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Technology And Information Management

Supply Chain Management STRATEGY, PLANNING, AND OPERATION

Fi f t h E d i t i o n

Sunil Chopra Kellogg School of Management

Peter Meindl Kepos Capital

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Library of Congress Cataloging-in-Publication Data

Chopra, Sunil, Supply chain management : strategy, planning, and operation / Sunil Chopra, Peter Meindl.—5th ed.

p. cm. ISBN-13: 978-0-13-274395-2 (alk. paper) ISBN-10: 0-13-274395-7 (alk. paper)

1. Marketing channels—Management. 2. Delivery of goods—Management. 3. Physical distribution of goods— Management. 4. Customer services—Management. 5. Industrial procurement. 6. Materials management. I. Meindl, Peter. II. Title. HF5415.13.C533 2013 658.7—dc23

2011037269

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Dedication

I would like to thank my colleagues at Kellogg for all that I have learned from them about logistics and supply chain management. I am grateful for the love and encouragement my parents, Krishan and Pushpa, and sisters, Sudha and

Swati, have always provided during every endeavor in my life. I thank my children, Ravi and Rajiv, for the joy they have brought me. Finally, none of this would have been possible without the constant love, caring, and support of my

wife, Maria Cristina.

—Sunil Chopra

I would like to thank three mentors—Sunil Chopra, Hau Lee, and Gerry Lieberman—who have taught me a great deal. Thank you also to my parents and sister for their love, and to my sons, Jamie and Eric, for making me smile and teaching me what life is truly all about. Most important, I thank my wife,

Sarah, who makes life wonderful and whom I love with all of my heart.

—Pete Meindl

ABOUT THE AUTHORS

SUNIL CHOPRA

Sunil Chopra is the IBM Distinguished Professor of Operations Management and Information Systems at the Kellogg School of Management. He has served as the interim dean and senior associate dean for curriculum and teaching, and the codirector of the MMM program, a joint dual-degree program between the Kellogg School of Management and the McCormick School of Engineering at Northwestern University. He has a Ph.D. in operations research from SUNY at Stony Brook. Prior to joining Kellogg, he taught at New York University and spent a year at IBM Research.

Professor Chopra’s research and teaching interests are in supply chain and logistics management, operations management, and the design of telecommunication networks. He has won several teaching awards at the MBA and Executive programs of Kellogg. He has authored more than 40 papers and two books.

He has been a department editor for Management Science and an associate editor for Manufacturing & Service Operations Management, Operations Research, and Decision Sciences Journal. His recent research has focused on understanding supply chain risk and devising effective risk mitigation strategies. He has also consulted for several firms in the area of supply chain and operations management.

PETER MEINDL

Peter Meindl is with Kepos Capital. Previously, he was a research officer with Barclays Global Investors, a consultant with the Boston Consulting Group and Mercer Management Consulting, and the director of strategy with i2 Technologies. He holds a Ph.D., M.S., B.S., and B.A. from Stanford, and an M.B.A. from the Kellogg School at Northwestern.

The first edition of this book won the prestigious Book of the Year award in 2002 from the Institute of Industrial Engineers.

CONTENTS

Preface x

Part I Building a Strategic Framework to Analyze Supply Chains

Chapter 1 UNDERSTANDING THE SUPPLY CHAIN 1 1.1 What Is a Supply Chain? 1

1.2 The Objective of a Supply Chain 3

1.3 The Importance of Supply Chain Decisions 4

1.4 Decision Phases in a Supply Chain 6

1.5 Process Views of a Supply Chain 8

1.6 Examples of Supply Chains 13

1.7 Summary of Learning Objectives 17 Discussion Questions 17 • Bibliography 18

Chapter 2 SUPPLY CHAIN PERFORMANCE: ACHIEVING STRATEGIC FIT AND SCOPE 19 2.1 Competitive and Supply Chain Strategies 19

2.2 Achieving Strategic Fit 21

2.3 Expanding Strategic Scope 32

2.4 Challenges to Achieving and Maintaining Strategic Fit 34

2.5 Summary of Learning Objectives 36 Discussion Questions 36 • Bibliography 37

Chapter 3 SUPPLY CHAIN DRIVERS AND METRICS 38 3.1 Financial Measures of Performance 38

