9 Supply Chain Design

For Operations Management, 9e by

PowerPoint Slides
Krajewski/Ritzman/Malhotra
by Jeff Heyl 2010 Pearson Education
Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall. 91
What is a Supply Chain?
A supply chain is the system of organizations, people,
activities, information and resources involved in
moving a product or service from supplier to
customer.
Supply chain activities transform raw materials and
components into a finished product that is delivered
to the end customer.

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Supply Chain

Supplier Manufacturer Distributor Retailer Customers

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Supply Chain Management
Supply Chain Management is
the design and management of processes
across organizational boundaries
with the goal of matching supply and demand
in the most cost effective way.

Supply Demand

Mission impossible: Matching Supply and Demand

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Supply Chains

Flowers: Arrangement
Packaging
Local/International materials

Maintenance FedEx delivery Local delivery Internet

services service service service

Flowers-on-Demand florist

Home Commercial
customers customers

Figure 9.2 Supply Chain for a Florist

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Supply Chains

Raw
Tier 3 Poland USA Canada Australia Malaysia
materials

Tier 2 Germany Mexico USA China Components

Major
Tier 1 Germany Mexico USA
subassemblies

Manufacturer
Assembly
Ireland

Distribution
USA Ireland
centers

East Coast West Coast East Europe West Europe Retail

Figure 9.2 Supply Chain for a Manufacturing Firm

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Drivers of Supply Chain Performance
Facilities
places where inventory is stored, assembled, or fabricated
production sites and storage sites
Inventory
raw materials, WIP, finished goods within a supply chain
inventory policies
Transportation
moving inventory from point to point in a supply chain
combinations of transportation modes and routes
Information
data and analysis regarding inventory, transportation, facilities throughout the supply
chain
potentially the biggest driver of supply chain performance
Sourcing
functions a firm performs and functions that are outsourced
Pricing
Price associated with goods and services provided by a firm to the supply chain

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A Framework for
Structuring Drivers

Competitive Strategy

Supply Chain
Strategy
Efficiency Responsiveness
Supply chain structure

Logistical Drivers

Facilities Inventory Transportation

Information Sourcing Pricing

Cross Functional Drivers

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Obstacles to Achieving
Strategic Fit
Increasing variety of products
Decreasing product life cycles
Increasingly demanding customers
Fragmentation of supply chain ownership
Globalization
Difficulty executing new strategies

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Supply Chain Design

Inefficient
supply chain
operations Area of
improved
operations
Total costs

Reduce costs
New supply chain
efficiency curve with
changes in design
and execution

Improve
perform-
ance

Supply chain performance

Figure 9.1 Supply Chain Efficiency Curve

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Supply Chain Design

The goal is to reduce costs as well increase

performance.
Supply chains must be managed to coordinate the
inputs with the outputs in a firm to achieve the
appropriate competitive priorities of the firm.
The Internet offers firms an alternative to
traditional methods for managing the supply
chain.
A supply chain strategy is essential for service as
well as manufacturing firms.

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Supply Chains

Every firm or organization is a member of some

supply chain

Services
Provide support for the essential elements of various
services the firm delivers

Manufacturing
Control inventory by managing the flow of materials
Suppliers identified by position in supply chain tiers
Suppliers and customers

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Inventory and Supply Chains

Input flow of materials

Inventory level

Figure 9.4 Creation of

Inventory

Scrap flow

Output flow of materials

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Inventory and Supply Chains

Balance the advantages and

disadvantages

Pressures for small inventories

Inventory holding cost
Cost of capital
Storage and handling costs
Taxes, insurance, and shrinkage

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Inventory and Supply Chains

Pressures for large inventories

Customer service
Ordering cost
Setup cost
Labor and equipment utilization
Transportation cost
Payments to suppliers

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Types of Inventory

Three aggregate categories

Raw materials
Work-in-process
Finished goods

Classified by how it is created

Cycle inventory
Safety stock inventory
Anticipation inventory
Pipeline inventory

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Types of Inventory

Figure 9.5 Inventory at Successive Stocking Points

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Cycle Inventory

Lot sizing principles

1. The lot size, Q, varies directly with the elapsed
time (or cycle) between orders.

2. The longer the time between orders for a

given item, the greater the cycle inventory
must be.
Q+0 Q
Average cycle inventory = =
2 2

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Safety Stock and Anticipation
Inventory

Safety Stock inventory

- Protects against uncertainties in
demand, lead time, and supply changes

Anticipation inventory
- Used to absorb uneven rates of demand
or supply
- Predictable, seasonal demand patterns
lend themselves well to the use of
anticipation inventory

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Pipeline Inventory

Pipeline inventory

Average demand during lead time = DL

Average demand per period = d
Number of periods in the items lead time = L

Pipeline inventory = DL = dL

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Estimating Inventory Levels
EXAMPLE 9.1
A plant makes monthly shipments of electric drills to
a wholesaler in average lot sizes of 280 drills. The
wholesalers average demand is 70 drills a week, and
the lead time from the plant is 3 weeks. The
wholesaler must pay for the inventory from the
moment the plant makes a shipment. If the
wholesaler is willing to increase its purchase
quantity to 350 units, the plant will give priority to the
wholesaler and guarantee a lead time of only 2
weeks. What is the effect on the wholesalers cycle
and pipeline inventories?

