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Risk, Disruption and Resilient Supply

Chain
Course Outline
• Introduction to Supply Chain Risks and
disruption, Sources of Risks, their characteristics,
supply chain ripple effect, the bullwhip effect,
disruption tails, and disruption overlays.

• Supply Chain Risk management, Managing


demand risks, Risk pooling, Mitigating supply
risks, Multi-sourcing, Nearshoring, Responsive
Network Design, Process flexibility, Role of
Time-to-Recover (TTR), and Time-to-Survive
(TTS). Methods for managing supply chain risks.

• Modeling Supply Chain Resilience, Measuring


Supply Chain Resilience
Reference Book

• Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th
Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky.
McGraw Hill Education. Copyright © 2022

• Introduction to Supply Chain Resilience: Management, Modelling, Technology by Dmitry


Ivanov. Springer Nature, 2021.

• Matching Supply with Demand: An Introduction to Operations Management, by Cachon and


Terweish, McGraw Hill Education.
Mid-Term Exam 20%

End-Term Exam 40%

Grading and Project


Evaluation 20%

Assignment, Quiz/Class participation


20%

Total
100%
Some key points about Supply Chain
Every supply chain should focus on seven rights: the right product to the right
customer at the right time in the right quantity with the right quality at the
right place and at the right cost.

The key to the success of a supply chain is responsiveness (agile supply


chain) and efficiency derived from cost-saving measures.

A supply chain is as strong as its weakest link.

Humanitarian supply chains, such as oxygen supply during the pandemic in


India, require innovative measures to ensure high speed of supply chain
replenishments. Delays are unacceptable as these may cause human lives.
Present’s Scenario of Supply Chain

• Increased dependencies • Increased number of • Decreased transparency in


amongst partners in the partners in the supply supply chain relationships
supply chain chain

• Increased new product • Increased changes in


introductions coupled supply chain design
with increased (network planning,
customization of products routing, distribution)
Factors That Make Supply Chains Riskier
• Increased globalization • Additional regulatory • Increased levels of economic
through outsourcing compliance imposed by uncertainty and market
government entities, further volatility
complicating international
trade

Demanding customers that


• Shorter product life cycles and create additional time-to-market • Supply side capacity
rapid rates of technology pressures by requiring better constraints, making it more
change on-time delivery, higher order fill difficult to meet demand
rates, and improved service level requirements
efficiencies

Complex networks of suppliers


• Natural disasters and external and third-party service
environmental events providers, as well as large
interdependencies among
multiple firms, which increase
the need to coordinate risk
Types of Risks in Supply Chain (based on impact severity)

Source: Introduction to supply chain resilience: Management, modelling, technology, by Dmitry Ivanov. Springer Nature , 2021.
Recent Supply Chain Disruptions
Recent Disruptions

Kaga Toshiba Electronics, the Toshiba subsidiary responsible for manufacturing power semiconductors, has
halted production with no restart date scheduled.

LCD panel and substrate maker Eizo has seen partial damage to its buildings and equipment in addition to
water and electricity cuts.
Recent Disruptions

Warning on Red Sea Ships: Houthis warned of attacks on Israeli-bound ships in the Red Sea. The Red Sea is a major route for
oil and fuel shipments globally.

Support for Palestinians:


Houthi actions aimed at supporting Palestinians facing Israeli aggression and siege in Gaza
Impact on Red Sea Shipping (December 2023)

Decrease in Ship Traffic: Shipping Companies' Response: Reasons for Rerouting:


Ship traffic in the Red Sea decreased by Some companies suspended operations. Security Concerns: Houthi attacks raised
20% in December 2023. Others shifted routes to the Cape of security concerns.
Good Hope. Geostrategic Shift: Rerouting aimed at
avoiding the volatile Red Sea region.
Impact

Container Ship Decrease: Key Companies' Response:


According to MarineTraffic data, the number of container Lloyd’s List Intelligence reported significant
ships passing through the Red Sea in December 2023 responses from major industry players post-
decreased by 25% compared to December 2022. attacks in the Babu'l Mendep Strait.
Notable companies, including:
• Maersk (Danish, world's largest container
company)
• MSC (Mediterranean Shipping Company,
Italian-Swiss)
• Hapag-Lloyd (German)
• CMA CGM (French)
• BP (British energy company)
• Disruption: Rerouting and suspension
impacted global trade.
• Delays and Increased Costs: Longer routes
led to delays and higher operational costs.
Impact • Regional tensions.
• Regional Instability: Challenges in
maintaining stability in the Red Sea amid
conflicts.
• 1. Suez Canal Blockage (2021):
- Ever Given container ship blocked the Suez
Canal, disrupting global maritime trade.
• 2. COVID-19 Pandemic (Ongoing):
Recent - Pandemic-related lockdowns, labor
Supply shortages, and transportation challenges
Chain impacting supply chains globally.

Disruptions • 3. Red Sea Rerouting (December 2023):


- Houthi attacks led to a 20% decrease in Red
Sea ship traffic, affecting shipping routes and
global trade.
Recent Supply Chain Disruptions
• 4. Chip Shortage (Ongoing):
- Semiconductor supply chain disruptions affecting various industries, especially
automotive.
• 5. Global Shipping Container Shortage (Ongoing):
- Imbalance in container availability, leading to delays and increased shipping costs.
• 6. Texas Winter Storm (2021):
- Severe weather in Texas disrupted energy supply chains, impacting oil and gas
production.
Types of Risks in Supply Chain (based on impact severity)

Source: Introduction to supply chain resilience: Management, modelling, technology, by Dmitry Ivanov. Springer Nature , 2021.
Supply Chain Risk and Risk Management

Supply chain risk is defined as the likelihood and consequence of events


occurring at any point along the supply chain, from raw material sources to
end-users (customers).

A set of activities that are coordinated in order to direct and control the end-to-
end supply chain of a business in terms of S.C. risks is known as supply chain
risk management.
Types of Planning in SC
Strategic levels planning decisions have a long-lasting effect on the organization

For example,
• decisions regarding product design
• what to make internally and what to outsource,
• selection of the suppliers,
• strategic partnering,
• decisions on the number, location and capacity of warehouses, and
manufacturing plants.

These decisions are very useful to establish the future direction of the
organisation, as it usually contains the organization's vision, mission, goals and
key measures of success. Source: Chapter 1: Designing and managing the Supply chain
Types of Planning in SC
Tactical level Planning decisions includes decisions that are typically updated
between once every quarter and once every year.

These are related to:


• purchasing
• production decisions
• inventory policies
• transportation strategies
• the frequency with which customers are visited.
Source: Chapter 1: Designing and managing the Supply chain
Types of Planning in SC
Operational level planning decisions refers to day-to-day decisions within the
organization.

For example,
• scheduling
• lead time
• quotations
• routing
• truck loading
Source: Chapter 1: Designing and managing the Supply chain
Interrelations of uncertainty, risk, disturbance, and disruption
(Dmitry Ivanov 2018a)
Interrelations of uncertainty, risk, disturbance, and
disruption (Ivanov 2018a)
1. Uncertainty:

It is a system property characterizing the incompleteness of our knowledge


about the system, its environment, and the conditions of its development.

2. Risk :

Risk arise from uncertainty. Risks can be identified, analyzed, controlled, and
regulated.

According to March and Shapira (1987), risk is a product of the probability of occurrence of a
negative event and the resulting amount of damage or impact.
Interrelations of uncertainty, risk, disturbance, and
disruption (Ivanov 2018a)
3. Disturbance
A disturbance is the consequence of risks.

Disturbance may cause a deviation (disruption) in the supply chain or not (e.g., a
supply chain can be robust and adaptive enough to overcome the disturbance).

4. Disruption
Operational disruption (e.g., a decrease in fill rate due to some demand fluctuation) or severe
disruptions (e.g., supplier unavailability or market disruption) are the results of disturbance
influences.
They may affect operations, processes, plans, network structures, goals, or strategies. To adjust
the supply chain in the case of deviations, adaptation measures need to be taken.
Supply Chain Risks
From the perspective of impact severity, different types of risks
in the supply chain can be classified into:

Areas of demand, supply, process, and structure entailing a


generalized separation in operational and disruption risks.

Operational and disruption risks are also also referred to as


LIHF (low-impact, high frequency) and HILF (high-impact,
low-frequency) risks.
.
Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology by Dmitry Ivanov. Springer Nature, 2021
SC Risk Type (Generalized Classification): Operational and
disruption
Low Impact High Frequency (LIHF) risks
of demand and supply uncertainty are
related to random uncertainty and
business-as-usual situation.

