Internet Based Supply Chain
          Strategies

            David Simchi-Levi

    Professor of Engineering Systems
  Ma...
Outline
• Supply Chain Dynamics
• Supply Chain Integration
  – A new Supply Chain Paradigm
• E-Business Strategies
  – Bus...
Sources
• Books

                Designing and Managing                             The Logic of
                    The S...
The Dynamics of the Supply Chain
Order Size




                                                                          ...
The Dynamics of the Supply Chain
Order Size




                                                                          ...
We Conclude:
In Traditional Supply Chains….

 • Order Variability is amplified up the
   supply chain; upstream echelons f...
The Bullwhip Effect




P&G   Retailers               Customers


           ©Copyright 2002 D. Simchi-Levi
What are the Causes….

• Promotional sales
• Volume and Transportation Discount
• Inflated orders
  - IBM Aptiva orders in...
What are the Causes….

• Single retailer, single manufacturer.
  – Retailer observes customer demand,
    Dt.
  – Retailer...
What are the Causes….
• Promotional sales
• Volume and Transportation Discount
• Inflated orders
  - IBM Aptiva orders inc...
Consequences….

• Single retailer, single manufacturer.
  – Retailer observes customer demand,
    Dt.
  – Retailer orders...
Consequences….
• Increased safety stock

• Reduced service level

• Inefficient allocation of resources

• Increased trans...
The Future is Not What it Used to Be
• A new e-Business Model
  – Reduce cost
  – Increase service level
  – Increase flex...
Reality is Different…..
• On-line Furniture Industry
   – After an investment of $70M Living.com declared bankruptcy
     ...
Reality is Different…..
• Amazon.com Example
  –   Founded in 1995
  –   1996: $16M Sales, $6M Loss
  –   1999: $1.6B Sale...
Reality is Different….
• Dell Example:
  – Dell Computer has outperformed the competition
    in terms of shareholder valu...
The e- Business Model
• e-Business is a collection of business models
  and processes motivated by Internet
  technology, ...
A new Supply Chain Paradigm
• A shift from a Push System...
  – Production decisions are based on forecast
• …to a Push-Pu...
From Make-to-Stock Model….
Suppliers   Assembly              Configuration




                   ©Copyright 2002 D. Simch...
Demand Forecast
• The three principles of all forecasting
  techniques:
   – Forecasts are always wrong
   – The longer th...
A new Supply Chain Paradigm
• A shift from a Push System...
  – Production decisions are based on forecast
• …to a Push-Pu...
Push-Pull Supply Chains




PUSH STRATEGY               PULL STRATEGY



                Push-Pull Boundary


            ...
A new Supply Chain Paradigm
• A shift from a Push System...
  – Production decisions are based on forecast
• …to a Push-Pu...
….to Assemble-to-Order Model
Suppliers   Assembly              Configuration




                   ©Copyright 2002 D. Sim...
Demand Forecast
• The three principles of all forecasting
  techniques:
   – Forecasts are always wrong
   – The longer th...
Business models in the Book
          Industry
• From Push Systems...
  – Barnes and Noble
• ...To Pull Systems
  – Amazon...
Direct-to-Consumer:Cost Trade-Off
                               Cost Trade-Off for BuyPC.com

                     $20
  ...
Business models in the Grocery
          Industry
• From Push Systems...
  – Supermarket supply chain
• ...To Pull Systems...
Business models in the Grocery
          Industry
• Key Challenges for e-grocer:
  – Transportation cost
     • Density of...
e-Business in the Retail Industry
• Brick-&-Mortar companies establish Virtual
  retail stores
  – Wal-Mart, K-Mart, Barne...
E-Fulfillment Requires a New
                     Logistics Infrastructure

                        Traditional Supply Cha...
Matching Supply Chain Strategies
         with Products
           Demand
          uncertainty
            (C.V.)



