Innovation and Strategies in Supply Chain Management David

Outline of the Presentation u Introduction u Push-Pull Systems u Supply Contracts ©Copyright 2004

Today’s Supply Chain Pitfalls • • • Long Lead Times Uncertain Demand Complex Product

The Bullwhip Effect and its Impact on the Supply Chain • Consider the order

The Bullwhip Effect and its Impact on the Supply Chain Figure 2. Point-of-sales Data-Original

The Bullwhip Effect and its Impact on the Supply Chain Figure 4. POS Data

Higher Variability in Orders Placed by Computer Retailer to Manufacturer Than Actual Sales Lee,

Increasing Variability of Orders Up the Supply Chain Lee, H, P. Padmanabhan and S.

We Conclude …. • Order Variability is amplified up the supply chain; upstream echelons

The Bullwhip Effect P&G Retailers Customers ©Copyright 2004 D. Simchi-Levi

What are the Causes…. • Promotional sales • Volume and Transportation Discounts • Inflated

What are the Causes…. • Single retailer, single manufacturer. – Retailer observes customer demand,

Consequences…. • Increased safety stock • Reduced service level ©Copyright 2004 D. Simchi-Levi

Consequences…. • Single retailer, single manufacturer. – Retailer observes customer demand, Dt. – Retailer

Consequences…. • Increased safety stock • Reduced service level • Inefficient allocation of resources

Multi-Stage Supply Chains Consider a multi-stage supply chain: – Stage i places order qi

Example: Automotive Supply Chain • Custom order takes 60 -70 days • Many different

Supply Chain Strategies • Achieving Global Optimization • Managing Uncertainty – Risk Pooling –

Sequential Optimization vs. Global Optimization Sequential Optimization Procurement Planning Manufacturing Planning Distribution Planning Demand

A new Supply Chain Paradigm • A shift from a Push System. . .

From Make-to-Stock Model…. Suppliers Assembly Configuration ©Copyright 2004 D. Simchi-Levi

Demand Forecast • The three principles of all forecasting techniques: – Forecasts are always

Push-Pull Supply Chains The Supply Chain Time Line Customers Suppliers PUSH STRATEGY Low Uncertainty

…. to Assemble-to-Order Model Suppliers Assembly Configuration ©Copyright 2004 D. Simchi-Levi

Business models in the Book Industry • From Push Systems. . . – Barnes

Direct-to-Consumer: Cost Trade-Off ©Copyright 2004 D. Simchi-Levi

Business models in the Grocery Industry • From Push Systems. . . – Supermarket

Business models in the Grocery Industry • Key Challenges for e-grocer: – Transportation cost

e-Business in the Retail Industry • Brick-&-Mortar companies establish Virtual retail stores – Wal-Mart,

Matching Supply Chain Strategies with Products Demand uncertainty (C. V. ) Pull H I

Shifting the Push-Pull Boundary: A Case Study • Manufacturer of circuit boards and other

Comparison of Performance Measures ©Copyright 2004 D. Simchi-Levi

Safety Stock vs. Quoted Lead Time For a given lead-time, the optimized supply chain

Supply Contracts • Fashion items – short life cycles – High product variety –

Supply Contracts Fixed Production Cost =$100, 000 Variable Production Cost=$35 Wholesale Price =$80 Selling

Demand Scenarios ©Copyright 2004 D. Simchi-Levi

Summary of Retailer Information • • Wholesale cost per unit (C): $80 Selling price

Scenario Analysis • Scenario One: – Suppose you make 12, 000 jackets and demand

Distributor Expected Profit ©Copyright 2004 D. Simchi-Levi

Supply Contracts (cont. ) • Distributor optimal order quantity is 12, 000 units •

Retailer Profit (Buy Back=$55) ©Copyright 2004 D. Simchi-Levi

Retailer Profit (Buy Back=$55) $513, 800 ©Copyright 2004 D. Simchi-Levi

Manufacturer Profit (Buy Back=$55) ©Copyright 2004 D. Simchi-Levi

Manufacturer Profit (Buy Back=$55) $471, 900 ©Copyright 2004 D. Simchi-Levi

Retailer Profit (Wholesale Price $70, RS 15%) ©Copyright 2004 D. Simchi-Levi

Retailer Profit (Wholesale Price $70, RS 15%) $504, 325 ©Copyright 2004 D. Simchi-Levi

