Increasing supply chain transparency only magnifies the bullwhip effect

Supply Chain Management ST R AT E G Y , P L A N N I N G , A N D OPE R AT I ON

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S i x 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, Kellogg School of Management, Peter Meindl, Kepos Capital.—Sixth Edition. pages cm ISBN 978-0-13-380020-3—ISBN 0-13-380020-2 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, 1970– II. Title. HF5415.13.C533 2015 658.7—dc23

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Dedication

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

—Peter 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 Manage- ment and the McCormick School of Engineering at Northwestern University. He has a PhD 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 Man- ufacturing & 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 a portfolio manager with Kepos Capital in New York. Previously, he was a research officer with Barclays Global Investors, a consultant with the Boston Consult- ing Group and Mercer Management Consulting, and the director of strategy with i2 Technologies. He holds PhD, MS, BS, and BA degrees from Stanford, and an MBA from the Kellogg School of Management at Northwestern.

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

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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 5 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 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 31 2.4 Challenges to Achieving and Maintaining

Strategic Fit 34 2.5 Summary of Learning Objectives 35

Discussion Questions 36 36 ▶ CASE STUDY: The Demise of Blockbuster 37

Chapter 3 SUPPLY CHAIN DRIVERS AND METRICS 40 3.1 Financial Measures of Performance 40 3.2 Drivers of Supply Chain Performance 44 3.3 Framework for Structuring Drivers 46 3.4 Facilities 47 3.5 Inventory 49 3.6 Transportation 52 3.7 Information 53 3.8 Sourcing 56 3.9 Pricing 57 3.10 Summary of Learning Objectives 59

Discussion Questions 60 61 ▶ CASE STUDY: Seven-Eleven Japan Co. 61 ▶ CASE STUDY: Financial Statements for Walmart Stores Inc. and

Macy’s Inc. 67

iv

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Part II Designing the Supply Chain Network

Chapter 4 DESIGNING DISTRIBUTION NETWORKS AND APPLICATIONS TO ONLINE SALES 69 4.1 The Role of Distribution in the Supply Chain 69 4.2 Factors Influencing Distribution Network Design 71 4.3 Design Options for a Distribution Network 74 4.4 Online Sales and the Distribution Network 87 4.5 Distribution Networks in Practice 100 4.6 Summary of Learning Objectives 101

Discussion Questions 102 102 ▶ CASE STUDY: Blue Nile and Diamond Retailing 103

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 133 134 138 ▶ CASE STUDY: Managing Growth at SportStuff.com 139 ▶ CASE STUDY: Designing the Production Network at CoolWipes 140

Chapter 6 DESIGNING GLOBAL SUPPLY CHAIN NETWORKS 142 6.1 The Impact of Globalization on Supply Chain Networks 142 6.2 The Offshoring Decision: Total Cost 144 6.3 Risk Management in Global Supply Chains 147 6.4 Discounted Cash Flows 151 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 160 6.7 Making Global Supply Chain Design Decisions Under

Uncertainty in Practice 168 6.8 Summary of Learning Objectives 169

Discussion Questions 169 170 171 ▶ CASE STUDY: BioPharma, Inc. 172 ▶ CASE STUDY: The Sourcing Decision at Forever Young 175

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

Chapter 7 DEMAND FORECASTING IN A SUPPLY CHAIN 177 7.1 The Role of Forecasting in a Supply Chain 177 7.2 Characteristics of Forecasts 178

Contents v

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vi Contents

7.3 Components of a Forecast and Forecasting Methods 179 180

7.5 Time-Series Forecasting Methods 182 7.6 Measures of Forecast Error 192

195 7.8 Forecasting Demand at Tahoe Salt 197 7.9 The Role of IT in Forecasting 202 7.10 Forecasting in Practice 203 7.11 Summary of Learning Objectives 204

Discussion Questions 204 205 206 ▶ CASE STUDY: Specialty Packaging Corporation 207