   P...
Locating the Push-Pull Boundary




               ©Copyright 2002 D. Simchi-Levi
Outline
• Supply Chain Dynamics
• Supply Chain Integration
  – A new Supply Chain Paradigm
• E-Business Strategies
  – Bus...
Smart Pricing?
• Dell:
   – Same product is sold at a different price to different consumers
     (private/small or large ...
Mail-in-Rebate
• What is the manufacturer trying to
  achieve with the rebate?
  – Why the manufacturer and not the retail...
Mail-in-Rebate
      • A Retailer and a manufacturer.
          – Retailer faces customer demand.
          – Retailer ord...
Demand-Price Relationship
 10000
Demand             P=2000-0.2Q




                                              2000

  ...
Retailer Expected Profit
                                               (No Rebate)
                             1,600,000...
Retailer Expected Profit
                                               (No Rebate)
                             1,600,000...
Manufacturer Profit
                                              (No Rebate)
                      6,000,000




        ...
Manufacturer Profit
                                              (No Rebate)
                      6,000,000




        ...
Retailer Expected Profit
                                           ($100 Rebate)
                           1,800,000


 ...
Retailer Expected Profit
                                           ($100 Rebate)
                           1,800,000
   ...
Manufacturer Profit
                                   ($100 Rebate)
                      6,000,000




                 ...
Manufacturer Profit
                                   ($100 Rebate)
                      6,000,000




                 ...
Retailer Expected Profit
(Reduced Wholesale Price $100 )
                           1,800,000


                          ...
Retailer Expected Profit
(Reduced Wholesale Price $100 )
                           1,800,000
                            ...
Manufacturer Profit
(Reduced Wholesale Price $100)
                       5,000,000


                       4,500,000


 ...
Manufacturer Profit
(Reduced Wholesale Price $100)
                       5,000,000


                       4,500,000


 ...
Mail-in-Rebate

         Strategy           Retailer Manufacturer                  Total
No Rebate                   1,370...
Managerial Insights
• Mail in Rebate allows supply chain
  partners to move away from sequential
  strategies toward globa...
Smart Pricing
• Customized Pricing
  – Revenue Management Techniques
    • Distinguish between customers according to thei...
Smart Pricing
• Dynamic Pricing
  – Changing prices over time without
    necessarily distinguishing between
    different...
When does Dynamic Pricing
Provide Significant Profit Benefit?
•   Limited Capacity
•   Demand Variability
•   Seasonality ...
The Internet makes Smart Pricing
             Possible
 • Low Menu Cost
 • Low Buyer Search Cost
 • Visibility
   – To the...
Internet Based Supply Chain Strategies
Internet Based Supply Chain Strategies
Internet Based Supply Chain Strategies
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Internet Based Supply Chain Strategies