3.2 Drivers of Supply Chain Performance 41

3.3 Framework for Structuring Drivers 43

3.4 Facilities 44

3.5 Inventory 47

3.6 Transportation 49

3.7 Information 51

3.8 Sourcing 54

3.9 Pricing 56

3.10 Summary of Learning Objectives 58 Discussion Questions 59 • Bibliography 59

� CASE STUDY: Seven-Eleven Japan Co. 60 � CASE STUDY: Financial Statements for Wal-Mart Stores Inc. 66

iv

Part II Designing the Supply Chain Network

Chapter 4 DESIGNING DISTRIBUTION NETWORKS AND APPLICATIONS TO ONLINE SALES 68 4.1 The Role of Distribution in the Supply Chain 68

4.2 Factors Influencing Distribution Network Design 69

4.3 Design Options for a Distribution Network 73

4.4 Online Sales and the Distribution Network 86

4.5 Distribution Networks in Practice 99

4.6 Summary of Learning Objectives 100 Discussion Questions 101 • Bibliography 101

� CASE STUDY: Blue Nile and Diamond Retailing 102

Chapter 5 NETWORK DESIGN IN THE SUPPLY CHAIN 108 5.1 The Role of Network Design in the Supply Chain 108

5.2 Factors Influencing Network Design Decisions 109

5.3 Framework for Network Design Decisions 114

5.4 Models for Facility Location and Capacity Allocation 116

5.5 Making Network Design Decisions in Practice 132

5.6 Summary of Learning Objectives 133 Discussion Questions 134 • Exercises 134 • Bibliography 139

� CASE STUDY: Managing Growth at SportStuff.com 139 � CASE STUDY: Designing the Production Network at CoolWipes 141

Chapter 6 DESIGNING GLOBAL SUPPLY CHAIN NETWORKS 143 6.1 The Impact of Globalization on Supply Chain Networks 143

6.2 The Offshoring Decision: Total Cost 145

6.3 Risk Management in Global Supply Chains 148

6.4 Discounted Cash Flows 152

6.5 Evaluating Network Design Decisions Using Decision Trees 153

6.6 To Onshore or Offshore: Evaluation of Global Supply Chain Design Decisions Under Uncertainty 161

6.7 Making Global Supply Chain Design Decisions Under Uncertainty in Practice 170

6.8 Summary of Learning Objectives 170 Discussion Questions 171 • Exercises 171 • Bibliography 173

� CASE STUDY: BioPharma, Inc. 174 � CASE STUDY: The Sourcing Decision at Forever Young 176

Part III Planning and Coordinating Demand and Supply in a Supply Chain

Chapter 7 DEMAND FORECASTING IN A SUPPLY CHAIN 178 7.1 The Role of Forecasting in a Supply Chain 178

7.2 Characteristics of Forecasts 179

Contents v

7.3 Components of a Forecast and Forecasting Methods 180

7.4 Basic Approach to Demand Forecasting 181

7.5 Time-Series Forecasting Methods 183

7.6 Measures of Forecast Error 193

7.7 Selecting the Best Smoothing Constant 195

7.8 Forecasting Demand at Tahoe Salt 197

7.9 The Role of IT in Forecasting 203

7.10 Risk Management in Forecasting 204

7.11 Forecasting in Practice 205

7.12 Summary of Learning Objectives 205 Discussion Questions 206 • Exercises 206 • Bibliography 208

� CASE STUDY: Specialty Packaging Corporation, Part A 208

Chapter 8 AGGREGATE PLANNING IN A SUPPLY CHAIN 211 8.1 The Role of Aggregate Planning in a Supply Chain 211

8.2 The Aggregate Planning Problem 213

8.3 Aggregate Planning Strategies 215

8.4 Aggregate Planning Using Linear Programming 216

8.5 Aggregate Planning in Excel 224

8.6 Building a Rough Master Production Schedule 226

8.7 The Role of IT in Aggregate Planning 227

8.8 Implementing Aggregate Planning in Practice 228

8.9 Summary of Learning Objectives 228 Discussion Questions 229 • Exercises 229 • Bibliography 231

� CASE STUDY: Specialty Packaging Corporation, Part B 231

Chapter 9 SALES AND OPERATIONS PLANNING: PLANNING SUPPLY AND DEMAND IN A SUPPLY CHAIN 234 9.1 Responding to Predictable Variability in the Supply Chain 234

