shop floor, which is further networked with xTu-
ple ERP system to connect to the stock replenishment system.
This entire system is designed to remove the need of human in-
teraction in the replenishment of inventory.
According to Wally Tonra, Vice President of Sales at xTuple, IoT

will have maximum impact in three key areas—increasing profit,
keeping inventory, and complying to certificates and regulations.
These three areas encompass, monitoring of inventory flow, facto-
S
ry climate conditions, product shrinkages, equipment utilisation,
control of inventory, management of product life, etc. Tonra also
added, the biggest challenge of integrating IoT with existing sup-
IM
ply chain systems such as a company’s ERP is to stay focused on
the business goal and implement those integrations that will fulfil
the overall needs of the specific business.
A number of airline companies are also early adapters of IoT. Boe-

ing uses Zebra’s Real-Time Locating System that tracks the loca-
tions of workers and the status of their safety harnesses.
M
The home application maker, Whirlpool uses IoT for locating mis-
placed inventory. It also helps the company in eliminating paper
tags and manual tracking, which in turn optimises inventory level
and increases system efficiency.
N
CHALLENGES
Though IoT provides a number of benefits, shifting to IoT re-

quires significant changes in the mindset of the supply chain
managers. Most large companies are habituated with centralised
control. The introduction of IoT will be a major blow to the cen-
tralised control as a significant amount of that control will have to
be delegated to software-based systems that make efficient deci-
sions automatically. According to Ed Nabrotzky, chief solutions of-
ficer, Omni-ID, letting the system become more dynamic is a struggle
conceptually for the supply chain industry, which is so very used to
specified processes and control.
In addition to psychological barriers, data security also poses a

major challenge in the IoT system. Best practices in data security
are yet to emerge as IoT is still in its nascent stage. According to
Mark Wheeler, director of Supply Chain Solutions at Zebra Tech-

Case study 9
n o t e s
nologies, Security concerns can be addressed by leveraging existing

standards and best practices for connecting the asset to IoT. A key
challenge is securely managing the complexity of the implementa-
tion and enabling the power and dynamism of cloud computing to
analyze the data provided and deliver value to the enterprise user.
questions
1. What is the core competency of an IoT system in increasing

the efficiency of a supply chain?
(Hint: It automates information sharing and decision-
making, thereby reducing (or eliminating in certain cases)
human intervention in supply chain decisions.)
2. What are the potential roadblocks for IoT to become a
S
mainstream supply chain practice?
(Hint: Psychological barrier, data security challenge, etc.)
IM
M
N

Case study 10
n o t e s
Global supply chain hit by terror threats
This Case Study discusses the concept of integration of a supply

chain. It is with respect to Chapter 10 of the book.
An analysis done by the Chartered Institute of Procurement

and Supply having 115,000 members in 150 countries, the risk
of the unstable commodity prices has been enhanced due to the
cross-border presence of Islamic State of Iraq and Syria (ISIS).
It was estimated that the closure of internal borders because of

the surge in refugees fleeing wars in the Middle East could in-
crease the cost of Europe’s supply chains by billions. All this fur-
ther led to enhancement in the financial volatility of the Middle
Eastern region in August 2015 that resulted into the increased
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number of risk associated with supply chain in advanced econo-
mies. The quarterly risk index dating back to 1995, found that
the chances of having disruptions in the supply chain are almost
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doubled from 40.4 in 2003 to 79.1 till date.
John Glen, Cips economist and senior economics lecturer at Cran-

field School of Management, said, although supply chain risks have
often felt remote, the European migrant crisis and conflicts in the Mid-
dle East mean that the risks are getting closer and feeling more acute.
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Due to the migrant crisis affecting Europe, the borders of Hun-

gary and Serbia have been fenced off. Moreover, Slovenia and
Croatia have also started to build fences on their national bound-
aries since November 2015. All this resulted into the enhanced
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lead time for the goods moving across these borders. Austria and
Germany are particularly affected, whereas this situation led to the
increment of 10 per cent in delivery prices by German companies,
Cips said.
In the Middle East, due to the risk posed by ISIS, the transporta-
tion of goods across the region became challenging. Moreover, the
risk ratings of several nearby countries such as Kuwait, Tunisia
and Bahrain were increased after a number of terrorist attacks.
Turkey has resorted to using sea freight services for transporting
goods, which is a more expensive option.
But Cips cautioned that this was a short-term solution which threat-
ens to have an impact on costs further up the chain or the quality of
goods being produced at the bottom of it.