Such risks are also known as recurrent or


operational risks (Tang 2006; Chopra et
al. 2007).

Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology by Dmitry Ivanov. Springer Nature, 2021.
Recurrent Risks
Re-current risks are often smaller in scale and cause temporary breakdowns in supply
chain streams.

Recurrent risks often come in the form of:

• Inadequate reporting on inventory and capacity.


• Demand fluctuations based on customer needs.
• Events such as seasonal weather.
Source: https://blog.flexis.com/recurrent-vs.-disruptive-supply-chain-risks
Disruption Risks
The second and more severe category of breakdown is called disruptive supply chain
risks
Disruptive risks most often present in:

•Large-scale natural disasters or weather events, such as earthquakes and floods.


•Resource availability, like Port or labor strikes, damage to facility, and major
equipment failures.
•Regional political, ethnic, or religious conflicts, protests, and unrest.
Source: https://blog.flexis.com/recurrent-vs.-disruptive-supply-chain-risks

Drought, floods, freezing temperatures, severe storms, tropical cyclones, wildfires, winter storms
Disruption supply chain risks
Disruption is considered an HILF (High Impact Low Frequency) event.

There are three different kinds of disruptions.

1. Random disruptions belong to the category of known-known uncertainty,


i.e., we know which events can happen, when they can happen, and how
likely they are.

For example, each summer, countries in Southeast Asia and the associated
supplier locations are hit by typhoons.

Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology by Dmitry Ivanov. Springer Nature, 2021.
Disruption supply chain risks
2. The hazard disruptions are close to known-unknown uncertainty, i.e., we
know which events can happen but we do not know when they would happen
and what their impact is.

An example is the continuously existing danger of earthquakes in Japan, which is


however hardly predictable.

Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology by Dmitry Ivanov. Springer Nature, 2021 .
Disruption supply chain risks
3. The deep disruptions are related to the unknown-unknown uncertainty, i.e.,
we do not know what can happen and when, and what the consequences are.

The deep disruptions represent the most complex case for decision-making.

One example for deep disruption is the COVID-19 pandemic


Examples of Disruptions in Supply chain

Factor Example Impact


Earthquake in Thailand, 1999 Apple computers’ production in Asia has been paralyzed

Flood in Saxony, 2002 Significant production decrease at Volkswagen

Natural disasters (i.e. Earthquake in Japan, 2007 Production breakdown in Toyota’s supply chains
floods, earthquake, amounted to 55,000 cars
tsunami, Hurricane ) Earthquake and tsunami in Japan, 2011 Massive collapses in global automotive and electronics
supply chains; Toyota lost its market leadership position

Floods in Chennai, India, in 2015 Production of academic literature has been stopped at
many international publishing houses
Examples of Disruptions in Supply chain
Factor Example Impact
Terrorism September 11, 2001 Five Ford plants have been closed for a long time

Disruptions in many supply chains

Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology by Dmitry Ivanov. Springer Nature, 2021.
Examples of Disruptions in Supply chain
Factor Example Impact
Epidemics and COVID-19 global pandemic in 2020–2021 Worldwide disruptions in supply and demand,
pandemics devastating effects in many global and local supply
chains; ripple effects; supply chain collapses and
long-term performance degradation
Man-made disasters Transportation disruption in Suez Canal in Many ripple effects in global supply chains due to
March 2021 delayed deliveries and destabilization of the global
shipment schedules
Examples of Disruptions in Supply chain
Factor Example Impact
Strikes Strikes at Hyundai plants in 2016 Production of 130,000 cars has been affected
Legal contract Disputes Volkswagen and Prevent Group Six German factories face production halt on parts
contract dispute in summer 2016 shortage; 27,700 workers were affected, with some
sent home and others moved to short-time working
Ripple Effect
In several contexts, disruptions can be localized without an associated cascading
effect throughout a network.

However, in other situations, disruptions in a supplier base propagate to


downstream supply chain networks, adversely impacting the performance of
individual firms and networks.

Definitions of Ripple Effect


DF1:- Ripple effect describes the disruption propagation in the supply chain
network entailing unavailability of components at different SC networks and an
associated performance degradation.
Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology by Dmitry Ivanov. Springer Nature, 2021.
Ripple Effect
A ripple effect occurs when an initial disturbance to a system propagates
outward to disturb an increasingly larger portion of the system, like ripples
expanding across the water when an object is dropped into it.

Source: https://savvy.directorprep.com/blog/the-ripple-effect
Ripple Effect Definition Source: Ivanov, D. (2018b).

DF2:- According to Dolgui et al. (2020), the ripple effect “refers to structural
dynamics and describes a downstream propagation of the downscaling in
demand fulfilment in the supply chain as a result of a severe disruption.”

DF3:- Ivanov et al. (2014b) state that the “ripple effect describes the impact of a
disruption on supply chain performance and disruption-based scope of changes
in the supply chain structures and parameters.”

These definitions imply that the ripple effect refers to multi-stage networks and
triggering failures in the network elements as a domino or cascading effect.
Examples of Ripple Effect Source: Ivanov, D. (2018b).

Example :

The earthquake and tsunami in Japan in 2011 disrupted multiple suppliers in the
automotive industry and led to production breaks and material shortages
worldwide, leading to numerous ripple effects in global supply chains.

Two examples of a ripple effect triggered by COVID-19 immediately after the


epidemic outbreak.

Fiat Automobiles halted production at a car factory in Serbia in response to being


unable to receive parts from China.
Reasons for Ripple Effect

Source: Ivanov, D. (2018b). Revealing interfaces of supply chain resilience and sustainability: A simulation study.
International Journal of Production Research, 56(10), 3507–3523
Reasons and Countermeasures for the Ripple Effect
Reasons Supply chain Ripple effect impact Countermeasures
designs
Single Sourcing In the non-disrupted scenario, it is Multiple/dual
irrational to avoid lean practices. At the sourcing/ backup
same time, a capacity disruption may suppliers
Leanness Low Inventory result in the ripple effect and Risk mitigation
performance decreases inventory
Inflexible Postponement
capacity

Source: Ivanov, D. (2018b).


Reasons and Countermeasures for the Ripple Effect

Reasons Supply chain Ripple effect impact Countermeasures


designs
Globalization Without a coordinated contingency policy, Geographical sourcing
disruption recovery and performance impact diversification
estimation can be very long lasting and expensive.

Decentralization Identify disruptions, and adjust order allocation


Complexity
Multi-stage supply rules using a coordinated contingency policy. Supplier segmentation
chains according to disruption
Effective end-to-end digital integration and risks
coordination across various partners in SC
networks

Source: Ivanov, D. (2018b).


Bullwhip effect

Variability of demand amplified as we move up the supply chain from the


retailer to the distributor to the manufacturer to the suppliers
P&G - Supply Chain Dynamics & Complexity
Impact of Bullwhip Effect

• Poor customer service due to unavailable products


• Increased inventory
• Express shipments
• Overtime production and idle scheduling of production
• Excessive or inadequate capacity
How to manage Bullwhip effect
Disseminate sales, capacity, and inventory information to reduce
gaming

To share data, use electronic data interchange (EDI) and the internet

Transfer of point-of-sale data to distributors and manufacturers

Use direct selling strategies (home-to-home and person-to-person)


to get downstream demand information

Share consumption information with upstream members


Source: Designing and managing the Supply chain book
Difference between ripple effect and bullwhip effect Source: Ivanov, D. (2018b).

Feature Ripple Effect Bullwhip effect


What uncertainty? Hazard, deep uncertainty (close to known- Random uncertainty (known-known
known uncertainty or unknown-known uncertainty)
uncertainty)
What risks? Disruption, exceptional risks (e.g. a plant Operational, recurrent risks (e.g.
explosion) demand fluctuation)

What can be disturbed? Structures and critical performance (such as Operational parameters such as lead
supplier unavailability or revenue) time and inventory

How are deviations prevented? Flexibility Information coordination

What happens after the Short-term stabilization and middle- and long- Short-term coordination to balance
disturbance? term recovery; high coordination efforts and demand and supply
investments
What is performance impact? Output performance can decrease, such as in Current operational performance can
annual revenues or profits decrease such as in daily or weekly
stock out/overage costs
Risk Pooling
Risk pooling is an important concept in supply chain management.

Risk pooling suggests that demand variability is reduced if one


aggregates demand across locations because as demand is aggregated
across different locations, it becomes more likely that high demand
from one customer will be offset by low demand from another.