9.2 Managing Supply 235

9.3 Managing Demand 237

9.4 Implementing Sales and Operations Planning in Practice 244

9.5 Summary of Learning Objectives 245 Discussion Questions 245 • Exercises 246 • Bibliography 248

� CASE STUDY: Mintendo Game Girl 248

Chapter 10 COORDINATION IN A SUPPLY CHAIN 250 10.1 Lack of Supply Chain Coordination and the Bullwhip Effect 250

10.2 The Effect on Performance of Lack of Coordination 252

10.3 Obstacles to Coordination in a Supply Chain 254

10.4 Managerial Levers to Achieve Coordination 258

10.5 Continuous Replenishment and Vendor-Managed Inventories 263

10.6 Collaborative Planning, Forecasting, and Replenishment 264

vi Contents

10.7 Achieving Coordination in Practice 267

10.8 Summary of Learning Objectives 269 Discussion Questions 269 • Bibliography 270

Part IV Planning and Managing Inventories in a Supply Chain

Chapter 11 MANAGING ECONOMIES OF SCALE IN A SUPPLY CHAIN: CYCLE INVENTORY 271 11.1 The Role of Cycle Inventory in a Supply Chain 271

11.2 Estimating Cycle Inventory–Related Costs in Practice 274

11.3 Economies of Scale to Exploit Fixed Costs 276

11.4 Economies of Scale to Exploit Quantity Discounts 289

11.5 Short-Term Discounting: Trade Promotions 300

11.6 Managing Multiechelon Cycle Inventory 305

11.7 Summary of Learning Objectives 307 Discussion Questions 308 • Exercises 308 • Bibliography 310

� CASE STUDY: Delivery Strategy at MoonChem 311 Appendix 11A: Economic Order Quantity 313

Chapter 12 MANAGING UNCERTAINTY IN A SUPPLY CHAIN: SAFETY INVENTORY 314 12.1 The Role of Safety Inventory in a Supply Chain 314

12.2 Determining the Appropriate Level of Safety Inventory 316

12.3 Impact of Supply Uncertainty on Safety Inventory 327

12.4 Impact of Aggregation on Safety Inventory 329

12.5 Impact of Replenishment Policies on Safety Inventory 341

12.6 Managing Safety Inventory in a Multiechelon Supply Chain 344

12.7 The Role of IT in Inventory Management 345

12.8 Estimating and Managing Safety Inventory in Practice 346

12.9 Summary of Learning Objectives 347 Discussion Questions 348 • Exercises 348 • Bibliography 351

� CASE STUDY: Managing Inventories at ALKO Inc. 351 � CASE STUDY: Should Packaging be Postponed to the DC? 353

Appendix 12A: The Normal Distribution 354

Appendix 12B: The Normal Distribution in Excel 355

Appendix 12C: Expected Shortage Cost per Cycle 356

Appendix 12D: Evaluating Safety Inventory for Slow-Moving Items 357

Chapter 13 DETERMINING THE OPTIMAL LEVEL OF PRODUCT AVAILABILITY 358 13.1 The Importance of the Level of Product Availability 358

13.2 Factors Affecting Optimal Level of Product Availability 359

13.3 Managerial Levers to Improve Supply Chain Profitability 370

Contents vii

13.4 Setting Product Availability for Multiple Products Under Capacity Constraints 384

13.5 Setting Optimal Levels of Product Availability in Practice 386

13.6 Summary of Learning Objectives 387 Discussion Questions 388 • Exercises 388 • Bibliography 390

Appendix 13A: Optimal Level of Product Availability 391

Appendix 13B: An Intermediate Evaluation 391

Appendix 13C: Expected Profit from an Order 392

Appendix 13D: Expected Overstock from an Order 393

Appendix 13E: Expected Understock from an Order 394

Appendix 13F: Simulation Using Spreadsheets 394

Part V Designing and Planning Transportation Networks

Chapter 14 TRANSPORTATION IN A SUPPLY CHAIN 397 14.1 The Role of Transportation in a Supply Chain 397

