2

Supply Chain Strategy and

Performance Measures
Learning Objectives

After reading this chapter, you will be able to answer the following questions:

> What are the key supply chain performance measures?

> How does supply chain performance affect financial performance?

> Why is it necessary to ensure a good fit of the business strategy with the supply chain
strategy?

> What are the different dimensions of customer service?

> What are the ways in which a firm can simultaneously reduce supply chain costs and improve
customer service?

Three management students are poring over data that they have recently acquired and want to
incorporate it into their presentation for the next morning. They have been at it for quite some
time, when one of them calls Dominos and orders pizzas for the whole group. The pizzas arrive
in exactly 25 minutes. While they take a break and devour the pizzas, they wonder how Dominos
manages to deliver pizzas within 30 minutes to almost any location in Bangalore even with the
traffic snarls in Bangalore and the unpredictability of the timing and quantity of the pizza that
might be ordered by customers.

Dominos, in its efforts to deal with such unpredictable variables, has set up outlets at 15
strategic locations across Bangalore. It plans its resources (raw material, equipment and human
resource) in such a manner that it can deliver on time to any location in Bangalore. Dominos
business strategy to deliver delicious pizzas in 30 minutes is a reflection of its commitment to
bring fun and excitement into the lives of its customers. It designs and operates its supply chain
so that it can support this business strategy.
In this chapter, the focus is on supply chain strategy and supply chain performance measures.
We discuss customer service and cost trade-offs and suggest ways by which a firm can integrate
business and supply chain strategies. We also look at the various dimensions of customer service
and use two of these, namely, order delivery time and responsiveness, to characterize various
types of supply chains. A framework to analyse the impact of supply chain initiative on business

This chapter is prepared by Prof Rahul Patil, SJMSOM and Prof Janat Shah, Director IIM Udaipur for the
second edition of the Supply Chain Management : Text and Cases book.
performance has been provided. Finally, an approach that can help firms in enhancing their
supply chain performance on an ongoing basis has been suggested.

Supply Chain Performance Measures

Introduction
As name implies, a SC performance measure does a performance evaluation (often concise and
objective) of a supply chain from a specific perspective. A supply chain can quickly and objectively
decide how it has been doing over time and with reference to its competitors by looking at its
performance measures. The measures can also help supply chain managers in discussing and
evaluating different improvement initiatives using a common set of goals. In this Section, we define
and measure different supply chain performance measures. There are many supply chain
performance measures. We first divide these measures into customer service, inventory and supply
chain cost categories. Some measures such as product variety are relevant for all supply chains.
However, not all measures may be relevant for a supply chain. Hence, we first characterize supply
chains into three types as below and define the measures that will be relevant to them under
the above categories.
A critical characteristic of the supply chain is the customer order penetration point or decoupling
point. There are essentially three types of supply chains characterized by the customer order
penetration point: make to stock (MTS), make to order (MTO) and configure to order (CTO). Figure 2.1
is a conceptual representation of these three types of supply chains. If customers expect their order
(an order can either be a formal document or even an informal instruction, e.g., a customer asking a
retailer for a tube of tooth paste is treated as an order) to be fulfilled instantaneously, then the supply
chain is in the MTS business. If the customer gives some time to the focal firm to carry out some
activities before delivery, the supply chain is in the CTO business. If the customer gives enough time
to the focal firm to carry out the complete set of operations (source, make, assemble and deliver)
after placing the order, the supply chain is called MTO. Typically, supply chains in the consumer
products business operate on an MTS basis where the customer expects the products to be on the
shelf at the retailers outlet. Equipment supply chains typically operate with an MTO supply chain
where all the activities are started after getting the order. A firm in the pizza home delivery business
is in the CTO business, because your pizza is configured the way you want, with the toppings of your
choice, using ingredients kept in readiness, prior to an order. CTO is also known as assemble to order
(ATO) or build to order (BTO) business model.

This chapter is prepared by Prof Rahul Patil, SJMSOM and Prof Janat Shah, Director IIM Udaipur for the
second edition of the Supply Chain Management : Text and Cases book.
Figure 2.1 Order penetration point based supply chain typology.