Chapter 8 AGGREGATE PLANNING IN A SUPPLY CHAIN 209 8.1 The Role of Aggregate Planning in a Supply Chain 209 8.2 The Aggregate Planning Problem 211 8.3 Aggregate Planning Strategies 213 8.4 Aggregate Planning at Red Tomato Tools 214 8.5 Aggregate Planning Using Linear Programming 215 8.6 Aggregate Planning in Excel 220

224 8.8 The Role of IT in Aggregate Planning 225 8.9 Implementing Aggregate Planning in Practice 225 8.10 Summary of Learning Objectives 226

Discussion Questions 227 227 229 ▶ CASE STUDY: Kloss Planters and Harvesters 229

Chapter 9 SALES AND OPERATIONS PLANNING: PLANNING SUPPLY AND DEMAND IN A SUPPLY CHAIN 231 9.1 Responding to Predictable Variability in the Supply Chain 231 9.2 Managing Supply 232 9.3 Managing Demand 234 9.4 Sales and Operations Planning at Red Tomato 235 9.5 Implementing Sales and Operations Planning in Practice 241 9.6 Summary of Learning Objectives 242

Discussion Questions 242 242 244 ▶ CASE STUDY: Mintendo Game Girl 245 ▶ CASE STUDY: Promotion Challenges at Gulmarg Skis 246

Chapter 10 COORDINATION IN A SUPPLY CHAIN 248 248

10.2 The Effect on Performance of Lack of Coordination 250 10.3 Obstacles to Coordination in a Supply Chain 252 10.4 Managerial Levers to Achieve Coordination 256 10.5 Continuous Replenishment and Vendor-Managed

Inventories 261

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Contents vii

10.6 Collaborative Planning, Forecasting, and Replenishment 261 10.7 Achieving Coordination in Practice 265 10.8 Summary of Learning Objectives 266

Discussion Questions 267 267

Part IV Planning and Managing Inventories in a Supply Chain

Chapter 11 MANAGING ECONOMIES OF SCALE IN A SUPPLY CHAIN: CYCLE INVENTORY 268 11.1 The Role of Cycle Inventory in a Supply Chain 268 11.2 Estimating Cycle Inventory-Related Costs in Practice 271 11.3 Economies of Scale to Exploit Fixed Costs 273 11.4 Aggregating Multiple Products in a Single Order 278 11.5 Economies of Scale to Exploit Quantity Discounts 286 11.6 Short-Term Discounting: Trade Promotions 297 11.7 Managing Multiechelon Cycle Inventory 302 11.8 Summary of Learning Objectives 305

Discussion Questions 306 306 309 ▶ CASE STUDY: Delivery Strategy at MoonChem 310 ▶ CASE STUDY: Pricing and Delivery at KAR Foods 312

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 Factors Affecting the Level of Safety Inventory 316 12.3 Determining the Appropriate Level of Safety Inventory 318 12.4 Impact of Supply Uncertainty on Safety Inventory 327 12.5 Impact of Aggregation on Safety Inventory 330 12.6 Impact of Replenishment Policies on Safety Inventory 342 12.7 Managing Safety Inventory in a Multiechelon Supply Chain 346 12.8 The Role of IT in Inventory Management 346 12.9 Estimating and Managing Safety Inventory in Practice 347 12.10 Summary of Learning Objectives 348

Discussion Questions 349 349 353 ▶ CASE STUDY: Managing Inventories at ALKO Inc. 353 ▶ CASE STUDY: Should Packing Be Postponed to the DC? 356

Appendix 12A: The Normal Distribution 357 358

Appendix 12C: Expected Shortage per Replenishment Cycle 358 Appendix 12D: Evaluating Safety Inventory for Slow-Moving

Items 359

Chapter 13 DETERMINING THE OPTIMAL LEVEL OF PRODUCT AVAILABILITY 361 13.1 The Importance of the Level of Product Availability 361 13.2 Factors Affecting Optimal Level of Product Availability 362

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viii Contents

13.3 Managerial Levers to Improve Supply Chain Profitability 372 13.4 Setting Product Availability for Multiple Products Under

Capacity Constraints 386 13.5 Setting Optimal Levels of Product Availability in Practice 389 13.6 Summary of Learning Objectives 389

