SEM

(Partial Least Square Structural equation modeling)

Introduction
Supply chain is an essential element to operational efficiency, product availability in
market and lastly in profitability of company. Unlike the sales models, for supply
chain quite different type of analysis is done, some of them are:

Segmentation of Goods on basis of their Demands

Inventory Budget Optimization
Forecasting integrated with Inventory Optimization
Vendor management
Drivers of Profitability etc

As often the focus is on operational efficiency the variable which can be are also
very different, A high level glimpse of variable list can consists of:

Inventory Days on Hand (Raw material, Finished Goods, Work in Progress)

Dispatch rate
Defect per million unit sold
Obsolete Inventory
Write off
Dispatch Cycle
Repairs and maintenance
Distribution (Primary & secondary)
Sales and Profitability data etc

There are various statistical techniques available for above solutions like
correspondence Analysis, logistic Regression, Forecasting, structural equation
Models, Graphical probabilistic models etc. Considering the large number of
Variables, complex relationship between variable and Hierarchy of constructs in
occurrence, Very few techniques proves to be useful in solving business problem.
SCOPE OF BLOG
Having introduced various business problem applicable on supply chain in this blog
we attempt to solve one such business problem (Drivers of Profitability) using
Partial least square Structural Equation modeling. In the following section we will
briefly talk about Structural Equation Models, Partial Least Square Structural
Equation Model, and Their usefulness and finally how it helps to find the important
drivers of profitability.
PLS-SEM Introduction
Structural Equation Model (SEM) -refers to a diverse set of unrelated computer
algorithms and statistical methods that fit networks of constructs to data. SEM has
two parts 1. Measurement Model and 2.Path Model. Two types of SEM are popular

-Covarience based and Partial least square SEM. PLS SEM is particularly useful tool
when:

When data size is Small

Latent Constructs(both formative and reflective) are required in the Model
Object of study is exploratory not confirmatory
When the objective is to find out impact of both Individual variable and Latent
Constructs
When there is single variable Constructs in the Model
When there are more than 1 dependent variable in model and there are
relationship between both (eq- Sales and Profitability , Brand Equity and Sales
Value)

This blog wont be covering details on Technical aspects of PLS-SEM but rather on
how business problem can be solved and approach taken in doing so
Business Problem:-Drivers of Profitability (Measurement of Operation
efficiency)
Consider a CPG company which has large presence in market and to measure their
operation efficiency they wants to know:1. What are the important drivers of supply chain and market variables which
impacts overall profitability
2. How these drivers are interrelated , while explaining the Profitability
3. How much Profitability is likely to get impact if one of its drivers increases /
decreases
4. What is the contribution of each supply chain driver etc
Once the business problem is defined, the next step is defining the scope of study
which include:Time Frame of the study: Since the supply chain data is available monthly mostly
along with the market level and financial data. Building model on monthly data
seems to be appropriate.
Selection of Raw variable and other parameter: While listing down various
parameter of Sales, marketing, supply chain and financial there can approximate 40
KPI that can be tested on its impact on target variable (profitability).As we are
interested in building structural model , we take all the independent variable in
model (irrespective to whether they are significant or not)
Expectation of study: whether the objective of the study is exploratory or
confirmatory, whether one dependent variable is need to be tested or multiple
dependent variables is to tested
With Market, Financial and Supply Chain Variables Considered and less time period
data available: - there is a need to

1. Understand which group of variables have similar behavior and can be used
to form a construct (Factor), which can represent these variables altogether.
(which will also reduce multicollinearity among independent variable)
2. How these variable/Constructs can be used to form a Network path explaining
their business dynamics while explaining the variance in the target variable
as well
3. Formation of Initial hypothesis to be tested as per business knowledge on
both measurement model and path model
With the above said requirement two statistical techniques are particularly useful

Bayesian Networks (through Machine learning)

Structural equation Models (PLS SEM , CB SEM)

(For the purpose of this blog we restrain ourselves to PLS SEM)

Data Preparation: Once the independent variables are identified, all the variables
needs to be standardized as to bring all variables to same level as to avoid biasness
among variable, variables which have lots of missing values should be avoided,
missing value imputation can be performed on variable on which 5% cases are
missing
Measurement Model:-Once the data is prepared, formation of constructs is done
which the first part is of PLS SEM (Measurement Model) . For eq sales variable like
(sales volume and sales value) usually have high correlation so instead of using
these parameter separately they can be used to form a constructs as Sales
performance. Similarly instead of treating Raw Inventory, Work in progress
Inventory and finished goods inventory separately, they can be used to form a
construct as Inventory. As construct can be reflective or formative so careful
analysis can be done in order to define constructs. Once these constructs are
defined through bootstrap methods they are evaluated whether they are statistical
significant or not (there are 7-8 parameters on which these measurement models
are evaluated like loadings, weight, signs etc). this is an iterative process and
Finding a stable measurement model is utmost important before moving to path
model as any error which remain in measurement model will increase in path model
and will impact the quality of result.
Path model: Once the Measurement model is validated the path model is prepared
as per initial hypothesis as to see how our initial hypothesis holds true here too
quite tests are done to verify the path model on basis of signs , t statistics and R2,
PLS SEM is particularly useful in finding the impact of exogenous constructs to
endogenous constructs. Based on these results we can change our path model
hypothesis such that variance of data is properly explained. The value of R2 in
supply chain is likely to be lower them the usual R2 that we find in sales analytics.
Since this analysis is exploratory so it helps to form a concrete hypothesis on the
business parameters. Once these results make sense both statistically and
commercially. Further analysis can be done using covariance based structural
equation model on large scale data for the confirmatory study to deduce the drivers
of profitability

Conclusion:- Supply chain analytics is quite different in terms of business problem

and variables as compared to Sales and customer Analytics, with high numbers of
KPI (variables), complex relationship between them , path hypothesis and lesser
number of data points not all statistical techniques can be applied, this blog briefly
explained one such technique (PLS SEM) to solve a business problem (drivers of
profitability) as to form concrete exploratory analysis further steps to verify these
results with confirmatory models can provide useful insights to companies