Performance Measures for MTS Supply Chain

Customer Service Measures

In a MTS environment, the customer is impatient and hence a supply chain provides service to a
customer by immediately fulfilling customer demand from its available finished goods inventory. One
dimension of customer service measures attempt to evaluate the ability of the firm to instantaneously
meet customer demand. In MTS distribution channel, following measures are used: case fill rate, line
fill rate and out of stock probability.

Case Fill Rate:

It is a ratio of total number of cases supplied to total number of cases ordered over a chosen period.
Line Fill Rate:

It measures number Of SKUs which were supplied in full or partial in a P.O. or per customer over a
chosen period
Both measures can be computed at different levels: Purchase Order, Customer, region etc.

Example:
Consider a FMCG distributor who supplies to 2 depots. The Table 1 shows depots purchase orders
and the distributors shipment details.

Compute case fill rate, line file rate with partial delivery allowed, line fill rate with full delivery?
This chapter is prepared by Prof Rahul Patil, SJMSOM and Prof Janat Shah, Director IIM Udaipur for the
second edition of the Supply Chain Management : Text and Cases book.
Case Fill (for Dist 23) = Supplied Quantity in Cases / Ordered Quantity in Cases = 185/350 = 52.86%

Line Fill (SKU Fill) Dist 23 with partial delivery allowed: 3 out of 4 SKUs were either supplied in Full or
Partial.
Hence Line Fill for Dist 23 with partial delivery allowed is 3/4 = 75%

Line Fill (SKU Fill) Dist 23 with full delivery: Only 1 out of 4 SKUs were either supplied in Full.
Hence Line Fill for Dist 23 with full delivery is 1/4 = 25%

Out of Stock Probability:

It is ratio of the time for which the product is not available on the shelf to the time for which the store
is open to the customers over a chosen period. A recent study has shown that an average out of stock
probability for retail stores is 8.3%.

Product Variety

The quantum of variety offered by a firm is an important dimension of customer service. In the past
couple of years, a variety explosion has taken place in most product categories. Higher product
variety offers greater choices to the customer who is likely to get a product that fits closest to his or
her actual requirements. Some firms like Dell Computers and National Panasonic go to the extent of
allowing their customers to design their own products. Thus this measure is relevant to all MTS, CTO
and MTO supply chains.

3
99-COLOUR C A M PA I G N BY TVS MOTORS
TVS Motors, a two-wheeler manufacturing company, has been offering the Scooty range of two wheelers for the
young generation. TVS, in its market research, found that colour is the prominent way of self-expression among
women consumers. Based on this finding, TVS recently introduced the 99-colour campaign in select cities with
the intention of attracting young women. The customer can choose from a range of 99 shades, available for a
premium of Rs 1,0001,900. Offering 99 shades can be a supply chain nightmare. TVS has come up with an
innovative way of managing such a wide variety of offering. TVS stocks unpainted panels at the retail outlet.
These unpainted panels are sent to Asian Paints who return the panel, painted in the colour chosen by a
customer, to the retail outlet within 24 hours. So TVS can manage product delivery in 48 hours without
worrying about the large amount of finished stock at the retail outlets.

Inventory Related Measures

MTS supply chain carries finished goods (FG), work in process (WIP) and raw material (RM) inventory.
Different types of measures are used to evaluate their inventory performance: inventory turnover
ratio, raw material, WIP and FG in days and length of supply chain. An accurate method is to record
all types of inventories at all relevant locations to derive measures. It can be time consuming though
ERP systems and data warehouses nowadays can make this task easier compared to the past. We will

This chapter is prepared by Prof Rahul Patil, SJMSOM and Prof Janat Shah, Director IIM Udaipur for the
second edition of the Supply Chain Management : Text and Cases book.
discuss an approximate but a quick method to calculate the measures ( both inventory and supply
chain cost) from financial statements of listed companies. In most countries, it is not difficult to get
financial databases that are reliable. All the listed companies maintain their data on their Web sites
and most countries have an agency that compiles these data and makes it available to interested
parties at a nominal price. For example, India has the Prowess databases, maintained by the
Centre for Monitoring Indian Economy (CMIE), compiled using publicly disclosed financial
performance data.
The relevant expressions (data for which are usually available in databases like Prowess) that
are used in this section are shown in Table 2.2.Using the data presented in Table 2.2, one can
calculate:

Total length of the chain:.The total length of the chain is arrived at by adding up the days of
inventory for raw materials, work in progress and finished goods. The firm that has the minimum total
length of the chain is said to have the best performance.