  1. 1. Internet Based Supply Chain Strategies David Simchi-Levi Professor of Engineering Systems Massachusetts Institute of Technology Tel: 617-253-6160 E-mail: dslevi@mit.edu
  2. 2. Outline • Supply Chain Dynamics • Supply Chain Integration – A new Supply Chain Paradigm • E-Business Strategies – Business-to-Consumer – Strategic Pricing – Business-to-Business ©Copyright 2002 D. Simchi-Levi
  3. 3. Sources • Books Designing and Managing The Logic of The Supply Chain Logistics Publisher: McGraw-Hill, 1999 Publisher: Springer, 1997 • Articles – The Effect of e-Business on Supply Chain Management, Working Paper, MIT, April 2001. By David Simchi-Levi (MIT) and Edith Simchi-Levi (LogicTools). ©Copyright 2002 D. Simchi-Levi
  4. 4. The Dynamics of the Supply Chain Order Size Customer Customer Demand Demand Retailer Orders Retailer Orders Distributor Orders Distributor Orders Production Plan Production Plan Time Source: Tom Mc Guffry, Electronic Commerce and Value Chain Management, 1998 ©Copyright 2002 D. Simchi-Levi
  5. 5. The Dynamics of the Supply Chain Order Size Customer Customer Demand Demand Production Plan Production Plan Time Source: Tom Mc Guffry, Electronic Commerce and Value Chain Management, 1998 ©Copyright 2002 D. Simchi-Levi
  6. 6. We Conclude: In Traditional Supply Chains…. • Order Variability is amplified up the supply chain; upstream echelons face higher variability. • What you see is not what they face. ©Copyright 2002 D. Simchi-Levi
  7. 7. The Bullwhip Effect P&G Retailers Customers ©Copyright 2002 D. Simchi-Levi
  8. 8. What are the Causes…. • Promotional sales • Volume and Transportation Discount • Inflated orders - IBM Aptiva orders increased by 2-3 times when retailers thought that IBM would be out of stock over Christmas - Same with Motorola’s Cellular phones ©Copyright 2002 D. Simchi-Levi
  9. 9. What are the Causes…. • Single retailer, single manufacturer. – Retailer observes customer demand, Dt. – Retailer orders qt from manufacturer. Dt qt Retailer Manufacturer L ©Copyright 2002 D. Simchi-Levi
  10. 10. What are the Causes…. • Promotional sales • Volume and Transportation Discount • Inflated orders - IBM Aptiva orders increased by 2-3 times when retailers though that IBM would be out of stock over Christmas - Same with Motorola’s Cellular phones • Demand Forecast • Long cycle times ©Copyright 2002 D. Simchi-Levi
  11. 11. Consequences…. • Single retailer, single manufacturer. – Retailer observes customer demand, Dt. – Retailer orders qt from manufacturer. Dt qt Retailer Manufacturer L ©Copyright 2002 D. Simchi-Levi
  12. 12. Consequences…. • Increased safety stock • Reduced service level • Inefficient allocation of resources • Increased transportation costs ©Copyright 2002 D. Simchi-Levi
  13. 13. The Future is Not What it Used to Be • A new e-Business Model – Reduce cost – Increase service level – Increase flexibility – Increase Profit ©Copyright 2002 D. Simchi-Levi
  14. 14. Reality is Different….. • On-line Furniture Industry – After an investment of $70M Living.com declared bankruptcy in August 2000 – Logistics brought the recent downfall of Furniture.com after about 20 months of operation • On-line Grocery Industry – Shoplink.com, Streamline.com, Web van recently retired from this market – Peapod escaped this fate when it was sold to Royal Ahold after heavy losses ©Copyright 2002 D. Simchi-Levi
  15. 15. Reality is Different….. • Amazon.com Example – Founded in 1995 – 1996: $16M Sales, $6M Loss – 1999: $1.6B Sales, $720M Loss – 2000: $2.7B Sales, $1.4B Loss – Last quarter of 2001: $50M Profit • Total debt: $2.2B ©Copyright 2002 D. Simchi-Levi
