3. Syllabus
• Strategic Sourcing Supply Chain Network optimization models.
• Impact of uncertainty on Network Design.
• Network Design decisions using Decision trees.
• Planning Demand.
• multiple items -multiple location inventory management.
• Pricing and Revenue Management.
4. Impact Of Uncertainty On Network Design
• Supply chain design decisions such as the number and size of plants
to build, the size and scope of a distribution system, and whether to
buy or lease one's facilities involve significant investment.
• These decisions, once made, cannot be altered in the short term.
They remain in place for several years and define the constraints
within which the supply chain must compete.
• Thus, it is important that these decisions be evaluated as accurately
as possible.
• Over the life of a supply chain network, a company experiences
fluctuations in demand, prices, exchange rates, and the competitive
environment.
5. • A decision that looks very good under the current environment may
be quite poor if the situation changes. For example, long-term
contracts for warehousing are more attractive if the demand and
price of warehousing do not change in the future or if the price of
warehousing goes up. (Example Bus pass)
• In contrast, a short-term contract is more attractive if either demand
or the price of warehousing drops in the future.
• The degree of demand and price uncertainty has a significant
influence on the appropriate portfolio of long- and short-term
warehousing space that a firm should carry.
• Uncertainty of demand and price drives the value of building flexible
production capacity at a plant. If price and demand do vary over time
in a global network, flexible production capacity can be reconfigured
to maximize, profits in the new environment.
7. Decision Tree
A decision tree is a schematic representation of the alternatives available to a decision
maker and
their possible consequences. The term gets its name from the tree like appearance of the
diagram. Although tree diagrams can be used in place of a pay-off table, they are
particularly useful for analyzing situations that involve sequential decisions.
A decision tree is composed of a number of nodes that have branches emanating from
them. Square nodes denote decision points, and circular nodes denote chance events.
Read the tree from left to right. Branches leaving square nodes represent alternatives;
branches leaving circular nodes represent chance events (i.e., the possible states of
nature).
After the tree has been drawn, it is analyzed from right to left; that is, starting with the last
decision that might be made. For each decision, choose the alternative that will yield the
greatest
return (or the lowest cost). If chance events follow a decision, choose the alternative that
has the
highest expected monetary value (or lowest expected cost).
7
9. A manufacturer of small Power tools is faced with foreign competition,
which necessitates that it either modify its existing product or abandon
it and market a new product. regardless of which course of action it
follows, it will have the opportunity to drop or rice prices if it
experiences a low initial demand. Payoff and probability values
associated with the alternative course of action are shown in figure.
Analyze the decision tree, and determined which cause of action
should be chosen to maximize the expected monetary value. Assume
monetary amounts are present value profits.
9
13. Evaluating Network Design Decisions Using Decision
Trees
A manager makes several different decisions when designing a supply
chain network. For instance:
• Should the firm sign a long-term contract for warehousing space or
get space from the spot market as needed?
• What should the firm's mix of long-term and spot markets be in the
portfolio of transportation capacity?
• How much capacity should various facilities have? What fraction of
this capacity should be flexible?
14. • If uncertainty is ignored, a manager will always sign long-term contracts (because
they are typically cheaper) and avoid all flexible capacity (because it is more
expensive). Such decisions, however, can hurt the firm if future demand or prices
are not as forecasted at the time of the decision.
• During network design, managers thus need a methodology that allows them to
estimate the uncertainty in their forecast of demand and price and then
incorporate this uncertainty in the decision-making process. Such a methodology
is most important for network design decisions because these decisions are hard
to change in the short term. In this section, we describe such a methodology and
show that accounting for uncertainty can have a significant impact on the value
of network design decisions.
Evaluating Network Design Decisions Using Decision
Trees
15. Evaluating Network Design Decisions Using Decision
Trees
A decision tree is a graphic device used to evaluate decisions under uncertainty. Decision trees with
DCFs can be used to evaluate supply chain design decisions given uncertainty in prices, demand,
exchange rates, and inflation.
• The decision tree analysis methodology is summarized as follows:
1. Identify the duration of each period (month, quarter, etc.) and the number of periods T over which
the decision is to be evaluated.
2. Identify factors such as demand, price, and exchange rate whose fluctuation will be considered
over the next T periods.
3. Identify representations of uncertainty for each factor; that is, determine what distribution to use
to model the uncertainty.