Case study 10
n o t e s
Complex and lengthy supply chains had adverse effect on the

timely delivery of products. This led to the shortage of products
in some regions. However, there has been some positive news as
well since US has eased sanctions on Iran and Cuba. This has
opened new trade routes for the supply of products across the
world. Steps are being taken to reintegrate Iran into the Middle
Eastern supply chain. However, it would be done with contingen-
cy planning in place. US can reinforce sanctions on Iran at a short
notice of 65 days.
(Source: Adapted from: http://www.ft.com/cms/s/
0/05bfb10e-8de3-11e5-a549-b89a1dfede9b.html#axzz3ttH6bVKM)
questions
1. In the context of the case, explain the effects of closure of
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internal borders on the global supply chain.
(Hint: It results into the addition of billions of costs in
Europe’s supply chains and enhancement in the financial
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volatility.)
2. Why has the transportation of goods become challenging
in Middle East?
(Hint: Due to threat posed by ISIS and increasing number
of terrorist attacks.)
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Case study 11
n o t e s
Long Grove Confectionery Co.
This Case Study discusses the problems faced by a premium choco-

late manufacturer, Long Grove Confectionery Co. and how compa-
ny devised its postponement strategy. It is with respect to Chapter
11 of the book.
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(Source: www.longgrove.com)
Long Grove Confectionery Co. (LGCC) is a US-based local con-

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fectionery manufacturer. It is located in Illinois, USA. It manu-
factures premium high-end chocolates. This case is regarding the
postponement strategy sought by LGCC in the late 1990s when
most of their products were sold through the wholesale network
by use of catalogues. However, the remaining products were also
sold in the company’s own stores. The company offered a lot of
product variants which led to the development of certain unfa-
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vourable situations for the company and also affected its financial
performance and revenues. One such situation occurred when
a good amount of packaging material inventory (that was pur-
chased for seasonal products) was left unused and it needed to
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be discarded by the company (in ideal situation). However, the

second such situation occurred when the company did not dis-
card the packaging immediately and carried it over for use in next
season for packing similar products. This led to a problem for the
marketing department as it will have to sell similar products it
sold last year. In such a situation, the company was forced to mi-
nimise the cost impact of leftover inventory to reduce the impact
on profits.
The company analysed its situation and found that the root cause
of their problem was that it was not able to predict the demand
for new products efficiently and accurately. The variance related
to a particular product’s demand can fluctuate either on the high-
er side or on the lower side. The fluctuation can be on the higher
side (demand for more products than forecasted) if a big whole-
saler decides to retail the product all over the country. However,
fluctuation can be on the lower side (demand for less products
than forecasted) if the product is not able to attract much cus-
tomers. It means that the major problem of LGCC was related

Case study 11
n o t e s
to matching the demand and supply quantities. Another prob-

lem was that LGCC was not able to obtain quantity discounts as
it did not place huge orders. Due to this, LGCC’s profit margin
was reduced. Now, here the company was faced with a vicious
cycle, if it placed large orders for packaging material, it would get
quantity discounts; however, if the actual sales are lower than the
forecasts, it will again have to bear the cost of unused inventory
(and disposal costs) that it again would carry over to next season.
Another problem with LGCC was that it used very special kind of
packaging for its products which added to its product’s unique-
ness. If the demand was less than expected, the packaging inven-
tory would lie idle with no alternative use whereas if the demand
exceeded forecast, additional inventory must be acquired in small
lots. Consequently, profits were lowered and costs increased due
to excess inventory holding costs and disposal costs (that arise as
S
a result of discarding the unused packaging material).
LGCC wanted to resolve all these problems by improving its fore-

IM
casting practice. However, the management of the company was
changed recently and the company had the same old information
systems. Therefore, it was difficult to resolve this problem in short
term. The new management wanted to introduce some new prod-
ucts it for which the forecasts of demand and sales were highly
unpredictable (being new). The management decided to reduce
the inventory holding costs and disposal costs. Most of the sales
M
for LGCC’s wholesale business is generated by use of catalogue.