  16. 16. Reality is Different…. • Dell Example: – Dell Computer has outperformed the competition in terms of shareholder value growth over the eight years period, 1988-1996, by over 3,000% (see Anderson and Lee, 1999) ©Copyright 2002 D. Simchi-Levi
  17. 17. The e- Business Model • e-Business is a collection of business models and processes motivated by Internet technology, and focusing on improving the extended enterprise performance – e-commerce is part of e-Business – Internet technology is the driver of the business change – The focus is on the extended enterprise: • Intra-organizational • Business to Consumer (B2C) • Business to Business (B2B) ©Copyright 2002 D. Simchi-Levi
  18. 18. A new Supply Chain Paradigm • A shift from a Push System... – Production decisions are based on forecast • …to a Push-Pull System – Parts inventory is replenished based on forecasts – Assembly is based on accurate customer demand ©Copyright 2002 D. Simchi-Levi
  19. 19. From Make-to-Stock Model…. Suppliers Assembly Configuration ©Copyright 2002 D. Simchi-Levi
  20. 20. Demand Forecast • The three principles of all forecasting techniques: – Forecasts are always wrong – The longer the forecast horizon the worst is the forecast – Aggregate forecasts are more accurate • The Risk Pooling Concept ©Copyright 2002 D. Simchi-Levi
  21. 21. A new Supply Chain Paradigm • A shift from a Push System... – Production decisions are based on forecast • …to a Push-Pull System ©Copyright 2002 D. Simchi-Levi
  22. 22. Push-Pull Supply Chains PUSH STRATEGY PULL STRATEGY Push-Pull Boundary ©Copyright 2002 D. Simchi-Levi
  23. 23. A new Supply Chain Paradigm • A shift from a Push System... – Production decisions are based on forecast • …to a Push-Pull System – Parts inventory is replenished based on forecasts – Assembly is based on accurate customer demand ©Copyright 2002 D. Simchi-Levi
  24. 24. ….to Assemble-to-Order Model Suppliers Assembly Configuration ©Copyright 2002 D. Simchi-Levi
  25. 25. Demand Forecast • The three principles of all forecasting techniques: – Forecasts are always wrong – The longer the forecast horizon the worst is the forecast – Aggregate forecasts are more accurate • The Risk Pooling Concept ©Copyright 2002 D. Simchi-Levi
  26. 26. Business models in the Book Industry • From Push Systems... – Barnes and Noble • ...To Pull Systems – Amazon.com, 1996-1999 • And, finally to Push-Pull Systems – Amazon.com, 1999-present • 7 warehouses, 3M sq. ft., ©Copyright 2002 D. Simchi-Levi
  27. 27. Direct-to-Consumer:Cost Trade-Off Cost Trade-Off for BuyPC.com $20 $18 $16 Cost ($ million) $14 Total Cost $12 Inventory $10 Transportation $8 Fixed Cost $6 $4 $2 $0 0 5 10 15 Number of DC's
  28. 28. Business models in the Grocery Industry • From Push Systems... – Supermarket supply chain • ...To Pull Systems – Peapod, 1989-1999 • Stock outs 8% to 10% • And, finally to Push-Pull Systems – Peapod, 1999-present • Dedicated warehouses • Stock outs less than 2% ©Copyright 2002 D. Simchi-Levi
  29. 29. Business models in the Grocery Industry • Key Challenges for e-grocer: – Transportation cost • Density of customers – Very short order cycle times • Less than 12 hours – Difficult to compete on cost • Must provide some added value such as convenience ©Copyright 2002 D. Simchi-Levi
  30. 30. e-Business in the Retail Industry • Brick-&-Mortar companies establish Virtual retail stores – Wal-Mart, K-Mart, Barnes and Noble • Use a hybrid approach in stocking – Fast moving/High volume products for local storage – Slow moving/Low volume products for on-line purchase • Channel Conflict Issues ©Copyright 2002 D. Simchi-Levi