This reduction in variability allows a decrease in safety stock and


therefore reduces average inventory.
Risk Pooling
Types of Risk
Pooling
• Location Pooling
• Lead time pooling
• Product Pooling
• Capacity Pooling
Types of Risk Pooling
• Location pooling refers to the practice of pooling. Demands from
separate geographic markets (e.g., combining the inventory from
stores in two different physical locations).

• Product pooling, on the other hand, refers to the practice of meeting


demand for multiple distinct products with a single, “universal”
product capable of satisfying the needs of all customers.

• Lead Time Pooling


or Delayed Differentiation: Addresses the problem of uncertainty
associated with product variety by making it possible to differentiate
the product in the last stages before it reaches the customers
Product Pooling: Universal Design
Two Hammer 3/2 wetsuits are available from O'Neill, both of which are
indistinguishable from one another save for the silk-screened logo.

Hammer 3/2 Surf Hammer 3/2 Dive

O'Neill might streamline its product line by adopting a single Hammer 3/2 suit, or
"Universal Hammer," instead of two separate designs.
Risk Pooling
For the same service level, which system will require more
inventory? Why?

For the same total inventory level, which system will have
better service? Why?

What are the factors that affect these answers?


ACME Case Study: Risk Pooling

ACME, a company that produces and distributes electronic


equipment in the Northeast of the United States, faces a
distribution problem. The current distribution system
partitions the Northeast into two markets, each of which has a
single warehouse. One warehouse is located in Paramus, New
Jersey, and the second is located in Newton, Massachusetts.
Customers, typically retailers, receive items directly from the
warehouses; in the current distribution system, each customer
is assigned to a single market and receives deliveries.
Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
The warehouses receive items from a manufacturing facility
in Chicago. The lead time for delivery to each of the
warehouses is about one week, and the manufacturing facility
has sufficient production capacity to satisfy any warehouse
order. The current distribution strategy provides a 97 percent
service level; that is, the inventory policy employed by each
warehouse is designed so that the probability of a stockout is
3 percent. Of course, unfilled orders are lost to the
competition and thus cannot be satisfied by future deliveries.

Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
ACME is considering the following alternative strategy:
Replace the two warehouses with a single warehouse
located between Paramus and Newton that will serve all
customer orders. We will refer to this proposed system
as the centralized distribution system. The CEO insists
that the same service level, 97 percent, be maintained
regardless of the logistics strategy employed.

Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
Obviously, the current distribution system with two
warehouses has an important advantage over the single
warehouse system because each warehouse is close to a
particular subset of customers, decreasing delivery time.
However, the proposed change also has an important
advantage; it allows ACME to achieve either the same service
level of 97 percent with much lower inventory or a higher
service level with the same amount of total inventory.

Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
• Intuitively, this is explained as follows. With random
demand, it is very likely that a higher-than-average demand
at one retailer will be offset by a lower-than-average
demand at another. As the number of retailers served by a
warehouse goes up, this likelihood also goes up. Indeed, this
is precisely the third principle of all forecasts described at
the beginning of Section 3.2.2: aggregate forecasts are more
accurate. How much can ACME reduce inventory if the
company decides to switch to the centralized system but
maintain the same 97 percent service level?

Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
• To answer that question, we need to perform a more rigorous
analysis of the inventory policy that ACME should use in both the
current system and the centralized system. We will explain this
analysis for two specific products, Product A and Product B,
although the analysis must be conducted for all products.
• For both products, an order from the factory costs $60 per order, and
holding inventory costs are $0.27 per unit per week. In the current
distribution system, the cost of transporting a product from a
warehouse to a customer is, on average, $1.05 per product. It is
estimated that in the centralized distribution system, the
transportation cost from the central warehouse will be, on average,
$1.10 per product. For this analysis, we assume that delivery lead
time is not significantly different in the two systems.
Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
• Tables 3-5 and 3-6 provide historical data for Products A and
B, respectively. The tables include weekly demand
information for each product for the last eight weeks in each
market area. Observe that Product B is a slow-moving
product: the demand for Product B is fairly small relative to
the demand for Product A. Table 3-7 provides a summary of
average weekly demand and the standard deviation of weekly
demand for each product. It also presents the coefficient of
variation of demand faced by each warehouse.

Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
This is defined as follows:

It is important at this point to understand the difference between the


standard deviation and the coefficient of variation, both of which provide a
measure of the variability of customer demand. Indeed, while the standard
deviation measures the absolute variability of customer demands, the
coefficient of variation measures variability relative to average demand.
For instance, in the case of the two products analyzed here, we observe that
Product A has a much larger standard deviation while Product B has a
significantly larger coefficient of variation. This distinction between the
two products plays an important role in the final analysis.
Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
Finally, note that for each product, the average demand faced
by the warehouse in the centralized distribution system is the
sum of the average demand faced by each of the existing
warehouses. However, the variability faced by the central
warehouse, measured either by the standard deviation or the
coefficient of variation, is much smaller than the combined
variabilities faced by the two existing warehouses. This has a
major impact on inventory levels in the current and proposed
systems. These levels, calculated as we have described in
previous sections, are shown in Table 3-8.

Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
• Notice that the average inventory for Product A at the warehouse in
Paramus, New Jersey, is about

Similarly, average inventory at the Newton, Massachusetts, warehouse


for the same product is about 91 units, while average inventory in the
centralized warehouse is about 132 units. Thus, the average inventory
for Product A is reduced by about 36 percent when ACME shifts from
the current system to the new, centralized system—a significant
reduction in average inventory.
Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
Benefits of Risk Pooling
• Centralizing inventory control reduces both safety stock and average
inventory level for the same service level.
• Intuitively, in a centralized distribution system, whenever demand
from one market area is higher than average while demand in another
market area is lower than average, items in the warehouses that are
originally allocated for one market can be reallocated to the other.
• This reallocation process is not possible in a decentralized system
where different warehouses serve different markets.

Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
• The higher the coefficient of variation, the greater the
benefit obtained from centralized systems; that is, the
greater the benefit from risk pooling. This is explained
as follows. Average inventory includes two
components: one proportional to average weekly
demand (Q) and the other proportional to the standard
deviation of weekly demand (safety stock). Since the
reduction in average inventory is achieved mainly
through a reduction in safety stock, the higher the
coefficient of variation, the larger the impact of safety
stock on inventory reduction.
Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
• The benefits from risk pooling depend on the behavior of
demand from one market relative to demand from another.

• We say that demand from two markets is positively


correlated if it is very likely that whenever demand from
one market is greater than average, demand from the other
market is also greater than average. Similarly, when demand
from one market is smaller than average, so is demand from
the other. Intuitively, the benefit from risk pooling
decreases as the correlation between demand from the
two markets becomes more positive.
Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
Lead Time Pooling: Delay
Differentiation
DESMISE OF MOBILE RECHARGE COUPONS IN INDIA: A
CLASSIC CASE OF DELAYED PRODUCT
DIFFERENTIATION
Till early 2006, Indian prepaid mobile phone users were offered different denominations of recharge
coupons for recharging their mobile phones for talk time at the retailer shop.

Due to many varieties of denominations, the supply chain of recharge coupons was overloaded with these
coupons at different supply chain stages, such as service provider, distributor, retailer, etc.

Despite huge inventory, customers always complained about the non-availability of other denominations
that they were looking for.

This was due to the working capital limitation of a large number of small retailers who could not afford to
keep sufficient inventory of all denominations or maintain frequent replenishment from distributors.
DESMISE OF MOBILE RECHARGE COUPONS IN INDIA: A CLASSIC
CASE OF DELAYED PRODUCT DIFFERENTIATION

Of late, service providers have come up with an e-recharge system, through which a
retailer can refill the customer’s mobile talk-time account with any denomination
through electronic mode.

This completely arrested the existing twin problem of physical inventory for some
denominations along with the stock-out situation for the remaining denominations.