However, the catalogue includes both the hot selling products as
well as the slow selling products. The slow selling products are
advertised in the catalogue so as to use the excess inventory from
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last year; these products are often advertised as on sale products

in catalogue. It means that these slow sellers occupy the scarce
and costly catalogue space which should be given to new products
and increase focus on hot sellers.
All the problems were piling up and the management decided

that it needs to develop a postponement plan in order to delay
differentiation of products to the later stages of the supply chain.
The management analysed the possibility of modifying the pack-
aging designs of products in such a way that different products
could be packaged using standard packaging material while at
the same time they maintain a unique, premium and distinctive
appearance. Earlier, LGCC used specially designed boxes that
had decorative features over it. However, after the decision of
management to modify packaging, LGCC started using standard
boxes along with specially designed wrappers, bows, coverings
etc., which could be used with standard boxes to produce similar
experience as before.

Case study 11: Long Grove Confectionery Co. 307
Case study 11
n o t e s
As a result of this, the differentiation in packaging was shifted to

later stage in the process. The company was also able to forecast
demand and sales more accurately. And lastly, the unused inven-
tory could be applied to other products. The safety stock require-
ment was reduced drastically which lowered costs as the packag-
ing inventory was now common for all products. LGCC was also
able to receive quantity discounts because now it could order in
large quantities which led to cost reduction and increase in rev-
enue.
(Source: Adapted from, (2015). Retrieved 10 December 2015, from http://www.kellogg.
northwestern.edu/course/opns430/modules/supply_chain_management/postpone-
ment-august141998.pdf)
questions
1. What was the main problem of LGCC and its cause?
S
(Hint: The problem of LGCC was related to unused
inventory and the associated disposal and carrying costs.
The root cause of the problem was that it was not able
IM
to predict the demand for new products efficiently and
accurately.)
2. How did LGCC solve its problem and increase its profits?
(Hint: By shifting differentiation in packaging to later
stage in the process.)
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Case study 12
n o t e s
APPLICATION OF BIG DATA AND ANALYTICS in

EFFECTIVE SUPPLY CHAIN STRATEGY FORMULATION
This Case Study discusses how big data and analytics can be used
to develop more informed and efficient supply chain strategies. It is
with respect to Chapter 13 of the book.
Supply Chain
Management
&
Big Data
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IM
(Source: www.entrepreneurial-insights.com)
Big Data refers to an overwhelmingly complex data set that cannot

M
be analysed using traditional data processing applications. The

concept of Big Data has emerged due to a huge amount of data
being produced every day from different business transactions.
So far, the applications of Big Data were limited to business areas,
N
such as customer segmentation, marketing, financial services, etc.

However, recently, Big Data is being used to develop supply chain
strategies as it enables supply chain managers to analyse a vast
amount of data generated from different supply chain activities,
functions and interfaces. The following three factors make an ap-
plication of Big Data in supply chain quite obvious:
1. Supply chains generate a huge amount of data.
2. Supply chain is a large cost component.
3. Advanced analytics can be strategically used to optimise
supply chain performance.
When it comes to the optimisation of a supply chain, most com-

panies cannot see the forest for the trees. In other words, they
fail to see the bigger picture and find out factors that truly drive
business value for an organisation. Therefore, even though most
companies try to optimise their supply chain, they fail to do it stra-
tegically.

Case study 12: APPLICATION OF BIG DATA AND ANALYTICS in EFFECTIVE
SUPPLY CHAIN STRATEGY FORMULATION 309
Case study 12
n o t e s
Most chief financial officers (CFOs) and chief operating officers

(COOs) use the Supply Chain Operations Reference (SCOR) mod-
el as a standard framework to organise and execute the supply
chain functions. When it comes to supply chain optimisation,
planning is the most difficult stage and it bears maximum impact
on the cost because of the Bullwhip Effect.
It has been observed in many organisations that Big Data can

have significant impact on accurate planning, which in turn, helps
organisations to deliver the right product in the right amount at
the right time. Techniques, such as advanced algorithms and ma-
chine learning, improve forecast accuracy across SKUs of the
organisation. This results in less waste, less inventory and fewer
stock-outs, which in turn, lead to higher Earnings before Interest,
Taxes, Depreciation and Amortization (EBITDA), lower working
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capital requirements and greater competitiveness.
OPTIMISING FOR FAST-CHANGING MARKETS