4. Identify the periodic discount rate k for each period.
5. Represent the decision tree with defined states in each period as well as the transition probabilities
between states in successive periods.
6. Starting at period T, work back to Period 0 identifying the optimal decision and the expected cash
flows at each step. Expected cash flows at each state in a given period should be discounted back
when included in the previous period.
16. 1. Get all warehousing space from the spot market as needed.
2. Sign a three-year lease for a fixed amount of warehouse space and get
additional requirements from the spot market.
3. Sign a flexible lease with a minimum charge that allows variable
usage of warehouse space up to a limit with the additional requirement
from the spot market.
27. Introduction
• The estimation of likely events
that might or will occur that are
estimated based on the
previous data available is a
justifiable way to understand or
to define forecasting.
• In general we hear forecasting
with respect to or aspect to two
factors in our daily life.
27
28. In any industrial enterprise, forecasting is the first level decision activity. That
is the demand of a particular product must be available before taking up any
other decision problems like, materials planning, scheduling, type of
production system (Mass or batch production) to be implemented, etc. So,
forecasting provides a basis for coordination of plans for activities in various
parts of a company. All the functional managers in any organization will base
their decisions on the forecast value. So, it is a vital information for the
organization. Due to these reasons, proper care should be exercised while
estimating forecast values.
28
29. Forecasting Objectives And Uses
Forecasts are estimates of the occurrence, timing, or magnitude
of uncertain future events. Forecasts are essential for the smooth
operations of business organizations. They provide information
that can assist managers in guiding future activities toward
organizational goals.
Operations managers are primarily concerned with forecasts of
demand which are often made by (or in conjunction with)
marketing. However, managers also use forecasts to estimate
raw material prices, plan for appropriate levels of personnel, help
decide how much inventory to carry, and a host of other activities.
This results in better use of capacity, more responsive service to
customers, and improved profitability
29
30. Characteristics Of Forecasts
• Forecasts are always wrong and should thus include both the
expected value of the forecast and a measure of forecast error.
• Long-term forecasts are usually less accurate than short-term
forecasts; long-term forecasts have a larger standard deviation of
error relative to the mean than short-term forecasts.
• Aggregate forecasts are usually more accurate than disaggregate
forecasts, as they tend to have a smaller standard deviation of error
relative to the mean. The greater the aggregation, the more accurate
is the forecast.
31. In general, the farther up the supply chain a company is (or the farther
it is from the consumer), the greater is the distortion of information it
receives. One classic example of this is the bullwhip effect (see Chapter
17), in which order variation is amplified as orders move farther from
the end customer. As a result, the farther up the supply chain an
enterprise is, the larger is the forecast error. Collaborative forecasting
based on sales to the end customer helps upstream enterprises reduce
forecast error.
Characteristics Of Forecasts
34. Qualitative
Qualitative forecasting methods are primarily subjective and rely on
human judgment. They are most appropriate when little historical data
is available or when experts have market intelligence that may affect
the forecast. Such methods may also be necessary to forecast demand
several years into the future in a new industry.
• Jury of Executive opinion
• Salesforce Composite method (Pooled salesforce estimate)
• Market Research method (Consumer survey method)
• Other judgement methods (Delphi Method)
35. Time series
Time-series forecasting methods use historical demand to make a forecast.
They are based on the assumption that past demand history is a good
indicator of future demand. These methods are most appropriate when the
basic demand pattern does not vary significantly from one year to the next.
These are the simplest methods to implement and can serve as a good
starting point for a demand forecast.
• Time Series methods
• Navie approach
• Moving average method
• Exponential smoothing method
36. Causal
Causal forecasting methods assume that the demand forecast is highly
correlated with certain factors in the environment (the state of the
economy, interest rates, etc.). Causal forecasting methods find this
correlation between demand and environmental factors and use
estimates of what environmental factors will be to forecast future
demand. For example, product pricing is strongly correlated with
demand. Companies can thus use causal methods to determine the
impact of price promotions on demand.
37. Simulation
Simulation forecasting methods imitate the consumer choices that give
rise to demand to arrive at a forecast. Using simulation, a firm can
combine time-series and causal methods to answer such questions as:
What will be the impact of a price promotion? What will be the impact
of a competitor opening a store nearby? Airlines simulate customer
buying behavior to forecast demand for higher-fare seats when there
are no seats available at the lower fares.