The technological possibility of having a single machine at the retailer level to


electronically generate the coupons of any denomination of any service provider has
revitalized this industry.
DESMISE OF MOBILE RECHARGE COUPONS IN INDIA: A CLASSIC CASE OF
DELAYED PRODUCT DIFFERENTIATION

• The delayed differentiation in deciding the


denomination till the time the customer places
an order is one of the finest examples of
moving the push- pull boundary towards the
customer end in the supply chain, which has
solved the twin problem of inventory and
stock-outs.
Push and Pull based Supply Chain
Aspect Push Supply Chain Pull Supply Chain

Initiation of Production Based on Forecasted Demand Triggered by Actual Customer Orders


Inventory Management High Levels of Inventory Low Levels of Inventory

Production Planning Production Planning is Forecast-Driven Production Planning is Demand-Driven


Lead Time Longer Lead Times Shorter Lead Times

Flexibility Less Flexible to Market Changes More Adaptive to Market Changes


Order Fulfillment Speed Slower Order Fulfillment Faster Order Fulfillment
May Have Issues with Meeting Customer
Customer Satisfaction Demand Better Ability to Meet Customer Demand
Risk of Overstock Higher Risk of Overstocking Lower Risk of Overstocking
Less Dependent on Real-Time Information More Dependent on Real-Time Information
Technology Dependence Systems Systems
Just-In-Time Manufacturing (e.g., Toyota
Examples Traditional Manufacturing (e.g., Apparel) System)
Case: Asian Paints Mastered the management of
Push-Pull Supply Chain
• Asian Paints Limited (APL) is the largest paint company in
India. It is the third largest in Asia and ninth largest in the
world. According to Bloomberg, in December 2021, Asian
Paints achieved the distinction of being the second-largest
paint company in the world with a market capitalization of
$46.2 billion, which is only next to Sherwin-Williams.

Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
Asian Paints Mastered the management of Push-Pull
Supply Chain
BACKGROUND

• Asian Paints started in 1942 as a partnership firm by four friends: Mr. Champaklal H.
Choksey, Mr. Chimanlal N. Choksi, Mr. Suryakant C. Dani, and Mr. Arvind R. Vakil.
• They started making paints in a garage. During World War II, there was a temporary
ban on import of paints. The crisis in the paint market was an opportunity for Asian
Paints.
• It captured this opportunity with both hands and started fulfilling orders. In 1945, this
partnership firm became a private limited company, which was named as Asian Oil
and Paint Co. Pvt. Ltd.
• In these initial days, APL concentrated on its supply chain to cater to the needs of
smaller and mid-cities of India as these markets were ignored by then-leading players
in the paint business, such as British Paints and Jenson & Nicholson.
• Year 1957 was an important year for APL as it started its plant in Bhandup, Mumbai.
It also came up with good-quality paint using phenolic and maleic acid resins.
Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
Asian Paints Mastered the management of
Push-Pull Supply Chain
BACKGROUND
In 1967, APL got the distinction of becoming the largest paint company in
India. Since then, this top position remained glued to APL. Much of its intense
growth should be attributed to the induction of visionary professionals such as
P. M. Murthy and K. B. S. Anand, both of whom joined APL in the 1970s.
As per the Integrated Report 2020-21 of APL, the following statement speaks
volumes about APL’s business intent: At Asian Paints, we are in the business of
creating a fresh meaning for every space we touch, with a commitment towards
making a difference and improving lives.

Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
Asian Paints Mastered the management of Push-Pull
Supply Chain
The operational capacity of APL is 1,730,000 KL of paints per annum
(as of 2020-21), which comes through 26 paint manufacturing plants
spanning over 14 countries and serving consumers in over 60
countries.
In India, the major manufacturing plants are located at Rohtak in
Haryana (plant production capacity (PPC) 400,000 KL/year), Khandala
in Maharashtra (PPC 300,000 KL/year), Mysuru in Karnataka (PPC
300,000 KL/year), Visakhapatnam in Andhra Pradesh (PPC of 300,000
KL/year), Sriperumbudur in Tamil Nadu (PPC 140,000 KL/ year),
Ankleshwar in Gujarat (PPC 130,000 KL/ year), Patancheru in
Telengana (PPC 80,000 KL/ year), and Kasna in Uttar Pradesh (PPC of
89,000 KL/year).
Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
Asian Paints Mastered the management of Push-Pull
Supply Chain

• Technologies involving Industry 4.0 are used at the plants for better management
of their supply chain. Data-driven analytics help in predictive and prescriptive
analytics. The focus of manufacturing facilities is on capacity utilization, system
flexibility, operational scalability, human safety, and business sustainability.
• Sensors on different machines churn out data related to the material used,
manufacturing parameters, etc.
• Using analytics frameworks, these real-time data help APL in optimizing cost
and manufacturing performance, such as cycle time reduction, carbon footprint
reduction, and material cost reduction. In addition, the analytics help in
managing its entire distribution network.
Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
SUPPLY CHAIN OF ASIAN PAINTS
The supply chain of APL offers a wide range of paints, both for decorative and industrial segments. In fact, in
the decorative paint market, APL has a market share of over 40 percent in India. Five important market forces
have played their role in driving the demand side of APL’s supply chain. These are:

1. The aspiration of retail consumers, as well as industry users, has grown considerably in recent years.

2. The average frequency with which home- painting is undertaken has gone up in recent years, and now it is
close to an average of 4-5 years in India.

3. The Government of India has undertaken many initiatives to provide homes to the homeless
(Pradhanmantri Awas Yojana), incentivizing rural and BPL (below the poverty line) populations to have
cemented (pucca) homes, etc.
Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
SUPPLY CHAIN OF ASIAN PAINTS

4. As of February 2022, from a 28 percent slab of GST, the paint industry has come to a much lower
slab of 18 percent GST.

5. A lot of industry demand is coming from the reality and construction sector, which is being
fuelled through low housing loans.

In addition, there are a few other important offerings of APL such as wall coverings, adhesives, and
services. In the downstream of its supply chain, in 2020-21, there were over 70,000 dealers in India,
18 Beautiful Homes Stores, and over 450 Colour Ideas stores. Compared with around 35,000
dealers in 2013-14, the expansion of dealers’ network of APL is phenomenal.
Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
• From factories, mainly base paints are shipped to about 150
company warehouses, which directly ship paint to dealers or
hardware stores, which also perform the role of dealer in the
APL’s supply chain.
• These hardware stores are like mom-and-pop stores. Most
SUPPLY retail consumers hire painters or contractors for their
CHAIN OF requirements. These painters and/or contractors are the
supply chain link between consumers and dealer/hardware
ASIAN stores. The order fulfillment and replenishment cycle of APL
is one of the very best in India. The business model aims to
PAINTS have same-day delivery to dealers. Thus, the procurement
lead time of dealers is very short. As a golden rule or guru
mantra of the supply chain, under demand uncertainty, a
shorter procurement lead time means lesser stock at the
dealer’s shop.

Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
SUPPLY CHAIN OF ASIAN PAINTS

APL follows a system called as “direct to dealer” distribution network.

Thus, due to the short and reliable procurement lead time of dealers, they
are able to manage their stores with very little inventory.

Yet they are able to ensure a very high service level.

Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
DEMAND SCENARIO IN THE PAINT INDUSTRY
Demand management is very complex in the paint industry. This is mainly due to the following reasons:

(a) Paint demand is highly seasonal in India. This is driven by festivals such as Deepawali, etc. It also depends upon
weather conditions, local issues, personal preference, and demography.

(b) The shelf life of a majority of paints is shorter. This means that it is a more perishable product than many other
FMCG products.

(c) There is a large number of colors and shades (called stock keeping units or SKUs) in the catalog of paint offered to
consumers.

(d) The paint business is also driven by local painters and contractors, whose availability affects the demand. For
example, during the COVID-19 time, many such labourers migrated from big and mid-size cities to their hometowns.
Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
MAGIC OF PUSH-PULL SUPPLY CHAIN OF ASIAN
PAINTS

In earlier times, due to a large number of shades and colors, there was always a great
possibility of witnessing a huge inventory of one SKU (say, dark green paint), and
simultaneously, at the same time, there existed a huge stock out of another SKU (say,
light green paint). This is due to changing customer preference and unpredictability in
demand. From the supply chain point of view, both inventory and stock-outs are
financial losses.

While, inventory has a carrying cost, stock-outs have an opportunity cost of not making
profit, which APL could have made, had there been no stock-outs.

Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
MAGIC OF PUSH-PULL SUPPLY CHAIN OF ASIAN PAINTS

To manage such a situation, APL now uses a dealer tinting machine (DTM), which is a coloring
machine available to the dealers of APL.

In the early 1990s, DTM concepts and technology were brought to India by another paint
company, Jenson and Nicholson, but soon, from the mid-1990s, APL started arming its dealers
with DTM. The number of dealers with DTM has exceeded 45,000 by the year 2021-21.

The purpose of arming dealers with DTM is to implement a supply chain strategy called a
delayed product differentiation or postponement strategy. From the factory, base paint,
which is a generic product, reaches the dealers via local distribution centers or depots.
Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
MAGIC OF PUSH-PULL SUPPLY CHAIN OF ASIAN
PAINTS

Only when a customer order is frozen at the dealer shop, the ordered quantity of
base (or white) paint is put into the DTM machine. A typical DTM has the facility
to mix three colors and 16 colorants into the base paint.