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Estimating Inventory Levels
SOLUTION
The wholesalers current cycle and pipeline inventories are

Q
Cycle inventory = = 140 drills
2

Pipeline inventory = DL = dL = (70 drills/week)(3 weeks)

= 210 drills

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Estimating Inventory Levels

1. Enter the average lot size, average demand during a period,

and the number of periods of lead time:

Average lot size 350

Average demand 70
Lead time 2

2. To compute cycle inventory, simply divide average lot size

by 2. To compute pipeline inventory, multiply average
demand by lead time

Cycle inventory 175

Pipeline inventory 140

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Measures of Supply Chain
Performance
Inventory measures

Average Number of Number of

Value of Value of
aggregate units of item units of item
= each unit + each unit
inventory A typically B typically
of item A of item B
value on hand on hand

Average aggregate inventory value

Weeks of supply =
Weekly sales (at cost)

Annual sales (at cost)

Inventory turnover =
Average aggregate inventory value

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Calculating Inventory Measures

EXAMPLE 9.2
The Eagle Machine Company averaged $2 million in
inventory last year, and the cost of goods sold was
$10 million. Figure 9.7 shows the breakout of raw
materials, work-in-process, and finished goods
inventories. The best inventory turnover in the
companys industry is six turns per year. If the
company has 52 business weeks per year, how many
weeks of supply were held in inventory? What was
the inventory turnover? What should the company
do?

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Calculating Inventory Measures

Figure 9.7 Calculating Inventory Measures

Using Inventory Estimator Solver

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Calculating Inventory Measures

SOLUTION
The average aggregate inventory value of $2 million translates
into 10.4 weeks of supply and 5 turns per year, calculated as
follows:

$2 million
Weeks of supply = = 10.4 weeks
($10 million)/(52 weeks)

$10 million
Inventory turns = = 5 turns/year
$2 million

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Application 9.1
A recent accounting statement showed total inventories (raw
materials + WIP + finished goods) to be $6,821,000. This years
cost of goods sold is $19.2 million. The company operates 52
weeks per year. How many weeks of supply are being held?
What is the inventory turnover?

Average aggregate inventory value

Weeks of supply =
Weekly sales (at cost)

$6,821,000
= = 18.5 weeks
($19,200,000)/(52 weeks)

$19,200,000
Inventory turnover = = 2.8 turns
$6,821,000

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Measures of Supply Chain
Performance

Financial measures

Total revenue
Cost of goods sold
Operating expenses
Cash flow
Working capital
Return on assets

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Measures of Supply Chain
Performance
Total revenue Figure 9.8 How Supply Chain Decisions Can Affect ROA
Increase sales through
better customer service

Cost of goods sold Net income

Reduce costs of Improve profits with
transportation and greater revenue and
purchased materials lower costs

Operating expenses
Reduce fixed expenses by Return on assets
reducing overhead (ROA)
associated with supply
chain operations Increase ROA with
higher net income and
Working capital fewer total assets
Reduce working capital
Net cash flows by reducing inventory
investment, lead times,
Improve positive cash flows and backlogs
by reducing lead times and Total assets
backlogs
Achieve the same or
better performance
Fixed assets with fewer assets
Inventory Reduce the number of
Increase inventory turnover warehouses through
improved supply chain
design

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Mass Customization

Competitive advantages
Managing customer relationships
Eliminate finished goods inventory
Increased perceived value of services or
products
Supply chain design for mass
customization
Assemble-to-order strategy
Modular design
Postponement

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Outsourcing Processes

Make-or-buy decision

Vertical integration
Backward integration
Forward integration

Outsourcing
Offshoring

Benefits to outsourcing
Pitfalls to outsourcing

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Using Break-Even Analysis
EXAMPLE 9.3
Thompson manufacturing produces industrial scales
for the electronics industry. Management is
considering outsourcing the shipping operation to a
logistics provider experienced in the electronics
industry. Thompsons annual fixed costs of the
shipping operation are $1,500,000, which includes
costs of the equipment and infrastructure for the
operation. The estimated variable cost of shipping
the scales with the in-house operation is $4.50 per
ton-mile. If Thompson outsourced the operation to
Carter Trucking, the annual fixed costs of the
infrastructure and management time needed to
manage the contract would be $250,000. Carter
would charge $8.50 per ton-mile. What is the break-
even quantity?
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Solved Problem 2
A firms cost of goods sold last year was $3,410,000, and the
firm operates 52 weeks per year. It carries seven items in
inventory: three raw materials, two work-in-process items, and
two finished goods. The following table contains last years
average inventory level for each item, along with its value.

a. What is the average Category Part Average Unit Value

aggregate inventory Number Level
value? Raw materials 1 15,000 $ 3.00
2 2,500 5.00
b. How many weeks of
3 3,000 1.00
supply does the firm
Work-in-process 4 5,000 14.00
maintain?
5 4,000 18.00
c. What was the Finished goods 6 2,000 48.00
inventory turnover 7 1,000 62.00
last year?

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Solved Problem 2
SOLUTION
a.
Part Number Average Level Unit Value Total Value
1 15,000 $ 3.00 =
2 2,500 5.00 =
3 3,000 1.00 =
4 5,000 14.00 =
5 4,000 18.00 =
6 2,000 48.00 =
7 1,000 62.00 =
Average aggregate inventory value =

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Solved Problem 2
SOLUTION
a.
Part Number Average Level Unit Value Total Value
1 15,000 $ 3.00 = $ 45,000
2 2,500 5.00 = 12,500
3 3,000 1.00 = 3,000
4 5,000 14.00 = 70,000
5 4,000 18.00 = 72,000
6 2,000 48.00 = 96,000
7 1,000 62.00 = 62,000
Average aggregate inventory value = $360,500

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Solved Problem 2
b. Average weekly sales at cost = $3,410,000/52 weeks
= $65,577/week

Average aggregate inventory value

Weeks of supply =
Weekly sales (at cost)
$360,500
= = 5.5 weeks
$65,577

Annual sales (at cost)

c. Inventory turnover =
Average aggregate inventory value

$3,410,000
= = 9.5 turns
$360,500

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