Calculating the Length of Various Stages of the Chain

The following formulae (terms defined in Tabe 2.2) are used to calculate the length of the various
stages in the supply chain:

DRM, DWIP, DFG = Days of raw material, work in process and finished goods, respectively

DRM = RM 365/CRM,

Table 2.2: Terms directly obtained from the financial statements.

Terms from the income Symb Terms from the balance sheet Symb
and expenditure ol ol
statement
Cost of raw materials* CRM Inventories (inclusive of raw materials, semi- INV
finished goods and finished goods)
Cost of production* CP Raw materials inventory RM
Cost of distribution* DC Semi-finished goods inventory SFG
Cost of sales* CS Finished goods inventory FG
Net sales* NS Account receivables (excluding loans and AR
advances)
Account payables AP

* Data for one financial year.

DWIP = SFG 365/CP,
DFG = FG 365/CS

Total length of chain in days = DRM + DWIP + DFG

This chapter is prepared by Prof Rahul Patil, SJMSOM and Prof Janat Shah, Director IIM Udaipur for the
second edition of the Supply Chain Management : Text and Cases book.
Supply Chain Cost Measures
Internal Supply Chain Management Cost
It is a sum of total inventory carrying costs and the distribution costs (DC). We calculate the internal
supply chain inefficiency ratio as follows:

SCC = DC + INV ICC

where SCC is the supply chain management costs, ICC is the inventory carrying cost rate per year.
The ICC for most firms is estimated to be in the range of 0.150.25. The methodology for estimating
ICC is presented in Chapter 4. In the absence of any data, one can work with an ICC of 0.2.

Efficiency of Supply Chain Management

The internal supply chain inefficiency ratio is a measure of the efficiency of internal supply chain
management. It is a ratio of supply chain costs to net sales

SCI = SCC/NS

and SCI is the supply chain inefficiency ratio and NS is net sales.The supply chain inefficiency ratio
(the lower the better) provides an insight into the internal supply chain management efficiency of the
firm. This measure is termed the supply chain inefficiency ratio since the supply chain cost will be
higher if there are inefficiencies in the system. Firms with efficient supply chain systems will have
relatively lower scores on this performance measure. Note that the cost measures are also relevant in
MTO and CTO supply chains in addition to MTS chains.

Make to Order and Configure to Order Supply Chain Measures

Order Delivery Lead Time

Order delivery time is the time taken by the supply chain to complete all the activities from order
to delivery. This dimension of customer service has a significant impact on the way a supply chain
is designed and operated. Customer expectations on order delivery time could be practically zero,
as in the case of most of FMCG goods, or could be 1 week for certain consumer durables. For
example, a typical customer might expect pizzas to be served in 15 minutes at any pizza outlet,
or expect delivery in 40 minutes if the order has been placed for home delivery. E-retailers like
Fabmart promise to deliver goods within 48 hours at the doorstep of customers located in major
cities. Caterpillar pledges its commitment to customers: service within 48 hours at any place on
earth. For each of these firms, promised order delivery lead time has tremendous implications on
supply chain design and operations.
As shown in Figure 2.3, a typical firm sources material, manufactures components, assembles the
product and delivers the finished product to the end customer, with each of these activities having a