Manufacturer Profit (Wholesale Price $70, RS 15%) ©Copyright 2004 D. Simchi-Levi

Manufacturer Profit (Wholesale Price $70, RS 15%) $481, 375 ©Copyright 2004 D. Simchi-Levi

Supply Contracts ©Copyright 2004 D. Simchi-Levi

Supply Chain Profit ©Copyright 2004 D. Simchi-Levi

Supply Chain Profit $1, 014, 500 ©Copyright 2004 D. Simchi-Levi

Supply Contracts: Key Insights • Effective supply contracts allow supply chain partners to replace

Supply Contracts: Case Study • Example: Demand for a movie newly released video cassette

Supply Contracts: Case Study • Starting in 1998 Blockbuster entered a revenue sharing agreement

What are the drawbacks of RS? • Administrative Cost – Lawsuit brought by three

What are the drawbacks of RS? • Retailer may carry substitute or complementary products

Other Contracts • Quantity Flexibility Contracts – Supplier provides full refund for returned items

Slides: 75

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Innovation and Strategies in Supply Chain Management David Simchi-Levi Professor of Engineering Systems Massachusetts Institute of Technology Tel: 617 -253 -6160 E-mail: dslevi@mit. edu

The Bullwhip Effect and its Impact on the Supply Chain • Consider the order pattern of a single color telev Figure 1. Order Stream Huang at el. (1996), Working paper, Philips Lab ©Copyright 2004 D. Simchi-Levi

What are the Causes…. • Promotional sales • Volume and Transportation Discounts • Inflated orders - IBM Aptiva orders increased by 2 -3 times when retailers thought that IBM would be out of stock over Christmas - Same with Motorola’s Cellular phones ©Copyright 2004 D. Simchi-Levi

What are the Causes…. • Single retailer, single manufacturer. – Retailer observes customer demand, Dt. – Retailer orders qt from manufacturer. Dt Retailer qt L Manufacturer ©Copyright 2004 D. Simchi-Levi

Multi-Stage Supply Chains Consider a multi-stage supply chain: – Stage i places order qi to stage i+1. – Li is lead time between stage i and i+1. qo=D Retailer Stage 1 q 1 L 1 Manufacturer Stage 2 q 2 L 2 Supplier Stage 3 ©Copyright 2004 D. Simchi-Levi

Example: Automotive Supply Chain • Custom order takes 60 -70 days • Many different products – High level of demand uncertainty • Dealers’ inventory does not capture demand accurately – GM estimates: “Research shows we lose 10% to 11% of sales because the car is not available” ©Copyright 2004 D. Simchi-Levi

Sequential Optimization vs. Global Optimization Sequential Optimization Procurement Planning Manufacturing Planning Distribution Planning Demand Planning Global Optimization Supply Contracts/Collaboration/Integration/DSS Procurement Planning Manufacturing Planning Distribution Planning Demand Planning Source: Duncan Mc. Farlane ©Copyright 2004 D. Simchi-Levi

Demand Forecast • The three principles of all forecasting techniques: – Forecasts are always wrong – The longer the forecast horizon the worst is the forecast – Aggregate forecasts are more accurate • Risk Pooling ©Copyright 2004 D. Simchi-Levi

A new Supply Chain Paradigm • A shift from a Push System. . . – Production decisions are based on forecast • …to a Push-Pull System – Parts inventory is replenished based on forecasts – Assembly is based on accurate customer demand ©Copyright 2004 D. Simchi-Levi

Business models in the Book Industry • From Push Systems. . . – Barnes and Noble • . . . To Pull Systems – Amazon. com, 1996 -1999 • And, finally to Push-Pull Systems – Amazon. com, 1999 -present • 7 warehouses, 3 M sq. ft. , ©Copyright 2004 D. Simchi-Levi

Business models in the Grocery Industry • From Push Systems. . . – Supermarket supply chain • . . . To Pull Systems – Peapod, 1989 -1999 • Stock outs 8% to 10% • And, finally to Push-Pull Systems – Peapod, 1999 -present • Dedicated warehouses • Stock outs less than 2% ©Copyright 2004 D. Simchi-Levi

e-Business in the Retail Industry • Brick-&-Mortar companies establish Virtual retail stores – Wal-Mart, K-Mart, Barnes and Noble • Use a hybrid approach in stocking – Fast moving/High volume products for local storage – Slow moving/Low volume products for on-line purchase • Channel Conflict Issues ©Copyright 2004 D. Simchi-Levi