The requisite quantity of colour and colourants is mixed with the base paint by a
computerized system. This system is fed with the customer’s ordered quantity and
code of the selected shade, which is displayed in a colour catalogue, available with
the dealer. After mixing the base paint with colour and colourants, it is stirred and
packed at the dealer shop. Over 5,000 different shades of paints (called SKUs) can
be produced from a single base paint by using a DTM.
Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
MAGIC OF PUSH-PULL SUPPLY CHAIN OF ASIAN PAINTS

With DTM at the dealer’s shop, two things happen simultaneously:

1. Stock-outs are rare now as the base-paint stock can be converted into any of the
available 5,000 SKUs demanded by customers after looking at the shade catalog of APL.

Therefore, the supply chain downstream of the decoupling point, which is DTM for this
case of APL, is the demand-driven or pull-type supply chain.

This part of the supply chain behaves as a make-to-order supply chain. This feature of
APL’s supply chain is the hallmark of a just-in-time or lean supply chain.
Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
MAGIC OF PUSH-PULL SUPPLY CHAIN OF ASIAN PAINTS

The upstream of the push-pull boundary,


As we have learned from a guru mantra in
where the DTM machine is located, is a
Chapter 2, the aggregate forecast is more
forecast-driven supply chain. But, most
accurate than the disaggregate forecast,
importantly, the forecast is for the generic
and the upstream forecast of base paint is
base paint, which encapsulates the
quite accurate.
demand of all SKUs downstream of DTM.

For a given uncertainty in customers’


demand, the average stock of base paint at
Postponement strategy, which is facilitated the dealer’s shop, which has a DTM, is
through the DTM at the push-pull much lesser than the total sum of the
boundary, is one of the major winning average stocks of different shades and
strategies of Asian Paint in its supply colours, had there been no DTM with the
chain. dealer. This fact was demonstrated and
established through the risk-pooling
concept in Chapter 2.

Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
A few learning lessons or guru mantras of this case study are as
follows:
• GM-1: Delayed product differentiation (postponement strategy) helps a ‘push-based supply
chain portion’ and a ‘pull-based supply chain portion’ to coexist within the same supply
chain.
• GM-2: The upstream of the push-pull boundary is a forecast-driven system, for which the
greatest advantage comes by virtue of forecasting accuracy coming through an aggregate
forecast of the generic product.
• GM-3: The downstream of the push-pull boundary is nearer to the point of sale. Therefore,
the demand-driven downstream behaves close to a just-in-time system. Here, the customized
products (such as different SKUs of paints) are managed as make-to-order, rather than make-
to-stock.
• GM-4: At the push-pull boundary, there is a need to have a strategic inventory of generic
products (like the base paint). This strategic inventory helps the planning at either side of the
push-pull boundary get decoupled. For this reason, this push-pull boundary is also called a
decoupling point.
Source: Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies (4th Edition) by David Simchi Levi, Edith Simchi Levi, Ravi Shankar, Philip Kaminsky. McGraw Hill Education. Copyright © 2022
Supply chain Supply chain resilience is the firm’s capability to
withstand, adapt, and recover from disruptions to meet
resilience customer demand and ensure the target performance.

Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology, by Dmitry Ivanov. Springer Nature, 2021.
Supply Chain Resilience

• Supply chains must be designed in a way to withstand disruptions (i.e., supply chain should exhibit
low vulnerability) and recover from disruptions quickly and at a minimal cost (i.e., supply chain
should offer high recoverability).
• Disruption risks such as tsunamis, fires, and strikes may have high impact on supply chain operations
and performance.
• Lack of supply chain resilience may result in financial losses, mismatches of demand and supply, and
destabilization of normal operational policies in production, distribution, and inventory control in the
face of today’s inevitable supply chain disruptions (Ivanov et al. 2016b, Pavlov et al. 2019; Gupta et
al. 2020, Yoon et al. 2020).

Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology, by Dmitry Ivanov. Springer Nature, 2021.
Supply Chain: Robustness, Agility and Lean

Aspect Supply Chain Robustness Supply Chain Agility Lean Supply Chain
Eliminating waste and maximizing efficiency
Focus Withstanding disruptions and shocks Adapting quickly to changing circumstances

Redundancy in resources and suppliers Minimal inventory levels


Strong risk management and contingency Flexible processes and resources Just-in-time deliveries
plans Rapid decision-making capabilities Continuous improvement focus
Key characteristics Focus on resilience and stability Ability to pivot and adjust strategies

Reduces costs and improves efficiency


Minimizes impact of disruptions Responds to changing market demands Increases customer satisfaction
Protects profits and brand reputation Capitalizes on new opportunities Boosts profitability
Benefits Provides stability and predictability Remains competitive in dynamic environments
Requires strong leadership and organizational Requires disciplined execution and cultural
agility change
Can be expensive to maintain redundancy Can be risky if mismanaged and leads to Can be vulnerable to disruptions in the
May stifle innovation due to emphasis on stockouts supply chain
stability May prioritize short-term efficiency over long- May lead to pressure on suppliers and
Challenges May lack responsiveness to rapid changes term resilience workforce
Developing modular product designs for easy Eliminating non-value-added activities from
adaptation the supply chain
Building buffer inventory for key materials Implementing cross-functional teams for faster Implementing Kanban systems for just-in-
Diversifying supplier base across different decision-making time deliveries
regions Utilizing real-time data analytics for demand Continuous improvement through kaizen
Examples Investing in cybersecurity measures forecasting events
Supply chain resilience
Supply chain resilience looks at maintaining some desired performance despite disruptions.

Using some proactive capabilities (i.e., inventory), a supply chain can absorb negative
disruption impacts (e.g., supply unavailability) without performance degradation.
However, if proactive capabilities do not help, performance (e.g., on-time delivery or
revenue) can decline.
In this case, reactive capabilities should be employed to restore the performance and
operations.
This takes time and creates costs. Thus far, building a resilient supply chain is based on
mitigating risks, preparedness for disruptions, stabilization, and recovery.

Risk = Virus
Resilience = Immune System
Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology, by Dmitry Ivanov. Springer Nature, 2021.
Proactive vs. Reactive Approaches to Supply Chain
Disruptions
Aspect Proactive Approach Reactive Approach

Anticipating and preparing for potential Responding to disruptions after they


Definition disruptions before they occur. have already happened.

Long-term focus, involves ongoing Short-term focus, involves immediate


Timeframe planning and risk management. responses to the current disruption.

Proactive vs. Systematic identification of potential Identification of risks as they

Reactive
Risk Identification risks and vulnerabilities. materialize or post-occurrence.

Approaches to
Implementation of preventive measures Implementation of recovery and
Mitigation Strategies and risk mitigation strategies. contingency plans.
Costs associated with reacting to

Supply Chain Costs


Initial investment in risk management
and prevention may be higher.
disruptions can be higher, including
potential losses.

Disruptions Examples
- Diversifying suppliers to reduce
dependence on a single source.
- Rerouting shipments in response to
unexpected transport issues.

- Implementing robust inventory - Negotiating with alternate suppliers


management practices. after a primary supplier fails.

- Conducting regular risk assessments - Activating backup production facilities


and scenario planning. in response to a factory shutdown.
Pillar Description

Having real-time data and insights into your entire supply


Visibility and Transparency chain. Proactive monitoring of risks and disruptions
through technology and open communication among
stakeholders.

The ability to quickly adjust to changing market


Agility and Adaptability conditions, unexpected events, and disruptions. Flexible
production processes, diverse supplier networks, and
efficient decision-making capabilities.

Six Pillars of Inventory Optimization


Maintaining the right level of inventory to avoid stockouts
while minimizing holding costs. Utilizing data analytics to
forecast demand and optimize inventory levels across the
Supply Chain supply chain.

Resilience Collaboration
Partnership
and Building strong relationships with suppliers, logistics
providers, and other stakeholders. Collaborative planning,
forecasting, and risk mitigation strategies.

Leveraging automation, artificial intelligence, and other


technologies to improve efficiency, visibility, and
Technology and Innovation adaptability. Investing in digital solutions that optimize
inventory management, transportation, and
communication.