14.2 Modes of Transportation and Their Performance Characteristics 399

14.3 Transportation Infrastructure and Policies 403

14.4 Design Options for a Transportation Network 406

14.5 Trade-Offs in Transportation Design 411

14.6 Tailored Transportation 420

14.7 The Role of IT in Transportation 422

14.8 Risk Management in Transportation 423

14.9 Making Transportation Decisions in Practice 424

14.10 Summary of Learning Objectives 424 Discussion Questions 425 • Exercises 425 • Bibliography 426

� CASE STUDY: Designing the Distribution Network for Michael’s Hardware 426

Part VI Managing Cross-Functional Drivers in a Supply Chain

Chapter 15 SOURCING DECISIONS IN A SUPPLY CHAIN 428 15.1 The Role of Sourcing in a Supply Chain 428

15.2 In-House or Outsource 430

15.3 Third- and Fourth-Party Logistics Providers 436

15.4 Using Total Cost to Score and Assess Suppliers 439

15.5 Supplier Selection—Auctions and Negotiations 441

15.6 Contracts, Risk Sharing, and Supply Chain Performance 444

15.7 Design Collaboration 455

15.8 The Procurement Process 457

15.9 Designing a Sourcing Portfolio: Tailored Sourcing 459

15.10 Risk Management in Sourcing 460

15.11 Making Sourcing Decisions in Practice 461

viii Contents

Contents ix

15.12 Summary of Learning Objectives 462 Discussion Questions 463 • Exercises 463 • Bibliography 464

Chapter 16 PRICING AND REVENUE MANAGEMENT IN A SUPPLY CHAIN 466 16.1 The Role of Pricing and Revenue Management in a Supply

Chain 466

16.2 Pricing and Revenue Management for Multiple Customer Segments 468

16.3 Pricing and Revenue Management for Perishable Assets 475

16.4 Pricing and Revenue Management for Seasonal Demand 481

16.5 Pricing and Revenue Management for Bulk and Spot Contracts 481

16.6 Using Pricing and Revenue Management in Practice 483

16.7 Summary of Learning Objectives 485 Discussion Questions 485 • Exercises 486 • Bibliography 487

Chapter 17 INFORMATION TECHNOLOGY IN A SUPPLY CHAIN 488 17.1 The Role of IT in a Supply Chain 488

17.2 The Supply Chain IT Framework 490

17.3 Customer Relationship Management 491

17.4 Internal Supply Chain Management 492

17.5 Supplier Relationship Management 493

17.6 The Transaction Management Foundation 494

17.7 The Future of IT in the Supply Chain 495

17.8 Risk Management in IT 496

17.9 Supply Chain IT in Practice 497

17.10 Summary of Learning Objectives 498 Discussion Questions 498 • Bibliography 498

Chapter 18 SUSTAINABILITY AND THE SUPPLY CHAIN 500 18.1 The Role of Sustainability in a Supply Chain 500

18.2 The Tragedy of the Commons 502

18.3 Key Metrics for Sustainability 504

18.4 Sustainability and Supply Chain Drivers 505

18.5 Closed-Loop Supply Chains 508

18.6 Summary of Learning Objectives 508 Discussion Questions 509 • Bibliography 509

Subject Index 510

x

PREFACE

This book is targeted toward an academic as well as a practitioner audience. On the academic side, it should be appropriate for M.B.A. students, engineering master’s students, and senior undergraduate students interested in supply chain management and logistics. It should also serve as a suitable reference for both concepts as well as methodology for practitioners in consulting and industry.

NEW TO THIS EDITION

The fifth edition has focused on building on the changes that were incorporated in the fourth edition. We have also added changes based on specific reviewer feedback that we believe significantly improve the book and its use by faculty and students.

• We have added several new mini-cases throughout the book. New cases appear in Chapters 3, 5, 6, 12, and 14. Information in other cases has been updated to be current.

• For numerical examples discussed in the book, we have spreadsheets that students can use to understand the concept. The spreadsheets provide the details of the example discussed, but are live which allows the student to try different what-if analyses. These spreadsheets are available at www.pearsonhighered.com/chopra.