This chapter is prepared by Prof Rahul Patil, SJMSOM and Prof Janat Shah, Director IIM Udaipur for the
second edition of the Supply Chain Management : Text and Cases book.
certain lead time. If we aggregate all the four lead times, we get the supply chain lead time, which is
the total time required for the supply chain to carry out all activities from the beginning to the end.
Unfortunately, for many firms, supply chain lead times and order delivery lead times usually do not
match. Ideally, a firm will prefer to work with a delivery lead time that is larger than the supply chain
lead time. In a competitive market, however, the order delivery lead time is dictated by competitive
offerings and customer needs and the supply chain lead time is usually much longer than the order
delivery lead time. The point at which the customer enters the supply chain (Figure 2.3) is called the
order penetration point. After the order penetration point, all activities do not face any uncertainties
because they are against specific customer orders. All the activities prior to the customer order must
be carried out against forecast and not on actual orders. For example, one wants pizzas to be
delivered within 40 minutes. Obviously the firm cannot procure the material, make the dough and
bake a base in those 40 minutes. A firm in the pizza home delivery business has to forecast likely
demand and execute most of the activities like procurement, preparing the pizza base and making all
the other ingredients ready before the order so that they can satisfy customer demand within 40
minutes. As all activities after the penetration point are carried out against an order, and all activities
prior to the penetration point are carried out against forecast, this point is also known as the
decoupling point. Essentially, the firm has to keep a decoupling stock ready at the customer
penetration point and manage both sides, that is, before and after order penetration point, differently.

Figure 2.3 Interaction between supply chain lead time and delivery lead time.

Delivery Reliability

As discussed in the earlier section, delivery lead time is an important dimension of customer
service, and delivery reliability essentially captures the degree to which a firm is able to service its
customers within the promised delivery time. Delivery reliability measures the fraction of customer
demand that is satisfied within the promised delivery lead time. For firms operating on an MTS
model, the percentage of orders getting served from the stock is known as product availability,
also commonly referred to as service level in supply chain literature. Similarly, for companies
offering products based on the CTO or MTO model, delivery reliability captures the percentage of
orders that are delivered within the promised delivery lead time. Given the nature of demand and
supply uncertainty, it is obviously more expensive to provide higher levels of service. Essentially,
firms have to trade-off inventory costs and stock-out costs to arrive at the optimum service level.
In the MTS business, a firm has to keep higher inventory if it is to offer higher levels of service .
This chapter is prepared by Prof Rahul Patil, SJMSOM and Prof Janat Shah, Director IIM Udaipur for the
second edition of the Supply Chain Management : Text and Cases book.
Firms in the CTO business will have to hold higher inventory before the order penetration point and
after that slack capacity in the system if they want to offer higher delivery reliability to customers .
Firms in the MTO business will have to work with slack capacity in the entire system if they want to
offer high delivery reliability. In general, firms will have to arrive at an optimal trade-off between
cost (costs related to high inventory and slack capacity) and service level while deciding on this
issue. In the industrial products category, performance on the delivery reliability front is monitored
and the supplier is usually chosen based on performance on this front.

SAFEXPRESS: OFFERING TIME-DEFINITE SERVICE FOR

EXPRESS DISTRIBUTION2
Safexpress wanted to start a time-definite service for express distribution in the mid-1990s. Aware of the
poor infrastructure and the multiplicity of check points at state borders, Safexpress knew that time-definite
delivery across India would prove to be a Herculean task. Therefore, before they started the service, they
mapped all the routes and identified all the check points and potential areas where trucks may get delayed.
They have identified 88 delivery gateways, including 44 strategically located hubs so that they can manage
time-definite service at an all-India level. Its entire fleet is equipped with GPS units so that any vehicle can be
tracked with a precision of 50 meters. To ensure that they offer the lowest transit times, they operate 24/7,
365 days a year. Safexpress has identified its key strength as knowledge and understanding of India and
has focused only on domestic business.