  31. 31. E-Fulfillment Requires a New Logistics Infrastructure Traditional Supply Chain e-Supply Chain Supply Chain Strategy Push Push-Pull Shipment Type Bulk Parcel Inventory Flow Unidirectional Bi-directional Reverse Logistics Simple Highly Complex Destination Small Number of Stores Highly Dispersed Customers Lead Times Depends Short ©Copyright 2002 D. Simchi-Levi
  32. 32. Matching Supply Chain Strategies with Products Demand uncertainty (C.V.) Pull H I II Computer Furniture IV III Books & CDs Grocery Push L Delivery cost L H Unit price Pull Push ©Copyright 2002 D. Simchi-Levi
  33. 33. Locating the Push-Pull Boundary ©Copyright 2002 D. Simchi-Levi
  34. 34. Outline • Supply Chain Dynamics • Supply Chain Integration – A new Supply Chain Paradigm • E-Business Strategies – Business-to-Consumer – Strategic Pricing – Business-to-Business ©Copyright 2002 D. Simchi-Levi
  35. 35. Smart Pricing? • Dell: – Same product is sold at a different price to different consumers (private/small or large business/government/academia/health care) – Price of the same product for the same industry is nothing but fixed • Amazon – Books.com had a lower price than Amazon 99% of the time, yet Amazon had 80% of the market in 2000 while Books.com only 2% • Nikon, Sharp… – Mail-In-Rebate • Boise Cascade office – Prices of 12,000 items sold on-line may change as often as daily ©Copyright 2002 D. Simchi-Levi
  36. 36. Mail-in-Rebate • What is the manufacturer trying to achieve with the rebate? – Why the manufacturer and not the retailer? • Should the manufacturer reduce the wholesale price instead of the rebate? • Are there other strategies that can be used to achieve the same effect? ©Copyright 2002 D. Simchi-Levi
  37. 37. Mail-in-Rebate • A Retailer and a manufacturer. – Retailer faces customer demand. – Retailer orders from manufacturer. Variable Production Cost=$200 Selling Price=? Retailer Manufacturer Wholesale Price=$900 ©Copyright 2002 D. Simchi-Levi
  38. 38. Demand-Price Relationship 10000 Demand P=2000-0.2Q 2000 Price ©Copyright 2002 D. Simchi-Levi
  39. 39. Retailer Expected Profit (No Rebate) 1,600,000 1,400,000 1,200,000 Retaile r Ex pected Profit 1,000,000 800,000 600,000 400,000 200,000 0 500 1,000 1,500 2,000 2,500 3,000 3,500 3,654 4,110 4,567 4,547 Order ©Copyright 2002 D. Simchi-Levi
  40. 40. Retailer Expected Profit (No Rebate) 1,600,000 1,400,000 $1,370,096 1,200,000 Retaile r Ex pected Profit 1,000,000 800,000 600,000 400,000 200,000 0 500 1,000 1,500 2,000 2,500 3,000 3,500 3,654 4,110 4,567 4,547 Order ©Copyright 2002 D. Simchi-Levi
  41. 41. Manufacturer Profit (No Rebate) 6,000,000 5,000,000 Manufacturer Profit 4,000,000 3,000,000 2,000,000 1,000,000 0 0 00 00 00 00 00 00 54 10 67 47 61 74 88 01 14 28 41 55 50 0 0 5 5 0 5 6 1 5 5 9 3 7 2 6 0 4 8 1, 1, 2, 2, 3, 3, 3, 4, 4, 4, 4, 5, 5, 6, 6, 7, 7, 7, Order ©Copyright 2002 D. Simchi-Levi
  42. 42. Manufacturer Profit (No Rebate) 6,000,000 5,000,000 Manufacturer Profit 4,000,000 3,000,000 2,000,000 $1,750,000 1,000,000 0 0 00 00 00 00 00 00 54 10 67 47 61 74 88 01 14 28 41 55 50 0 0 5 5 0 5 6 1 5 5 9 3 7 2 6 0 4 8 1, 1, 2, 2, 3, 3, 3, 4, 4, 4, 4, 5, 5, 6, 6, 7, 7, 7, Order ©Copyright 2002 D. Simchi-Levi
  43. 43. Retailer Expected Profit ($100 Rebate) 1,800,000 1,600,000 1,400,000 1,200,000 Retailer Expected Profit 1,000,000 800,000 600,000 400,000 200,000 0 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,110 4,567 4,547 4,961 Order ©Copyright 2002 D. Simchi-Levi
  44. 44. Retailer Expected Profit ($100 Rebate) 1,800,000 $1,644,115 1,600,000 1,400,000 1,200,000 Retailer Expected Profit 1,000,000 800,000 600,000 400,000 200,000 0 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,110 4,567 4,547 4,961 Order ©Copyright 2002 D. Simchi-Levi