• In Chapter 3, we have added a section on financial metrics and ratios and linked these to the different supply chain drivers and metrics. This chapter allows a faculty member to position the supply chain management as it directly impacts the financial performance of the firm. We have also added a supporting mini-case with which students can dig into Walmart’s financials in detail.

• We have enhanced Chapter 6, which focuses on designing global supply chains. In particular, we have included a detailed example in Section 6.6 that looks at the onshoring/offshoring decision as a real option in the context of uncertainty. A mini-case has also been included in the chapter to look at the offshoring/onshoring decision.

• Supply chain coordination (Chapter 17 in the fourth edition) is now part of the module on “Planning and Coordinating Demand and Supply in the Supply Chain.” Based on reviewer feedback, we decided it was appropriate to include the collaboration and coordination discussions with the forecasting and sales and operations planning discussions.

• In Chapter 7, we have enhanced the discussions on forecast errors and selecting the best smoothing constant.

• In Chapter 8, we have enhanced the discussions on identifying the aggregate unit and then disaggregating the aggregate plan.

• In Chapter 9, we now have a spreadsheet that allows students to work through the entire sales and operations planning process for the example presented. Spreadsheets are available that allow students to build every table shown in Chapters 7–9.

• In Chapter 11, we have added numerical examples supporting the entire discussion on the rationale for quantity discounts. Supporting spreadsheets are provided for students.

• In Chapter 12, we added numerical examples supporting the value of postponement discussion and a mini-case investigating a decision to potentially postpone packaging.

• In Chapter 13, we have also enhanced and highlighted the discussion on tailored postponement. • In Chapter 14, we have enhanced the quantitative examples which support the qualitative

discussion on the design of transportation networks. Students will also have live spreadsheets available to use with these examples. A mini-case at the end of the chapter allows students to dig even deeper into the quantitative factors in transportation network design.

• In Chapter 15, we have enhanced the discussion on risk sharing and supply chain contracts. Students will also have live spreadsheets with which they can evaluate different risk- sharing options. The chapter also contains an enhanced discussion of tailored sourcing when designing a supplier portfolio.

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Preface xi

• A new Chapter 18 focuses on sustainability and the supply chain. • We have added current examples throughout the book with a particular focus on bringing

in more global examples.

The book has grown from a course on supply chain management taught to second-year M.B.A. students at the Kellogg School of Management at Northwestern University. The goal of this class was to cover not only high-level supply chain strategy and concepts, but also to give students a solid understanding of the analytical tools necessary to solve supply chain problems. With this class goal in mind, our objective was to create a book that would develop an understanding of the following key areas and their interrelationships:

• The strategic role of a supply chain • The key strategic drivers of supply chain performance • Analytic methodologies for supply chain analysis

Our first objective in this book is for the reader to learn the strategic importance of good supply chain design, planning, and operation for every firm. The reader will be able to understand how good supply chain management can be a competitive advantage, whereas weaknesses in the supply chain can hurt the performance of a firm. We use many examples to illustrate this idea and develop a framework for supply chain strategy.

Within the strategic framework, we identify facilities, inventory, transportation, information, sourcing, and pricing as the key drivers of supply chain performance. Our second goal in the book is to convey how these drivers may be used on a conceptual and practical level during supply chain design, planning, and operation to improve performance. We have included a case on Seven-Eleven Japan that can be used to illustrate how the company uses various drivers to improve supply chain performance. For each driver of supply chain performance, our goal is to provide readers with prac- tical managerial levers and concepts that may be used to improve supply chain performance.

Utilizing these managerial levers requires knowledge of analytic methodologies for supply chain analysis. Our third goal is to give the reader an understanding of these methodologies. Every methodological discussion is illustrated with its application in Excel. In this discussion, we also stress the managerial context in which the methodology is used and the managerial levers for improvement that it supports.

The strategic frameworks and concepts discussed in the book are tied together through a variety of examples that show how a combination of concepts is needed to achieve significant increases in performance.

FOR INSTRUCTORS

The following supplements are available to adopting instructors.

Instructor’s Resource Center REGISTER. REDEEM. LOGIN. At www.pearsonhighered.com/irc, instructors can access a variety of print, media, and presentation resources that are available with this text in downloadable, digital format. For most texts, resources are also available for course management platforms such as Blackboard, WebCT, and Course Compass.