Supply Chain Benchmarking

A firm can compare its own performance with that of its competitors and the industry
aggregate in order to ascertain where it stands in terms of supply chain performance. Using
benchmarking data, a firm can also map a supply chain profile that allows it to effectively capture
both the dimensions of time and cost in one diagram. Further, a firm can also compare its own
profile with that of its competitors in order to ascertain where it stands in terms of costs and
length of time in the chain. Benchmarking is a useful tool for comparing the performance of
competing firms so as to identify areas of improvement for further detailed investigation, which
may lead to process improvements. In this section, we have focused on financial benchmarking,
which can help a firm in comparing its supply chain performance with competitors using financial
data. Once a firm has identified performance gaps, it should try and carry out a process
benchmarking exercise. Process benchmarking focuses on the investigation of business processes
of leading firms with the objective of identifying and observing the best practices from one or
more benchmark firms. Rather than re-inventing ideas, process benchmarking focuses on
borrowing ideas from best practice firms.
In this section, we look at an exhaustive list of supply chain performance measures and
demonstrate the significant impact of supply chain performance on business performance using
benchmarking data and also show the methodology for linking the two.

This chapter is prepared by Prof Rahul Patil, SJMSOM and Prof Janat Shah, Director IIM Udaipur for the
second edition of the Supply Chain Management : Text and Cases book.
 Among various sets of supply chain performance measures discussed in the literature, we focus on
a set of performance measures that have been most widely accepted in the industry. The Supply-
Chain Council is an independent, non-profit, global corporation interested in getting the industry to
standardize supply chain terms so that meaningful supply chain benchmarking can be carried out. It
has developed the Supply Chain Operations Reference (SCOR) model as the industry standard for
supply chain management. Supply chain software vendors such as SAP have adopted the SCOR
performance measures in their performance management module. As per the SCOR model, supply
chain performance measures fall under the following four broad categories:

Cost

Assets

Reliability

Flexibility

Further, the SCOR model develops 11 performance measures as shown in Figure 2.7. The Supply-
Chain Council refers to measures related to costs and assets as internal-facing measures, while
reliability and flexibility are termed as customer-facing measures. Typically, a firm offers a bundle
consisting of price, delivery and flexibility to its customers. Price, in competitive markets, is dictated
by the market place. Thus, only delivery- and response-related measures are termed as customer-
facing measures. The performance measures related to assets and costs affect the profitability of
the firm and are, thus, termed as internal-facing measures. The use of standard measures allows
firms to carry out meaningful benchmarking studies.
Benchmarking studies carried out by the Supply-Chain Council have shown that there are
significant differences in performance across firms in various industries. Figure 2.8 shows the
performance of supply chain costs as a percentage of revenue for various industries. The best in the
class firms seem to work with substantially lower supply chain costs (difference of about 56 per cent
of revenue) across industries. These firms also seem to have substantial differences in performance
measures of reliability, assets and flexibility, as shown in Figure 2.9. Such significant differences in
performance also mean that firms seem to follow a wide variety of processes and systems.

This chapter is prepared by Prof Rahul Patil, SJMSOM and Prof Janat Shah, Director IIM Udaipur for the
second edition of the Supply Chain Management : Text and Cases book.
Figure 2.7 SCOR supply chain performance measures.

Source: www.supply-chain.org. Reproduced with permission.

Figure 2.8

Superior performers spend less on supply chain management.

Source: www.supply-chain.org. Reproduced with permission.

Figure 2.9 Comparative performances for consumer package goods.

Source: www.supply-chain.org. Reproduced with permission.

Firms can use SCOR to do competitive benchmarking. Attributes are categorized as superior(S),
advantage (A) and parity (P). This categorization helps firm in managing time and financial resources.

This chapter is prepared by Prof Rahul Patil, SJMSOM and Prof Janat Shah, Director IIM Udaipur for the
second edition of the Supply Chain Management : Text and Cases book.
For example, superior attributes are very important to the firm and hence they are recorded in detail
as shown in Figure 2.10. In this Figure, Reliability is a superior attribute and hence performance is measured up
to level 3. Parity attributes are least important and hence are recorded at aggregate level (Level 1).
S/A
Attribute Level-1 Metric Level-2 Metric Level-3 Metric Summary
/P

Perfect Order
Reliability S
Fulfillment Perfect Order Fulfilment

% Orders % Orders Delivered in

Reliability
Delivered in Full Full

Delivery Item
Reliability
Accuracy Delivery Item Accuracy

Delivery Quantity Delivery Quantity

Reliability
Accuracy Accuracy

Delivery
Reliability Performance to Delivery Performance
Commit Date to Commit Date
External