A company may find it difficult to decide which method is most
appropriate for forecasting. In fact, several studies have indicated that
using multiple forecasting methods to create a combined forecast is
more effective than using any one method alone.
38. Basic Approach To Demand Forecasting
• Understand the objective of forecasting.
• Integrate demand planning and forecasting throughout the supply
chain.
• Understand and identify customer segments.
• Identify the major factors that influence the demand forecast.
• Determine the appropriate forecasting technique.
• Establish performance and error measures for the forecast.
39. Understand the objective of forecasting
Every forecast supports decisions that are based on the forecast, so an important
first step is to identify these decisions clearly. Examples of such decisions include
how much of a particular product to make, how much to inventory, and how
much to order. All parties affected by a supply chain decision should be aware of
the link between the decision and the forecast. For example, Wal-Mart's plans to
discount detergent during the mt)nth of July must be shared with the
manufacturer, the transporter, and others involved in filling demand, as they all
must make decisions that are affected by the forecast of demand. All parties
should come up with a common forecast for the promotion and a shared plan of
action based on the forecast. Failure to make these decisions jointly may result
in either too much or too little product in various stages of the supply chain.
40. Integrate demand planning and forecasting
throughout the supply chain.
A company should link its forecast to all planning activities throughout the supply
chain. These include capacity planning, production planning, promotion planning,
and purchasing, among others. This link should exist at both the information system
and the human resources management level. As a variety of functions are affected
by the outcom’s of the planning process, it is important that all of them are
integrated into the forecasting process. In one unfortunately common scenario, a
retailer develops forecasts based on promotional activities, whereas a manufacturer,
unaware of these promotions, develops a different forecast for its production
planning based on historical orders. This leads to a mismatch between supply and
demand, resulting in poor customer service.
To accomplish this integration, it is a good idea for a firm to have a cross-functional
team, with members from each affected function responsible for forecasting
demand and an even better idea is to have members of different companies in the
supply chain working together to create a forecast.
41. Understand And Identify Customer Segments
A firm must identify the customer segments the supply chain serves.
Customers may be grouped by similarities in service requirements,
demand volumes, order frequency, demand volatility, seasonality, and
so forth. In general, companies may use different forecasting methods
for different segments. A clear understanding of the customer
segments facilitates an accurate and simplified approach to forecasting.
42. Identify Major Factors That Influence
The Demand Forecast
• Next, a finn must identify demand, supply, and product-related
phenomena that influence the demand forecast. On the demand side,
a company must ascertain whether demand is growing, declining, or
has a seasonal pattern. These estimates must be based on demad-not
sales data.
43. Determine The Appropriate Forecasting
Technique
In selecting an appropriate forecasting technique, a company should
first understand the dimensions that are relevant to the forecast. These
dimensions include geographic area, product groups, and customer
groups. The company should understand the differences in demand
along each dimension and will likely want different forecasts and
techniques for each dimension. At this stage, a firm selects an
appropriate forecasting method from among the four methods
discussed earlier--qualitative, time-series, causal, or simulation. As
mentioned earlier, using a combination of these methods is often most
effective.
44. Establish Performance And Error Measures For
The Forecast
• Companies should establish clear performance measures to evaluate the
accuracy and timeliness of the forecast. These measures should be highly
correlated with the objectives of the business decisions based on these
forecasts.
• For example, consider a mail-order company that uses a forecast to place
orders with its suppliers up the supply chain. Suppliers take two months to
send in the orders. The mail-order company must ensure that the forecast is
created at least two months before the start of the sales season because of the
two-month lead time for replenishment. At the end of the sales season, the
company must compare actual demand to forecasted demand to estimate the
accuracy of the forecast. Then plans for decreasing future forecast errors or
responding to the observed forecast errors can be put into place.
46. • we have considered managing the inventory for a single item. However, in
actuality, managing the inventory in a supply chain involves dealing with a
large number of items, often stocked at multiple stock points at various
stages in the supply chain. So far we have only looked at the problem of
managing inventory for a single item at a single stock point.
• The supply chain can rarely be managed by a single decision maker.
Complex supply chains are decomposed into multiple decision-making
units managing individual stock points, which in turn connect various
production and transportation activities within a chain.