NEED HELP? Our dedicated Technical Support team is ready to assist instructors with questions about the media supplements that accompany this text. Visit http://247.pearsoned.com/ for answers to frequently asked questions and toll-free user support phone numbers. The supplements are avail- able to adopting instructors. Detailed descriptions are provided on the Instructor’s Resource Center.

INSTRUCTOR’S SOLUTIONS MANUAL This manual is offered in Microsoft Word, and contains sample syllabi, chapter lecture notes, and solutions to all the end-of-chapter questions. The solu- tion spreadsheets are provided in Microsoft Excel. Where applicable, both the Excel and Word solutions are provided. It is available for download at www.pearsonhighered.com/chopra

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xii Preface

TEST ITEM FILE The file contains true/false questions, multiple-choice questions, and essay/prob- lem questions. It is available for download at www.pearsonhighered.com/chopra

POWERPOINT SLIDES These slides provide the instructor with individual lecture outlines to accompany the text. The slides include many of the figures and tables from the text. These lecture notes can be used as is, or professors can easily modify them to reflect specific presentation needs. They are available for download at www.pearsonhighered.com/chopra

FOR STUDENTS

The following material is available to students at www.pearsonhighered.com/chopra:

• Spreadsheets for numerical examples discussed in the book. These provide the details of the example discussed, but are live and allow the student to try different what-if analyses.

• Spreadsheets that allow students to build every table shown in Chapters 7–9.

ACKNOWLEDGMENTS

We would like to thank the many people who helped us throughout this process. We thank the reviewers whose suggestions significantly improved the book, including Iqbal Ali of the University of Massachusetts, Amherst; Ming Ling Chuang of Western Connecticut State University; Chia-Shin Chung of Cleveland State University; Phillip G. Cohen of San Jacinto College North Campus; Sime Curkovic of Western Michigan University; Chunxing Fan of Tennessee State University; Srinagesh Gavirneni of Cornell University; Richard Germain of the University of Louisville; Dr. Michael R. Godfrey of University of Wisconsin, Oshkosh; Scott E. Grasman of the Missouri University of Science & Technology; Jatinder (Jeet) Gupta of the University of Alabama, Huntsville; James K. Higginson of the University of Waterloo (Ontario); James K. Ho of University of Illinois at Chicago; Patrick Jeffers of Iowa State University; Mehdi Kaighobadi of Florida Atlantic University; Alireza Lari of Fayetteville State University; Bryan Lee of Missouri Western State College; Jianzhi (James) Li of University of Texas–Pan American; Arnold Maltz of Arizona State University; Daniel Marrone of SUNY Farmingdale; Charles Munson of Washington State University; James Noble of the University of Missouri, Columbia; William Roach of Washburn University; Subroto Roy of the University of New Haven; Effie Stavrulaki of Pennsylvania State University; Scott Thorne of Southeast Missouri State University, Frenck Waage of the University of Massachusetts; Chongqi Wu of California State University, East Bay, Boston; and Kefeng Xu of University of Texas at San Antonio.

We are grateful to the students at the Kellogg School of Management who suffered through typo-ridden drafts of earlier versions of the book. Specifically, we thank Christoph Roettelle and Vikas Vats for carefully reviewing several chapters and solving problems at the end of the chapters in early editions. We would also like to thank our editor, Chuck Synovec, and the staff at Prentice Hall, including Clara Bartunek, production project manager; Anne Fahlgren, executive marketing manager; Mary Kate Murray, senior project manager; and Ashlee Bradbury, editorial assistant, for their efforts with the book. Finally, we would like to thank you, our readers, for reading and using this book. We hope it contributes to all of your efforts to improve the performance of companies and supply chains throughout the world. We would be pleased to hear your comments and suggestions for future editions of this text.