Discussion Questions 390 390 392 ▶ CASE STUDY: The Need for Speed at Winner Apparel 393

Appendix 13A: Optimal Level of Product Availability 394 395

Appendix 13C: Expected Profit from an Order 396 Appendix 13D: Expected Overstock from an Order 396 Appendix 13E: Expected Understock from an Order 397 Appendix 13F: Simulation Using Spreadsheets 397

Part V Designing and Planning Transportation Networks

Chapter 14 TRANSPORTATION IN A SUPPLY CHAIN 400 14.1 The Role of Transportation in a Supply Chain 400 14.2 Modes of Transportation and Their Performance

Characteristics 402 14.3 Transportation Infrastructure and Policies 406 14.4 Design Options for a Transportation Network 409 14.5 Mumbai Dabbawalas: A Highly Responsive Distribution

Network 415 14.6 Trade-Offs in Transportation Design 416 14.7 Tailored Transportation 425 14.8 The Role of IT in Transportation 427 14.9 Making Transportation Decisions in Practice 427 14.10 Summary of Learning Objectives 428

Discussion Questions 429 429 ▶ CASE STUDY: Designing the Distribution Network for Michael’s

Hardware 430 ▶ CASE STUDY: The Future of Same-Day Delivery: Same as the Past? 431 ▶ CASE STUDY: Selecting Transportation Modes for China Imports 432

Part VI Managing Cross-Functional Drivers in a Supply Chain

Chapter 15 SOURCING DECISIONS IN A SUPPLY CHAIN 433 15.1 The Role of Sourcing in a Supply Chain 433 15.2 In-House or Outsource? 435 15.3 Examples of Successful Third-Party Suppliers 441 15.4 Total Cost of Ownership 443 15.5 Supplier Selection—Auctions and Negotiations 446 15.6 Sharing Risk and Reward in the Supply Chain 448 15.7 The Impact of Incentives When Outsourcing 459

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Contents ix

15.8 Designing a Sourcing Portfolio: Tailored Sourcing 461 15.9 Making Sourcing Decisions in Practice 463 15.10 Summary of Learning Objectives 464

Discussion Questions 465 465 466

Chapter 16 PRICING AND REVENUE MANAGEMENT IN A SUPPLY CHAIN 468

468

Segments 470 477 484

Contracts 484 486

16.7 Summary of Learning Objectives 487 Discussion Questions 488 488 489

▶ CASE STUDY: To Savor or to Groupon? 490

Chapter 17 SUSTAINABILITY AND THE SUPPLY CHAIN 492 492

494 17.3 Key Pillars of Sustainability 497

500 504 505

17.7 Summary of Learning Objectives 507 Discussion Questions 508 508

Part VII Online Chapter

Chapter A INFORMATION TECHNOLOGY IN A SUPPLY CHAIN

Summary of Learning Objectives

509

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PREFACE

This book is targeted toward an academic as well as a practitioner audience. On the academic side, it should be appropriate for MBA students, engineering master’s students, and senior under- graduate students interested in supply chain management and logistics. It should also serve as a suitable reference for both concepts as well as providing a methodology for practitioners in con- sulting and industry.

NEW TO THIS EDITION The sixth edition has focused on allowing students to learn more as they study with the book. We have tightened the link between examples in the book and associated spreadsheets and have added exercises and cases in several chapters. We have also added changes based on spe- cific reviewer feedback that we believe significantly improve the book and its use by faculty and students.

- ters 2, 8, 9, 11, 13, 14, and 16. Information in other cases has been updated to be current.

students can use to understand the concept. These spreadsheets are referred to in the book and allow the student to try different “what-if” analyses. These spreadsheets are available at www.pearsonhighered.com/chopra along with basic guidance on how they may be used.