Reliability Date Achievement Date Achievement

Reliability Location Achievement Location Achievement

Accurate Accurate
Reliability
Documentation Documentation

Shipping Shipping
Reliability
Documentation Accuracy Documentation Accuracy

Billing Documentation Billing Documentation

Reliability
Accuracy Accuracy

Reliability Perfect Condition Perfect Condition

% Orders Received % Orders Received

Reliability
Damage-Free Damage-Free

The attribute categorization also helps in doing benchmarking in a strategy fashion. Performance
on superior attribute is compared with the best in class (superior group) in the industry. Similar logic
is used for other attributes types. This systematic approach helps firms in identifying right
opportunities for improvement as shown in Figure 2.10. For example, reliability (97%) is an S attribute
for the firm and hence is compared with the Superior group (98%). This comparison suggests that
firm needs to increase its reliability performance by 1% to move to the superior league in its business.
Note that without this categorization, firm might have compared its performance with the average
(92%) and may have decided that there is no need to improve its reliability performance and thus
would have made a mistake. Up stream supply chain flexibility (62 days) is a parity attribute and
hence is compared with parity group (80 days). Note that the superior group has a better
performance ( 40 days). Still, the firm is doing well on upstream supply chain flexibility and hence
This chapter is prepared by Prof Rahul Patil, SJMSOM and Prof Janat Shah, Director IIM Udaipur for the
second edition of the Supply Chain Management : Text and Cases book.
there is no need to focus on this front till the parity benchmark changes. Thus, the firm can do
strategic tradeoffs in a better way with this approach.

Attribute Contact S/A/P Metric You Parity Advantage Superior Gap

Reliabilit Perfect = 98% - 97%

Customer S 97% 92% 95% 98%
y Order Fulfillment = 1%

Order
Respons
Customer A Fulfillment Cycle 14 days 8 days 6 days 4 days 8 Days
e
Time

Upstream
Flexibilit
Customer P Supply Chain 62 days 80 days 60 days 40 days 0
y
Flexibility

Supply Chain
Cost Internal P 12.2% 10.8% 10.4% 10.2% 1.4%
Mgmt Cost

Cash-to-Cash
Assets Internal A 35 days 45 days 33 days 20 days 2 Days
Cycle Time

Figure 2.10: Competitive Benchmarking using SCOR Model

SCOR measures, however, do not capture order delivery lead time and measures related to
product variety. So, to that extent, performance measures under the SCOR model do not seem to be
comprehensive. While relating the SCOR model to the cost versus customer service trade-off
framework, we combine costs- and assets-related measures.
Supply chain benchmarking using frameworks like SCOR is difficult to implement in countries in
Asia where data availability is a big problem. Alternatively, one may like to focus on fewer but
important metrics like cost and assets utilization data, for which data are available in financial
statements of listed companies.

Supply Chain Strategy

A firms supply chain strategy should ensure that its supply chain provides superior value to the end
customer in an efficient manner. Value offering (bundling of goods and services) to a customer should
be available at a reasonable price. In almost all product categories, customers want more variety and
quicker services at lower prices. Firms must recognize the nature of trade-offs between customer
service and costs and arrive at an optimal decision on this front. If various processes and decisions
within the chain are not aligned to suit a companys business strategy, it obviously cannot remain
competitive in the long run. The firm has to understand the relationship between business strategy
and supply chain decisions and how different business environments pose different kinds of
challenges to the supply chain.
This chapter is prepared by Prof Rahul Patil, SJMSOM and Prof Janat Shah, Director IIM Udaipur for the
second edition of the Supply Chain Management : Text and Cases book.
Different frameworks have been proposed to chalk out an appropriate supply chain strategy. These
frameworks are based on few fundamentals: customer service and cost trade off, demand
characteristics and demand and supply characteristics. In the subsequent sections, we discuss them
in detail.