Sunil Chopra

Kellogg School of Management Northwestern University

Peter Meindl

Kepos Capital

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1 � � �

1

Understanding the Supply Chain

LEARNING OBJECTIVES

After reading this chapter, you will be able to

1. Discuss the goal of a supply chain and explain the impact of supply chain decisions on the success of a firm.

2. Identify the three key supply chain decision phases and explain the significance of each one.

3. Describe the cycle and push/pull views of a supply chain.

4. Classify the supply chain macro processes in a firm.

In this chapter, we provide a conceptual understanding of what a supply chain is and the various issues that need to be considered when designing, planning, or operating a supply chain. We discuss the significance of supply chain decisions and supply chain performance for the success of a firm. We also provide several examples from different industries to emphasize the variety of supply chain issues that companies need to consider at the strategic, plan- ning, and operational levels.

1.1 WHAT IS A SUPPLY CHAIN?

A supply chain consists of all parties involved, directly or indirectly, in fulfilling a customer request. The supply chain includes not only the manufacturer and suppliers, but also transporters, warehouses, retailers, and even cus- tomers themselves. Within each organization, such as a manufacturer, the supply chain includes all functions involved in receiving and filling a customer request. These functions include, but are not limited to, new product development, marketing, operations, distribution, finance, and customer service.

Consider a customer walking into a Wal-Mart store to purchase detergent. The supply chain begins with the customer and his or her need for detergent. The next stage of this supply chain is the Wal-Mart retail store that the customer visits. Wal-Mart stocks its shelves using inventory that may have been supplied from a finished-goods warehouse or a distributor using trucks supplied by a third party. The distributor in turn is stocked by the manufac- turer (say, Procter & Gamble [P&G] in this case). The P&G manufacturing plant receives raw material from a variety of suppliers, who may themselves have been supplied by lower-tier suppliers. For example, packaging material may come from Pactiv Corporation (formerly Tenneco Packaging) while Pactiv receives raw materials to manufacture the packaging from other suppliers. This supply chain is illustrated in Figure 1-1, with the arrows cor- responding to the direction of physical product flow.

A supply chain is dynamic and involves the constant flow of information, product, and funds between different stages. In our example, Wal-Mart provides the product, as well as pricing and availability information, to the customer. The customer transfers funds to Wal-Mart. Wal-Mart conveys point-of-sales data as well as replenishment orders to the warehouse or dis- tributor, who transfers the replenishment order via trucks back to the store. Wal-Mart transfers funds to the distributor after the replenishment. The distributor also provides pricing information and sends delivery schedules to Wal-Mart. Wal-Mart may send back packaging material to be recycled. Similar information, material, and fund flows take place across the entire supply chain.

In another example, when a customer makes a purchase online from Dell Computer, the supply chain includes, among others, the customer, Dell’s Web site, the Dell assembly plant, and all of Dell’s suppliers and their suppliers. The Web site provides the customer with information regarding pricing, product variety, and product availability. Having made a product choice, the customer enters the order information and pays for the product. The customer may later return to the Web site to check the status of the order. Stages further up the supply chain use customer order information to fill the request. That process involves an additional flow of information, product, and funds among various stages of the supply chain.

These examples illustrate that the customer is an integral part of the supply chain. In fact, the primary purpose of any supply chain is to satisfy customer needs and, in the process, gener- ate profit for itself. The term supply chain conjures up images of product or supply moving from suppliers to manufacturers to distributors to retailers to customers along a chain. This is certainly part of the supply chain, but it is also important to visualize information, funds, and product flows along both directions of this chain. The term supply chain may also imply that only one player is involved at each stage. In reality, a manufacturer may receive material from several suppliers and then supply several distributors. Thus, most supply chains are actually networks. It may be more accurate to use the term supply network or supply web to describe the structure of most supply chains, as shown in Figure 1-2.

A typical supply chain may involve a variety of stages, including the following:

• Customers • Retailers • Wholesalers/distributors • Manufacturers • Component/raw material suppliers

Each stage in a supply chain is connected through the flow of products, information, and funds. These flows often occur in both directions and may be managed by one of the stages or an intermediary.