  45. 45. Manufacturer Profit ($100 Rebate) 6,000,000 5,000,000 Manufacturer Profit 4,000,000 3,000,000 2,000,000 1,000,000 0 0 0 0 0 0 0 0 0 7 7 1 4 8 1 4 8 1 5 8 00 50 00 50 00 50 00 11 56 54 96 37 78 20 61 02 44 85 26 1, 1, 2, 2, 3, 3, 4, 4, 4, 4, 4, 5, 5, 6, 6, 7, 7, 7, 8, Order ©Copyright 2002 D. Simchi-Levi
  46. 46. Manufacturer Profit ($100 Rebate) 6,000,000 5,000,000 Manufacturer Profit 4,000,000 3,000,000 2,000,000 $1,810,392 1,000,000 0 0 0 0 0 0 0 0 0 7 7 1 4 8 1 4 8 1 5 8 00 50 00 50 00 50 00 11 56 54 96 37 78 20 61 02 44 85 26 1, 1, 2, 2, 3, 3, 4, 4, 4, 4, 4, 5, 5, 6, 6, 7, 7, 7, 8, Order ©Copyright 2002 D. Simchi-Levi
  47. 47. Retailer Expected Profit (Reduced Wholesale Price $100 ) 1,800,000 1,600,000 1,400,000 1,200,000 Retailer Expected Profit 1,000,000 800,000 600,000 400,000 200,000 0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,110 4,567 5,024 Order ©Copyright 2002 D. Simchi-Levi
  48. 48. Retailer Expected Profit (Reduced Wholesale Price $100 ) 1,800,000 $1,654,508 1,600,000 1,400,000 1,200,000 Retailer Expected Profit 1,000,000 800,000 600,000 400,000 200,000 0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,110 4,567 5,024 Order ©Copyright 2002 D. Simchi-Levi
  49. 49. Manufacturer Profit (Reduced Wholesale Price $100) 5,000,000 4,500,000 4,000,000 Manufacturer Profit 3,500,000 3,000,000 2,500,000 2,000,000 1,500,000 1,000,000 500,000 0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,110 4,567 5,024 4,961 5,374 5,788 6,201 6,614 7,028 7,441 7,855 Order ©Copyright 2002 D. Simchi-Levi
  50. 50. Manufacturer Profit (Reduced Wholesale Price $100) 5,000,000 4,500,000 4,000,000 Manufacturer Profit 3,500,000 3,000,000 2,500,000 $1,800,000 2,000,000 1,500,000 1,000,000 500,000 0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,110 4,567 5,024 4,961 5,374 5,788 6,201 6,614 7,028 7,441 7,855 Order ©Copyright 2002 D. Simchi-Levi
  51. 51. Mail-in-Rebate Strategy Retailer Manufacturer Total No Rebate 1,370,096 1,750,000 3,120,096 With Rebate ($100) 1,644,115 1,810,392 3,454,507 Reduce Wholesale P ($100) 1,654,508 1,800,000 3,454,508 Global Optimization 3,929,189 ©Copyright 2002 D. Simchi-Levi
  52. 52. Managerial Insights • Mail in Rebate allows supply chain partners to move away from sequential strategies toward global optimization – Provides retailers with upside incentive • Mail in Rebate outperforms wholesale price discount ©Copyright 2002 D. Simchi-Levi
  53. 53. Smart Pricing • Customized Pricing – Revenue Management Techniques • Distinguish between customers according to their price sensitivity – Influence retailer pricing strategies – Move supply chain partners toward global optimization ©Copyright 2002 D. Simchi-Levi
  54. 54. Smart Pricing • Dynamic Pricing – Changing prices over time without necessarily distinguishing between different customers – Find the optimal trade-off between high price and low demand versus low price and high demand ©Copyright 2002 D. Simchi-Levi
  55. 55. When does Dynamic Pricing Provide Significant Profit Benefit? • Limited Capacity • Demand Variability • Seasonality in Demand Pattern • Short Planning Horizon ©Copyright 2002 D. Simchi-Levi
  56. 56. The Internet makes Smart Pricing Possible • Low Menu Cost • Low Buyer Search Cost • Visibility – To the back-end of the supply chain allows to coordinate pricing, production and distribution • Customer Segmentation – Difficult in conventional stores and easier on the Internet • Testing Capability ©Copyright 2002 D. Simchi-Levi

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