IM
A supply chain plays a crucial role in driving a competitive advan-
tage and a dynamic global business environment. Today, increased
volatility in the market, continuous changes in customer buying pat-
terns, emergence of new markets, etc. make it difficult for manag-
ers to decide the areas of focus. Advanced analytics can help organ-
isations in predicting patterns in customer preferences and major
M
economic trends. This information helps organisations in creating a

more efficient and responsive supply chain. For example, if analyt-
ics predict that customers value convenience, managers can focus
more on distribution and how quickly products reach customers.
N
Similarly, in case customers value quality, maximum focus should

be on areas such as R&D, product life cycle management, supplier
relationship management and manufacturing.
ANALYTICS AND SUPPLY CHAIN STRATEGY
Analytics can help in better forecasting and demand planning with

the help of data collected from point-of-sale (POS), usage informa-
tion, etc. Accurate prediction of customers’ needs helps in deciding
the inventory level at different stages of the supply chain. Data ana-
lytics also helps in devising strategies to improve quality. Moreover,
using analytics on supplier spends can help in rationalising the sup-
plier base and leverage the economy of scale. Analytics can also be
applied for measuring product profitability, optimising working cap-
ital requirements and reducing the inventory level.

Case study 12
n o t e s
questions
1. How do analytics and Big Data enable managers to make

better supply chain strategies?
(Hint: Pattern recognition, accurate forecasting,
information sharing, etc.)
2. How can quality be improved through analytics?
(Hint: Analysis of customer feedback, study of production
processes, etc.)
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CHAPTER NO. CHAPTER NAME PAGE NO.

Role of Supply Chain in Economy and

2 Aggregate Planning in Supply Chain 27

3 Sourcing in Supply Chain Management 51

4 Inventory Management in Supply Chain 73

7 Pricing and Revenue Management 147

8 Demand Forecasting in Supply Chain 165

9 Information Technology in Supply Chain Management 187

10 Supply Chain Integration 201

11 Supply Chain Restructuring 221

12 Metrics and Drivers of Supply Chain 239

13 Supply Chain Strategies and Performance Measures 261

14 Case Studies 281

NMIMS Global Access - School for Continuing Education

A dva n c e d Su pply C hain

Item, Multiple Location Inventory Management; Inventory Models

Designing Distribution Networks & Application to e-Business: Role of Distribution in Supply

NMIMS Global Access - School for Continuing Education

mance; Enhancing Supply Chain Performance

NMIMS Global Access - School for Continuing Education

ROLE OF SUPPLY CHAIN IN ECONOMY AND

Self Assessment Questions

Self Assessment Questions

NMIMS Global Access - School for Continuing Education

NMIMS Global Access - School for Continuing Education

SUPPLY CHAIN AT WHIRLPOOL

Whirlpool is one of the leading American multinational organi-

In order to solve these problems, Whirlpool supply chain man-

agement and IT teams initiated the task of replacing their myriad

the system also provided collaborative tools for forecasting and

NMIMS Global Access - School for Continuing Education

After studying this chapter, you will be able to:

Supply chain management is the integration of various functions,

to make on-time delivery of products to customers through a coordi-

NMIMS Global Access - School for Continuing Education

1.2 Concept of Supply Chain

According to the American Production and Inventory Control So-

ness processes of an organisation from end-user through original suppli-

In the words of Mohanty and Deshmukh, a supply chain is a network

of facilities and distribution options that performs the functions of pro-

self assessment Questions

1. Supply chain is a dynamic process, wherein various parties

NMIMS Global Access - School for Continuing Education

Depict a supply chain network in a leading Indian logistics firm.

Meaning of Supply Chain

Figure 1.1 shows an example of the supply chain management process

Weaving factory Apparel distribution centre Retailer

Figure 1.1: Supply Chain Management at an Apparel Organisation

1.3.1 Objectives of Supply Chain Management

The SCM approach is adopted in organisations to build cordial rela-

NMIMS Global Access - School for Continuing Education

ucts to maximise customer satisfaction. Figure 1.2 lists some of the

Creating Value for Customers