2 Chapter 1 • Understanding the Supply Chain

CustomerWal-MartStore

Wal-Mart or Third Party DC

P&G or Other Manufacturer

Timber Company

Paper Manufacturer

Pactiv Corporation

Chemical Manufacturer

Plastic Producer

FIGURE 1-1 Stages of a Detergent Supply Chain

Each stage in Figure 1-2 need not be present in a supply chain. As discussed in Chapter 4, the appro- priate design of the supply chain depends on both the customer’s needs and the roles played by the stages involved. For example, Dell has two supply chain structures that it uses to serve its customers. For its corporate clients and also some individuals who want a customized personal computer (PC), Dell builds to order; that is, a customer order initiates manufacturing at Dell. For these customers, Dell does not have a separate retailer, distributor, or wholesaler in the supply chain. Since 2007, Dell has also sold its PCs through Wal-Mart in the United States and the GOME Group, China’s largest elec- tronics retailer. Both Wal-Mart and the GOME Group carry Dell machines in inventory. This supply chain thus contains an extra stage (the retailer) compared to the direct sales model also used by Dell. In the case of other retail stores, the supply chain may also contain a wholesaler or distributor between the store and the manufacturer.

1.2 THE OBJECTIVE OF A SUPPLY CHAIN

The objective of every supply chain should be to maximize the overall value generated. The value (also known as supply chain surplus) a supply chain generates is the difference between what the value of the final product is to the customer and the costs the supply chain incurs in filling the customer’s request.

Supply Chain Surplus = Customer Value – Supply Chain Cost

The value of the final product may vary for each customer and can be estimated by the maximum amount the customer is willing to pay for it. The difference between the value of the product and its price remains with the customer as consumer surplus. The rest of the supply chain surplus becomes supply chain profitability, the difference between the revenue generated from the customer and the overall cost across the supply chain. For example, a customer pur- chasing a wireless router from Best Buy pays $60, which represents the revenue the supply chain receives. Customers who purchase the router clearly value it at or above $60. Thus, part of the supply chain surplus is left with the customer as consumer surplus. The rest stays with the supply chain as profit. Best Buy and other stages of the supply chain incur costs to convey information, produce components, store them, transport them, transfer funds, and so on. The difference between the $60 that the customer paid and the sum of all costs incurred by the supply chain to produce and distribute the router represents the supply chain profitability. Supply chain profitability is the total profit to be shared across all supply chain stages and inter- mediaries. The higher the supply chain profitability, the more successful is the supply chain.

Chapter 1 • Understanding the Supply Chain 3

Supplier Distributor Retailer CustomerManufacturer

Supplier Distributor Retailer CustomerManufacturer

Supplier Distributor Retailer CustomerManufacturer

FIGURE 1-2 Supply Chain Stages

For most profit-making supply chains, the supply chain surplus will be strongly correlated with profits. Supply chain success should be measured in terms of supply chain profitability and not in terms of the profits at an individual stage. (In subsequent chapters, we see that a focus on profitability at individual stages may lead to a reduction in overall supply chain profits.) A focus on growing the supply chain surplus pushes all members of the supply chain toward growing the size of the overall pie.

Having defined the success of a supply chain in terms of supply chain profitability, the next logical step is to look for sources of value, revenue, and cost. For any supply chain, there is only one source of revenue: the customer. The value obtained by a customer purchasing detergent at Wal-Mart depends upon several factors, including the functionality of the detergent, how far the customer has to travel to Wal-Mart, and the likelihood of finding the detergent in stock. The cus- tomer is the only one providing positive cash flow for the Wal-Mart supply chain. All other cash flows are simply fund exchanges that occur within the supply chain, given that different stages have different owners. When Wal-Mart pays its supplier, it is taking a portion of the funds the customer provides and passing that money on to the supplier. All flows of information, product, or funds generate costs within the supply chain. Thus, the appropriate management of these flows is a key to supply chain success. Effective supply chain management involves the management of supply chain assets and product, information, and fund flows to maximize total supply chain surplus. A growth in supply chain surplus increases the size of the total pie, allowing contributing members of the supply chain to benefit.

In this book, we have a strong focus on analyzing all supply chain decisions in terms of their impact on the supply chain surplus. These decisions and their impact can vary for a wide variety of reasons. For instance, consider the difference in the supply chain structure for fast-moving consumer goods observed in the United States and India. U.S. distributors play a much smaller role in this supply chain compared to their Indian counterparts. We argue that the difference in supply chain structure can be explained by the impact a distributor has on the supply chain surplus in the two countries.