• For multiple items, theoretically, supply chain analysis can be carried out
for each and every item using the approach outlined in this section
47. Selective Inventory Control Techniques
When dealing with a large number of items, the management
may not be in a position to focus attention on all items. For
example, a large company like IndianOil will have lakhs of SKUs
to handle; similarly, a grocery chain like Foodworld has to
manage thousands of SKUs. Obviously, not all items are likely
to be of equal importance. So it makes sense for a company to
classify items so that managers can pay suitable attention to
different categories of items. There are several classification
schemes for categorizing SKUs.
• ABC classification.
• FSN classification.
• VED classification.
48. ABC classification.
• Items are classified into three categories based on the value of the consumption. A-
category items contribute significantly to the value of inventory and consumption
and are controlled tightly and get more managerial attention.
• ABC classification is a ranking system for identifying and grouping items in terms of
how useful they are for achieving business goals. The system requires grouping
things into three categories: A - extremely important. B - moderately important. C -
relatively unimportant.
49. FSN classification
Items are classified based on the volume of usage: fast moving (F), slow moving (S) and non-
moving (N). Fast-moving items are usually stocked in a decentralized fashion while slow-
moving items are stocked centrally. Non-moving items are candidates for disposal and the
firm will like to make sure that non-moving items do not take up a significant share of
inventory investment. This classification is quite popular in the retail industry.
It looks at quantity, consumption rate and how often the item is issued and used. Fast-moving items are items in
your inventory stock that are issued or used frequently
50. VED classification
• Items are based on criticality: vital (V), essential (E) and desirable (D). This classification is
quite popular in maintenance management. Based on the VED classification, one can fix
different service levels for different items. Of course, a firm prefers to work with a very high
service level for V category of spare items.
• Cummins India is a classic example of a firm that has applied ideas of selective inventory
control techniques in managing its spares inventory.
52. Revenue management is the use of pricing to increase the profit
generated from a limited supply of supply chain assets. Supply chain
assets exist in two forms capacity and inventory. Capacity assets in the
supply chain exist for production, transportation, and storage.
Inventory assets exist throughout the supply chain and are carried to
improve product availability.
Revenue management may also be defined as the use of differential
pricing based on customer segment, time of use, and product or
capacity availability to increase supply chain surplus. The impact of
revenue management on supply chain performance can be significant.
One of the most often cited examples is the successful use of revenue
management by American Airlines to counter and finally defeat
PeopleExpress in the mid-1980s.
53.
54.
55. Revenue management adjusts the pricing and available supply of assets
to maximize profits. Revenue management has a significant impact on
supply chain profitability when one or more of the following four
conditions exist:
• The value of the product varies in different market segments.
• The product is highly perishable or product wastage occurs.
• Demand has seasonal and other peaks.
• The product is sold both in bulk and on the spot market.
56. The value of the product varies in different
market segments.
Airline seats are a good example of a product whose value varies by
market segment. A business traveler is willing to pay a higher fare for a
flight that matches his or her schedule. In contrast, a leisure traveler will
often alter his or her schedule to get a lower fare. An airline that can
extract a higher price from the business traveler compared to the leisure
traveler will always do better than an airline that charges the same price
to all travelers.
57.
58. The product is highly perishable or product
wastage occurs.
Fashion and seasonal apparel are examples of highly
perishable products. Production, storage, and transportation
capacity are examples of inventory or capacity that is wasted if
not utilized. The goal of revenue management in such a setting
is to adjust the price over time to maximize the profit obtained
from the available inventory or capacity.
59. Demand has seasonal and other peaks.
Orders at Amazon. com follow a seasonal pattern, with a peak in
December prior to Christmas. Serving this peak would require
Amazon.com to deploy a significant amount of temporary processing
capacity at high cost. Amazon.com uses revenue management ideas to
offer free shipping prior to the December peak. This shifts some of the
demand from the peak to the off-peak period and increases total profit
for Amazon.com. Some commuter railroads use a similar strategy to
deal with the distinct peaks in passenger travel. They charge higher fares
during peak periods and lower fares for off-peak travel. Differential
pricing for peak and off-peak periods results in significantly higher
profits.
60.
61. The product is sold both in bulk and on the
spot market.
Every product and every unit of capacity can be sold both in bulk and in
the spot market. An example is the owner of a warehouse who must
decide whether to lease the entire warehouse to customers willing to
sign long-term contracts or to save a portion of the warehouse for use
in the spot market. The long-term contract is more secure but typically
fetches a lower average price than the spot market. Revenue
management increases profits by finding the right portfolio of long-
term and spot-market customers.