Demand Characteristics (Fisher Framework)

Responsiveness captures the firms ability to handle the uncertainty of market demand. Supply
chains have also been characterized on the basis of the nature of demand uncertainty faced by
products in the market place. Based on the nature of demand uncertainty, products can be
classified as functional products or innovative products.
Functional products (grocery) are those that satisfy the basic needs of a customer and therefore
have low variety, stable and predictable demand, long life cycles and low profit margins. Innovative
products (fashion and technology products) are those that try to satisfy a broad range of customers
wants and have the following features: high variety, unstable and very-hard-to-predict demand, short
life cycles, high profit margins and frequent stock-outs and markdowns. See Table 2.1 for details on
the differences of various aspects of demand for different product categories.
Conceptually, the main functions of a supply chain are physical transformation of raw material into
the end product and market mediation. Physical function is the process of converting materials into
parts, then to finished products and then transporting them across the various stages of the chain.
Relevant costs incurred are due to production, transportation and inventory storage. The market
mediation function ensures that the variety of products reaching the market matches the needs of the
customers. Relevant costs incurred are due to demandsupply mismatch, resulting in either
obsolescence or lost sales and dissatisfied customers. In the case of functional products, the focus is
on meeting predictable demand cost effectively, while for innovative products, the focus is on
meeting unpredictable demand cost effectively.

Table 2.1: Functional versus innovative products: differences in demand.

Aspects of demand Functional (predictable Innovative (unpredictable

demand) demand)
Product life cycle More than 2 years 3 months to 1 year
Contribution margin (% of sales 520% 2060%
price)
Product variety Low (1020 variants per High (often thousands of variants
category) per category)
Likely forecast error 520% 40100%
Average stock-out rate 12% 1040%
End-of-season markdown 0% 1030%

Source: Adapted from M. L. Fisher, What Is the Right Supply Chain for Your Product? Harvard Business Review (MarchApril
1997): 8393. 1997 by the Harvard Business School Publishing Corporation. All rights reserved.

This chapter is prepared by Prof Rahul Patil, SJMSOM and Prof Janat Shah, Director IIM Udaipur for the
second edition of the Supply Chain Management : Text and Cases book.
 For functional products, low stock-out rate and low margins suggest that the physical function is
crucial for the supply chain of these products. Hence, for the supply chain of functional products,
achieving physical efficiency is a critical success factor. High stock-out rates and high margins for
innovative products suggest that the market mediation function is a crucial factor in the supply chain.
Thus, it is evident that functional products need efficient supply chains, while innovative products
need responsive chains.

1
I N V E N T O RY WRITE-OFF BY CISCO
Cisco, the global market leader in networking equipments like routers and switches, had seen more than 50 per
cent growth rate in 1999 and 2000. A similar growth trend had been forecast for 2001. Unfortunately, there was
a downturn in the economy and Cisco took a long time to respond to the change in the economic environment.
During the economic downturn, other networking companies cut back on inventory while Cisco decided to build
inventory. Cisco had entered into long-term commitments with its manufacturing partners and certain key
component makers. Cisco took sometime to recognize the downturn and by the time Cisco started putting
brakes on its supply chain, it was quite late. Cisco ended up writing off inventory worth $2.2 billion. Its stock
price plunged from $83 to $13.

Most firms often fail to take this into account when they introduce changes in their product
lines/offerings. For example, firms operating in the innovative products space would have usually
started their business with functional products and therefore would have focused on logistics
efficiencies. As they grew, they would have introduced innovative products to compete effectively in
the market but may not have changed their supply chain structure and processes. This would
naturally result in a mismatch between the product characteristics and the supply chain. As shown
in Figure 2.6, firms must ensure an appropriate match between the type of supply chain and the
nature of product characteristics. Demand unpredictability could occur either on the volume side or
on the product-mix side. In some instances, it is difficult to estimate the overall volume of demand
itself, resulting in volume uncertainty, while in others, the overall volume is predictable but
predicting demand at the individual variant level is extremely difficult, leading to product-mix
uncertainty. For example, when it comes to new technology products, firms face volume uncertainty.
While in the case of some innovative products, where the overall category is at a mature stage
(garments, jewellery), firms usually face product-mix uncertainty. Within the life cycle of products,
they are likely to face high volume uncertainty at the growth stage. Thus, during the growth stage
firms need to work with a responsive chain, and over a period of time, at the mature stage, firms
require an efficient chain.