Risk Management and Identifying potential risks and vulnerabilities in the supply
chain. Developing and implementing proactive
Contingency Planning contingency plans to mitigate the impact of disruptions.
Morbi Bridge Collapse

• The bridge was a suspension bridge built in the 19th


century.
• It was closed for repairs for several months before
reopening on October 25, 2022.
• The collapse occurred on October 30, 2022, at around
6:40 p.m.
• At least 135 people were killed, and more than 180
others were injured.
• The cause of the collapse is believed to be a combination
of overcrowding, faulty repairs, and inadequate
maintenance.
• The collapse has led to calls for improved safety
standards for infrastructure in India
Engineers diligently inspecting a bridge, symbolizing proactive
vigilance

Regular Inspections and Maintenance: Implement rigorous routines to identify and address
issues before they become critical.

Risk Assessment and Mitigation: Proactively assess vulnerabilities and implement measures like
weight restrictions and traffic flow management.

Modernization and Retrofitting: Prioritize upgrades for older bridges to meet current safety
standards and improve load capacity.

Investing in Infrastructure: Dedicate adequate funding to maintain, repair, and modernize


bridges, avoiding deferred maintenance.

Public Awareness and Education: Educate the public about bridge safety practices and
responsible usage.
Emergency Response and Rescue: Swift and efficient protocols
for saving lives and minimizing further harm.

Investigation and Analysis: Thoroughly investigate the cause of


the collapse to prevent similar tragedies in the future.

Reactive
Approaches: Structural Stabilization and Repair: Ensure remaining structure
stability and facilitate safe access for repair crews.

Picking Up
the Pieces Compensation and Support: Provide financial assistance,
medical care, and counseling to victims and affected families.

Lesson Learned and Implementation: Share valuable insights


from the incident to improve bridge safety practices nationwide.
Supply Chain Resilience
The best way to ensure your company’s ability to quickly reconfigure and recover during a crisis is to institute redundancies in the supply
chain. Supply chain redundancy is the ability to withstand any failure at any point in the primary supply chain by using backup resources.

Redundancies act to;

1. Support any weak spots in the supply chain

2. Prevent slowdowns or shutdowns

3. Provide safety stock in case of delivery failures or losses

4. Ensure competition, availability and design quality when a redundancy of suppliers is implemented.
Supply Chain Resilience

Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology, by Dmitry Ivanov. Springer Nature, 2021.
Adaptation in supply chain resilience

• Adaptation in supply chain resilience involves proactive


strategies to anticipate and respond effectively to disruptions.
• This includes building flexibility, diversifying suppliers,
integrating technology, fostering collaboration, optimizing
inventory, and continuously improving operations.
• The goal is to enhance the supply chain's ability to quickly
adjust and recover in the face of unexpected challenges.
Achieving adaptation in supply chain resilience
involves
2. Investment in
1. Regular risk 3. Building flexibility 4. Diversifying the
advanced
assessments. into operations. supplier network.
technology.

6. Enhancing 7. Optimizing
5. Implementing 8. Conducting
collaboration and inventory
agile practices. scenario planning.
communication. management.

11. Promoting a
12. Monitoring and
9. Investing in 10. Establishing culture of
evaluating
employee training. redundancy plans. continuous
performance.
improvement.
Redundancy

• Supply chain redundancy is the ability to withstand


any failure at any point in the primary supply chain by
using backup resources. This can be achieved through
holding extra inventory, maintaining low-capacity
utilization, using multiple suppliers, etc.
Stabilization

Stabilization in supply chain resilience involves minimizing variability in


processes, enhancing predictability, and reducing disruptions.

It contributes to accurate forecasting, efficient inventory management, stable


supplier relationships, and cost-effective operations.

By focusing on stability, organizations can better mitigate risks, ensure quality


control, and adapt to changes while maintaining a resilient supply chain.
Resilience capabilities of the supply chain

Main supply chain drivers Planning type Vulnerable part


Surplus inventory Proactive Manufacturing
Surplus inventory Proactive Manufacturing
Surplus inventory Proactive Supply
Backup supply, alternative transportation routing, quick respond, Proactive and Supply and
information integration, cooperation, and collaboration reactive manufacturing
Quick response, quick recovery, information sharing, backup capacity Proactive and Supply
reactive
Integration capabilities, external capabilities, flexibility Proactive Supply
Backup facility, capacity expansion Proactive Facility
Structural complexity reduction, process and resource utilization Proactive and Supply, facility
flexibility, efficient parametric redundancy reactive
Supplier’s reliability, segregation of suppliers, backup supplier, Proactive and Supply
surplus capacity of supplier, additional restorative capacity of reactive
supplier
Balancing Vulnerabilities and Capabilities

Balancing vulnerabilities and capabilities is a major concern in supply chain resilience management.

Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology, by Dmitry Ivanov. Springer Nature, 2021.
Balancing Vulnerabilities and Capabilities

Therefore, supply chains need to be


The main objective of supply chain At the same time, the achievement
planned to be robust and resilient
management is to increase total of planned performance can be
enough to (1) maintain their basic
supply chain output performance, hindered by disruptions in a real-
properties and ensure execution and
which is basically referred to as time execution environment. This
(2) be able to adapt their behavior in
supply chain effectiveness (i.e., sales requires supply chain protection
the case of disruptions to achieve
and service level) and efficiency against an efficient reaction to
planned performance using recovery
(supply chain costs). disruptions.
actions.

Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology, by Dmitry Ivanov. Springer Nature, 2021.
Supply Chain Resilience Capabilities
Three major Resilience capabilities

Redundancies (e.g., risk mitigation inventories, subcontracting capacities,


backup supply, and transportation infrastructures)

Recovery flexibility and contingency plans/Adaptation

End-to end supply chain visibility

Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology, by Dmitry Ivanov. Springer Nature, 2021.
Supply Chain Resilience Capabilities
Redundancy
In redundancy, different reserves (material inventory, capacities, and network design
redundancy), as well as facility fortification, can be named.

The redundancies are intended to protect the supply chain against disruptions based
on certain reserves or backups. This issue is related to the supply chain robustness.

Many companies invest in structural redundancy (e.g., Toyota extends its supply
chain subject to multiple sourcing and building new facilities on the supply side).

Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology, by Dmitry Ivanov. Springer Nature, 2021.
Quiz-1
• ABC, a company that produces and distributes electronic equipment in
Southern India, faces a distribution problem. The current distribution system
partitions the Southern into three markets, each with a single warehouse. One
warehouse is in City-A, the second is in City-B, and the third is in City-C.
Under the current distribution system, customers, typically retailers, receive
items directly from the warehouses, and the warehouses receive items from a
manufacturing facility. The lead time for delivery to each of the warehouses is
about two weeks, and with sufficient manufacturing capacity. The current
distribution strategy is to provide a 99 percent service level. An order from the
factory costs ₹6000 per order, and inventory holding costs are ₹8 per unit per
week. Demand for the past 6 weeks is given in the table below.
Week 1 2 3 4 5 6
City-A 202 275 226 232 336 183
City-B 336 260 314 310 204 360
City-C 222 290 250 256 352 208

a) What is the percentage of average inventory saved, if the company plans for a single
warehouse instead of three warehouses at present?

b) What is the percentage of average inventory saved if the company plans for a single
warehouse for city A, city B, and City C as it is? What is your comment on this
approach and why?
Redundancy

• Having backup plans and resources


in place in case of disruptions

Examples:
• Multiple suppliers for critical
materials
• Inventory buffer stocks
• Diversified transportation routes
Adaptation

• The ability to change your supply


chain in response to disruptions
• Examples:
• Quickly sourcing new suppliers
• Changing production processes
• Finding new transportation
routes
Supply Chain Adaptation

SC Adaptation has four major dimensions:


• Scalability (e.g., online retailers used capacity expansions to cope
with surges in demand during the COVID-19 pandemic).
• Process flexibility (e.g., auto manufacturers re-purposed their
production from cars to ventilators)
• Structural reconfiguration (e.g., usage of backup suppliers).
• Intertwining (e.g., collaboration of commercial and healthcare
supply chains) (Ivanov 2021b).
Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology, by Dmitry Ivanov. Springer Nature, 2021.
Examples of Redundancy and
Adaptation in the Supply
Chain Industry

• Chip shortage mitigation: Many companies, like Apple


and Samsung, are investing in building their own chip
manufacturing facilities or forging closer partnerships
with multiple chipmakers to reduce reliance on a single
source and mitigate the ongoing chip shortage.