Shifting the Push-Pull Boundary: A Case Study • Manufacturer of circuit boards and other hightech products • Sells customized products with high value and short life cycles • Multi-stage BOM – e. g. , copper & fiberglass circuit board enclosure processor • Case study concerns one of 27, 000 SKUs ©Copyright 2004 D. Simchi-Levi

Safety Stock vs. Quoted Lead Time For a given lead-time, the optimized supply chain provides reduced costs For a given cost, the optimized supply chain provides better lead-times ©Copyright 2004 D. Simchi-Levi

Summary of Retailer Information • • Wholesale cost per unit (C): $80 Selling price per unit (S): $125 Salvage value per unit (V): $20 Average demand = 13, 000 units • Should the retailer order more than average demand, less than average demand or exactly average demand? ©Copyright 2004 D. Simchi-Levi

Scenario Analysis • Scenario One: – Suppose you make 12, 000 jackets and demand ends up being 13, 000 jackets. – Profit = 125(12, 000) - 80(12, 000) = $540, 000 • Scenario Two: – Suppose you make 12, 000 jackets and demand ends up being 11, 000 jackets. – Profit = 125(11, 000) - 80(12, 000) + 20(1000) = $435, 000 ©Copyright 2004 D. Simchi-Levi

Supply Contracts (cont. ) • Distributor optimal order quantity is 12, 000 units • Distributor expected profit is $470, 000 • Manufacturer profit is $440, 000 • Supply Chain Profit is $910, 000 –IS there anything that the distributor and manufacturer can do to increase the profit of both? ©Copyright 2004 D. Simchi-Levi

Supply Contracts: Key Insights • Effective supply contracts allow supply chain partners to replace sequential optimization by global optimization • Buy Back and Revenue Sharing contracts achieve this objective through risk sharing ©Copyright 2004 D. Simchi-Levi

Supply Contracts: Case Study • Example: Demand for a movie newly released video cassette typically starts high and decreases rapidly – Peak demand last about 10 weeks • Blockbuster purchases a copy from a studio for $65 and rent for $3 – Hence, retailer must rent the tape at least 22 times before earning profit • Retailers cannot justify purchasing enough to cover the peak demand – In 1998, 20% of surveyed customers reported that they could not rent the movie they wanted ©Copyright 2004 D. Simchi-Levi

Supply Contracts: Case Study • Starting in 1998 Blockbuster entered a revenue sharing agreement with the major studios – Studio charges $8 per copy – Blockbuster pays 30 -45% of its rental income • Even if Blockbuster keeps only half of the rental income, the breakeven point is 6 rental per copy • The impact of revenue sharing on Blockbuster was dramatic – Rentals increased by 75% in test markets – Market share increased from 25% to 31% (The 2 nd largest retailer, Hollywood Entertainment Corp has 5% market share) ©Copyright 2004 D. Simchi-Levi

What are the drawbacks of RS? • Administrative Cost – Lawsuit brought by three independent video retailers who complained that they had been excluded from receiving the benefits of revenue sharing was dismissed (June 2002) – The Walt Disney Company has sued Blockbuster accusing them of cheating its video unit of approximately $120 million under a four year revenue sharing agreement (January 2003) • Impact on sales effort – Retailers have incentive to push products with higher profit margins – Automotive industry: automobile sales depends on retail effort ©Copyright 2004 D. Simchi-Levi

What are the drawbacks of RS? • Retailer may carry substitute or complementary products from other suppliers – One supplier offers revenue sharing while the other does not • Substitute products: retail will push the product with high margin • Complementary products: retailer may discount the product offered under revenue sharing to motivate sales of the other product ©Copyright 2004 D. Simchi-Levi

Other Contracts • Quantity Flexibility Contracts – Supplier provides full refund for returned items as long as the number of returns is no larger than a certain quantity • Sales Rebate Contracts – Supplier provides direct incentive for the retailer to increase sales by means of a rebate paid by the supplier for any item sold above a certain quantity ©Copyright 2004 D. Simchi-Levi