This chapter is prepared by Prof Rahul Patil, SJMSOM and Prof Janat Shah, Director IIM Udaipur for the
second edition of the Supply Chain Management : Text and Cases book.
Figure 2.6 Matching supply chain design with nature of products.

Source: M. L. Fisher, What Is the Right Supply Chain for Your Product? Harvard Business Review (MarchApril 1997): 8393.
Reprinted with permission. 1997 by the Harvard Business School Publishing Corporation. All rights reserved.

For innovative products, like fashion products, demand is inherently unpredictable at the final
customer end. Risk mitigation strategies involve buy back contracts, postponements or innovations in
a supply chain design that enhance flexibility. These issues are discussed extensively in Part IV.
Although, in theory, functional products ought not to face much demand uncertainty, in real life
manufacturers of functional products such as food products do see a large variability. In a typical
supply chain, it has been observed that for functional products, as we move down from retailers to
wholesalers and on to manufacturers, each stage in the chain distorts demand and the variability in
demand keeps increasing as we move down the chain. Thus, though variability can be quite low at
the end (final customer), a manufacturer usually sees high demand variability at his end. In Chapter 9
(Supply Chain Integration), the ways through which supply chains can avoid these distortions in the
chain are discussed.

Demand and Supply Characteristics (Lee Framework)

So far we have focused our attention on demand uncertainty. However, a firm could also face
uncertainty on account of supply in the chain. The terrorist attack in September 2001, the earthquake
in Japan, have now forced some firms with exposure to this risk to look at their supply chain
vulnerabilities, and firms have realized that they need to focus on both demand uncertainty and
supply chain disruptions. In addition to such events, some firms may face supply uncertainty because
of quality problems in manufacturing, uncertainties in transportation and evolving processes (that may
make current ones obsolete). For example, in hydropower industry, the supply depends upon the rains
and thus is uncertain. Hau Lee proposed a proposed framework that considers both supply and
demand characteristics. Four strategies: efficient, responsive, risk hedging and agile supply chains are
proposed as shown in Figure 2.7.

Supply Uncertainty Demand Uncertainty

Low ( Functional Products) High ( Innovative Products)
Low (Stable Process) Efficient Responsive

This chapter is prepared by Prof Rahul Patil, SJMSOM and Prof Janat Shah, Director IIM Udaipur for the
second edition of the Supply Chain Management : Text and Cases book.
High ( Evolving , Unstable Risk Hedging Agile
Process)
Figure 2.7 : Matching strategies to supply and demand uncertainty.

First two strategies (efficient and responsive) are similar to the two strategies from the Fishers
framework which assumes a stable and low uncertainty supply process.
When supply is unstable and evolving, a risk hedging strategy is appropriate for functional
products. Risk hedging can be implemented in a couple of ways. Safety stock needs to be added to
handle supply yield uncertainty and lead time uncertainty. This will bring inventory to appropriate
levels and will not affect the order fulfilment process due to product shortages. Appropriate number of
suppliers also needs to identified by the supply chain in a proactive manner. This may increase the
sourcing cost but will create back ups in the case of a failure. We will discuss relevant inventory
models in Part II. Traditional view of supplier development is also used to reduce supply uncertainty
itself. Internet can also used under this strategy to provide real time information about the supply to
take timely actions.
Firms facing both supply and demand uncertainty can use a right mix of both responsive and risk
hedging strategies to manage their supply chains. This bundle of actions is also called as agile
strategy. We discuss the relevant concepts and challenges in managing supply chain disruptions in
Part IV. Firms that have configured their supply chain design and operations to handle high levels of
demand uncertainty and supply chain disruptions effectively are known as firms with agile supply
chains.

Harvard Business Review (October 2004): 114121.

This chapter is prepared by Prof Rahul Patil, SJMSOM and Prof Janat Shah, Director IIM Udaipur for the
second edition of the Supply Chain Management : Text and Cases book.