• Multi-sourcing for critical materials: Companies in


industries like electric vehicles and renewable energy are
diversifying their sourcing of critical materials like lithium
and cobalt to avoid dependence on specific regions or
countries prone to instability.
Adaptation
• Nearshoring and reshoring: Companies are increasingly moving production
closer to their customer base to reduce reliance on long-distance shipping and
mitigate the impact of global disruptions like port congestion.
• Supply chain digitization: Businesses are adopting technologies like
blockchain and artificial intelligence to gain real-time visibility into their supply
chains, allowing for faster identification and response to disruptions.
• Agile manufacturing: Companies are implementing more flexible production
processes that can quickly adapt to changing demand patterns and resource
availability.
Adaptation:
• Walmart’s drone delivery pilots: Responding to labor shortages and delivery
challenges, Walmart is exploring drone delivery for specific items in select
locations, showcasing adaptation through innovation.
• Unilever's plant-based alternatives: Facing disruptions in meat supply chains,
Unilever invested in expanding its plant-based meat alternatives, demonstrating
adaptation through product diversification.
• Maersk's alternative shipping routes: To navigate port congestion and Suez
Canal blockages, Maersk adopted alternative shipping routes around Africa,
highlighting adaptation through route flexibility.
Supply Chain Resilience capabilities: Redundancy and Adaptation

Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology, by Dmitry Ivanov. Springer Nature, 2021.
Strategic Understanding of Supply Chain Resilience
Criterion Efficient supply chain Responsive supply chain Resilient supply chain
Primary goal Supply demand at the Respond quickly to Ensure demand fulfillment
lowest cost demand in the presence of
disruptions
Network organization Centralized global Responsive local and Diversification,
global balance localization, segmentation

Product design strategy Maximize performance at Create modularity to allow Re-purposing,


minimum product cost postponement of product postponement to ensure
differentiation product flexibility, product
substitution, capacity
pooling

Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology, by Dmitry Ivanov. Springer Nature, 2021.
Criterion Efficient supply Responsive supply Resilient supply
Strategic Understanding chain chain chain
of Supply Chain Pricing strategy Lower margins Higher margins Higher prices
Resilience because price is a because price is not caused by the costs
prime customer a prime customer of resilience
driver driver

Manufacturing Lower costs Maintain capacity Capacity


strategy through high flexibility to buffer reservations and
utilization against flexibility
demand/supply
uncertainty

Inventory strategy Minimize Maintain buffer Risk mitigation


inventory to lower inventory to deal inventory
cost with
demand/supply
uncertainty

Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology, by Dmitry Ivanov. Springer Nature, 2021.
Strategic Understanding of Supply Chain Resilience

Criterion Efficient supply Responsive supply chain Resilient supply


chain chain
Lead time Reduce, but not at the Reduce aggressively even Lead time
expense of costs if the costs are significant reservations

Supplier strategy Select based on cost Select based on speed, Supplier risk
and quality flexibility, reliability and exposure analysis;
quality backup suppliers and
dual sourcing

Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology, by Dmitry Ivanov. Springer Nature, 2021.
Examples:
• Amazon: Renowned for its efficient order fulfillment with fast
delivery times.
• Highly automated warehouses: Robots handle
picking, packing, and shipping, minimizing human error and
maximizing speed.
• Densely located warehouses: Warehouses are positioned close to
customers, reducing transportation times.
• Sophisticated inventory management: Predictive analytics helps
maintain optimal stock levels while avoiding overstocking or
stockouts.
Example

• Toyota: Known for its lean manufacturing principles, minimizing


waste and maximizing efficiency. This includes:
• Just-in-time (JIT) production: Parts arrive only when
needed, reducing inventory carrying costs.
• Continuous improvement (Kaizen): Constant small improvements to
processes over time.
• Strong supplier relationships: Collaborative partnerships ensure
smooth and efficient material flow
Responsive Supply Chain
• Zara: Adapts quickly to changing fashion trends, producing new
designs and getting them to stores fast. They achieve this through:
• Smaller production batches: Allows for frequent design changes
and quicker response to trends.
• Vertically integrated supply chain: Owning many steps of
production gives them more control and flexibility.
• Agile workforce: Employees are empowered to make decisions and
react quickly to changes.
Dell: Responsive Supply
Chain

• Dell: Offers customized computers with fast


turnaround times. They achieve this through:
• Build-to-order model: Assemble computers
based on specific customer orders, eliminating
pre-built inventory.
• Strong supplier relationships: Collaborate
with suppliers to ensure fast delivery of
components.
• Real-time visibility: Customers can track their
order status online throughout the production
process.
Resilient Supply Chain: Apple

• Apple: Their supply chain has weathered various


disruptions, including pandemics and natural
disasters. They achieve this through:
• Diversified supplier base: Not reliant on any
single supplier, mitigating risk from
individual disruptions.
• Inventory buffer stocks: Maintains some
safety stock to handle unexpected demand
surges or supply shortages.
• Strong risk management
practices: Proactively identifies and mitigates
potential risks.
Nestlé:

• Operates in over 180 countries and faces diverse risks. They achieve
resilience through:
• Local sourcing: Procures raw materials closer to production
facilities, reducing reliance on long-distance transportation.
• Flexible production: Can adapt production processes to different
situations and resource availability.
• Business continuity planning: Has plans in place to respond to
various disruptions
Supply Chain Resilience Management

The first stage is to identify the risks related to network


design structure, integrated supply chain processes, and
individual supplier risks.

Once the risks are identified, they need to be quantified.


Similarly, resilience and the ripple effect are assessed.

Next stage is to protect the supply chain by inventory,


capacity agility, and backup suppliers to mitigate the
negative impact of possible disruptions.

If a disruption happens, the objective is to respond by


deployment of contingency plans, recovery strategies, and
situational adaptations.

Supply chain resilience management is based on four major areas: Identify, Quantify, Mitigate, and Respond

Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology, by Dmitry Ivanov. Springer Nature, 2021.
Supply chain resilience capabilities

Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology, by Dmitry Ivanov. Springer Nature, 2021.
Supply chain recovery strategies

Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology, by Dmitry Ivanov. Springer Nature, 2021.
Resilience capacity of supply chains with three lines of defense

Source: Introduction to Supply Chain Resilience: Management, Modelling, Technology, by Dmitry Ivanov. Springer Nature, 2021.
Decision-Making under an Uncertain
Environment

A case of O’Neil Inc

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
O’Neil Inc
• O’Neil Inc. is a designer and manufacturer of apparel, wetsuits, and
accessories for water sports: surf, dive, water-ski, wake-board,
triathlon, and wind surf.

• O’Neil operates its own manufacturing facility in Mexico, but it does


not produce all of its products there.

• Some items are produced by TEC Group, O’Neil’s contract


manufacturer in Asia.

• TEC provides many benefits to O’Neil – Low Cost, Sourcing


Expertise, Flexible Capacity, etc.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
O’Neil Inc
◼ However, they do require a three-month lead time on all orders.

Generate forecast
of demand and
submit an order
to TEC Spring selling season

Nov Dec Jan Feb Mar Apr May Jun Jul Aug

Receive order Left over


from TEC at the units are
end of the discounted
month

◼ So, what are the production challenges of O’Neil?


Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
O’Neil Inc Hammer 3/2
◼ To better understand O’Neil production challenges, let’s consider
a particular wetsuit – Hammer 3/2, newly designed for the
upcoming spring season.
◼ O’Neil has decided to let TEC manufacture the Hammer 3/2.
◼ Due to TEC’s three-month lead time, O’Neil needs to submit an
order to TEC in November before the spring season.
◼ Using past sales data for similar products and the judgment of its
designers and sales representative, O’Neil developed a forecast of
3,200 units for total demand during the spring season for the
Hammer 3/2.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
O’Neil Inc Hammer 3/2

◼ The “too much/too little problem”:


➢ Order too much and inventory is left over at the end of the season
➢ Order too little and sales are lost.
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
O’Neil Inc Hammer 3/2

So, how much to order?

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
A PROCESS FOR EVALUATING THE PROBABILITY DEMAND IS EITHER LESS THAN OR
EQUAL TO Q (WHICH IS F(Q)) OR MORE THAN Q ( WHICH IS 1 − F(Q))

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
O’Neil Inc Hammer 3/2
◼ Generate a demand model to represent demand
➢ Use empirical demand distribution
➢ Choose a distribution function
◼ the normal distribution,
◼ the Poisson distribution.