- out using Solver if they so desire. For faculty that wants to continue using Solver, all mate- rial in the chapters has been even more tightly linked to the associated spreadsheets. We have also added a couple of new mini-cases to give students a chance to apply the concepts in the chapters.

advanced concepts, we have tightened the linkage to the associated spreadsheets. We have also added a mini-case.

dabbawalas, a responsive distri- bution network. We have tightened the linkage of examples to associated spreadsheets and added a couple of mini-cases.

third parties as well as the impact of incentives and the sharing of risk and reward in the supply chain.

updated and placed online at www.pearsonhighered.com/chopra.

pricing of sustainability.

bringing in more global examples.

The book has grown from a course on supply chain management taught to second-year MBA students at the Kellogg School of Management at Northwestern University. The goal of this class was not only to cover high-level supply chain strategy and concepts, but also to give

x

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http://www.pearsonhighered.com/chopra
Preface xi

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 under- standing of the following key areas and their interrelationships:

Our first objective in this book is for the reader to learn the strategic importance of good supply

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, informa- tion, 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 conceptual and practical levels during supply chain design, planning, and operation to improve performance. We have presented a variety of cases that can be used to illustrate how a company uses various drivers to improve supply chain performance. For each driver of supply chain performance, our goal is to provide readers with practical managerial levers and concepts that may be used to improve supply chain performance.

Using 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.

variety of examples that show how a combination of concepts is needed to achieve significant increases in performance.

FOR INSTRUCTORS

register to gain access to a variety of instructor resources available with this text in downloadable format. If assistance is needed, our dedicated technical support team is ready to help with the

- quently asked questions and toll-free user support phone numbers.

®

For Students

of the example discussed, but are live and allow the student to try different what-if analyses.

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xii Preface

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: Steven Brown, Arizona State University; Ming Chen, California State University, Long Beach; Sameer Kumar, Univer- sity of Saint Thomas; Frank Montabon, Iowa State University; Brian Sauser, University of North Texas; and Paul Venderspek, Colorado State University.

We are grateful to the students at the Kellogg School of Management who suffered through typo-ridden drafts of earlier versions of the book. We would also like to thank our editor, Dan Tylman, and the staff at Pearson, including Liz Napolitano, senior production project manager; Anne Fahlgren, executive product marketing manager; Claudia Fernandes, program manager; and Linda Albelli, 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 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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In this chapter, we provide a conceptual understanding of what a supply chain is and the various issues that must 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 empha- size the variety of supply chain issues that companies need to consider at the strategic, planning, 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 customers themselves. Within each organization, such as a manu- facturer, 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 Walmart 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 Walmart retail store that the customer visits. Walmart stocks its shelves using inventory that may have been supplied from a finished-goods warehouse or a distributor using trucks supplied

Understanding the Supply Chain

C H A P T E R

1

LEARNING OBJECTIVES After reading this chapter, you will be able to

1

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.

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2

by a third party. The distributor, in turn, is stocked by the manufacturer (say, Procter & Gamble [P&G] in this case). The P&G manufacturing plant receives raw material from a variety of sup- pliers, which may themselves have been supplied by lower-tier suppliers. For example, packag- ing material may come from Pactiv Corporation, whereas Pactiv receives raw materials to manufacture the packaging from other suppliers. This supply chain is illustrated in Figure 1-1, with the arrows corresponding to the direction of physical product flow.

A supply chain is dynamic and involves the constant flow of information, product, and funds among different stages. In our example, Walmart provides the product, as well as pric- ing and availability information, to the customer. The customer transfers funds to Walmart. Walmart conveys point-of-sales data and replenishment orders to the warehouse or distribu- tor, which transfers the replenishment order via trucks back to the store. Walmart transfers funds to the distributor after the replenishment. The distributor also provides pricing infor- mation and sends delivery schedules to Walmart. Walmart may send back packaging mate-

supply chain. In another example, when a customer makes a purchase online from Amazon, the supply

chain includes, among others, the customer, Amazon’s website, the Amazon warehouse, and all of Amazon’s suppliers and their suppliers. The website provides the customer with information regarding pricing, product variety, and product availability. After making a product choice, the customer enters the order information and pays for the product. The customer may later return

order information to fill the request. That process involves an additional flow of information, product, and funds among various stages of the supply chain.