◼ Gather economic inputs


➢ selling price,
➢ production/procurement cost,
➢ salvage value of inventory

◼ Choose an objective
➢ maximize expected profit
➢ satisfy a fill rate constraint.
◼ Choose a quantity to order
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
O’Neil Inc Hammer 3/2

Demand Models
O’Neil Inc Hammer 3/2
What is a demand model?
◼ A demand model specifies what demand outcomes are possible and the probability of these outcomes.
◼ Traditional distributions from statistics can be used as demand models:
➢ e.g., the normal, gamma, Poisson distributions

POISSON
GAMMA
NORMAL

Probability
Probability

0 50
100 150 200 0 1 2 3 4 5 6 7 8 9 10
Demand Demand
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
O’Neil Inc Hammer 3/2

Develop a Demand Model


O’Neil Inc Hammer 3/2
Hammer 3/2 has been redesigned for the upcoming spring season.

As a result, actual sales in the previous season might not be a good guide for expected demand
in the upcoming season.

In addition to the product redesign, factors that could influence expected demand include the
pricing and marketing strategy for the upcoming season, changes in fashion, changes in the
economy (e.g., is demand moving toward higher or lower price points), changes in
technology, and overall trends for the sport.

To account for all of these factors, O’Neill surveyed the opinion of a number of individuals
in the organization on their personal demand forecast for the Hammer 3/2.

The survey’s results were averaged to obtain the initial 3,200-unit forecast. This represents
the “intuition” portion of our demand forecast.
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
O’Neil Inc Hammer 3/2
Historical forecast performance at O’Neill
7000

6000

.
5000

Actual demand 4000

3000

2000

1000

0
0 1000 2000 3000 4000 5000 6000 7000
Forecast

Forecasts and actual demand for surf wet-suits from the previous season

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
O’Neil Inc Hammer 3/2
Empirical distribution function of forecast accuracy Product description
JR ZEN FL 3/2
Forecast
90
Actual demand
140
Error* A/F Ratio**
-50 1.56
EPIC 5/3 W/HD 120 83 37 0.69
JR ZEN 3/2 140 143 -3 1.02
WMS ZEN-ZIP 4/3 170 163 7 0.96
• Data from O’Neil previous spring season with wetsuits in the HEATWAVE 3/2
JR EPIC 3/2
170
180
212
175
-42
5
1.25
0.97
surf category. WMS ZEN 3/2
ZEN-ZIP 5/4/3 W/HOOD
180
270
195
317
-15
-47
1.08
1.17
WMS EPIC 5/3 W/HD 320 369 -49 1.15
• Start by evaluating the actual demand to forecast demand EVO 3/2
JR EPIC 4/3
380
380
587
571
-207
-191
1.54
1.50
ratio (the A/F ratio) from past observations. WMS EPIC 2MM FULL 390 311 79 0.80
HEATWAVE 4/3 430 274 156 0.64
ZEN 4/3 430 239 191 0.56
EVO 4/3 440 623 -183 1.42
ZEN FL 3/2 450 365 85 0.81
HEAT 4/3 460 450 10 0.98
ZEN-ZIP 2MM FULL 470 116 354 0.25
HEAT 3/2 500 635 -135 1.27
WMS EPIC 3/2 610 830 -220 1.36
WMS ELITE 3/2 650 364 286 0.56
ZEN-ZIP 3/2 660 788 -128 1.19
ZEN 2MM S/S FULL 680 453 227 0.67
EPIC 2MM S/S FULL 740 607 133 0.82
EPIC 4/3 1020 732 288 0.72
WMS EPIC 4/3 1060 1552 -492 1.46
JR HAMMER 3/2 1220 721 499 0.59
HAMMER 3/2 1300 1696 -396 1.30
HAMMER S/S FULL 1490 1832 -342 1.23
EPIC 3/2 2190 3504 -1314 1.60
ZEN 3/2 3190 1195 1995 0.37
ZEN-ZIP 4/3 3810 3289 521 0.86
WMS HAMMER 3/2 FULL 6490 3673 2817 0.57
* Error = Forecast - Actual demand
** A/F Ratio = Actual demand divided by Forecast
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
We see from the data key observations

The actual demand is less than 80 percent of the forecast


for one-third of the products
( i.e. the A/F ratio 0.8 has a percentile of 33.3)

The actual demand is greater than 125 percent of the


forecast for 27.3 percent of the products

(the A/F ratio 1.25 has a percentile of 72.7).

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and
Terweish, McGraw Hill Education.
O’Neil Inc Hammer 3/2
O’Neill’s Hammer 3/2 normal distribution forecast- 3200 (Forecasted demand)
Product description Forecast Actual demand Error A/F Ratio
JR ZEN FL 3/2 90 140 -50 1.5556 Note that: the forecast is not random, but the
EPIC 5/3 W/HD 120 83 37 0.6917 A/F ratio is random. Hence, the randomness
JR ZEN 3/2 140 143 -3 1.0214 in actual demand is directly related to the
WMS ZEN-ZIP 4/3 170 156 14 0.9176 randomness in the A/F ratio. Using standard
… … … … … results from statistics and the above equation,
ZEN 3/2 3190 1195 1995 0.3746 we get the following results:
ZEN-ZIP 4/3 3810 3289 521 0.8633
WMS HAMMER 3/2 FULL 6490 3673 2817 0.5659 Expected actual demand = Expected A/F
Average 0.9975 ratio × Forecast
Standard deviation 0.3690

Expected actual demand = 0.9975  3200 = 3192


Standard deviation of actual demand = 0.369  3200 = 1181
• O’Neill can choose a normal distribution with mean 3192 and standard deviation 1181 to represent
demand for the Hammer 3/2 during the Spring season.
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Suppose the average A/F ratio were 0.90, that is, on average, actual
demand is 90 percent of the forecast.

It is quite common for people to have overly optimistic forecasts, In


that case, expected actual demand would only be 0.90 × 3,200 =
2,880.

Because we want to choose a normal distribution that represents


actual demand, in that situation it would be better to choose a mean
of 2,880 even though our initial forecast is 3,200.
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
A PROCESS FOR USING HISTORICAL A/F RATIOS TO CHOOSE A MEAN AND STANDARD
DEVIATION FOR A NORMAL DISTRIBUTION FORECAST
Step 1
Assemble a data set of products for which the forecasting task is comparable to the product of interest.
The data should include an initial forecast of demand and the actual demand. We also need a forecast for the
item for the upcoming season.

Step 2 Evaluate the A/F ratio for each product in the data set.

Evaluate the average of the A/F ratios (that is, the expected A/F ratio) and the standard deviation of the A/F ratios.

In Excel use the average() and stdev () functions.

Step 3 The mean and standard deviation of the normal distribution that we will use as the forecast can now be
evaluated with the following two equations:

Expected demand = A/F ratio Expected A/F ratio × Forecast

Standard deviation of demand = Standard deviation of A/F ratios × Forecast


Where the forecast in the above equations is the forecast for the item for the upcoming season.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
The order quantity that maximizes
expected profit

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
O’Neil Inc Hammer 3/2
“Too much” and “too little” costs
• Co = overage / over-stock cost
• The consequence of ordering one more unit than what you would have ordered had you
known the demand.
• Suppose you had left over inventory (you over-ordered). Co is the increase in profit
you would have enjoyed had you ordered one fewer unit.
• For the Hammer 3/2 Co = Cost – Salvage value = c – v = 110 – 90 = 20

• Cu = underage / under-stock cost


• The consequence of ordering one fewer unit than what you would have ordered had you
known the demand.
• Suppose you had lost sales (you under-ordered). Cu is the increase in profit you
would have enjoyed had you ordered one more unit.
• For the Hammer 3/2 Cu = Price – Cost = p – c = 190 – 110 = 80
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
A PROCEDURE TO FIND THE ORDER QUANTITY THAT MAXIMIZES EXPECTED
PROFIT IN THE NEWSVENDOR MODEL

Step 1 Evaluate the critical ratio: CR = Cu/ (Cu + Co)

In the case of the Hammer 3/2, the underage cost is Cu = Price − Cost
and the overage cost is Co = Cost − Salvage value.

Step 2 If the demand forecast is a normal distribution with mean μ and


standard deviation σ, then follow steps A and B:
A. Find the optimal order quantity if demand had a standard normal
distribution. One method to achieve this is to find the z value in the
Standard Normal Distribution Function Table such that

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
A PROCEDURE TO FIND THE ORDER QUANTITY THAT MAXIMIZES EXPECTED
PROFIT IN THE NEWSVENDOR MODEL

Φ(z) = Cu/(Cu +Co)


(If the critical ratio value does not exist in the table, then find the two z values that
it falls between.

For example, the critical ratio 0.80 falls between z = 0.84 and z = 0.85. Then
choose the larger of those two z values.)
A second method is to use the Excel function Normsinv: z = Normsinv
(Critical ratio).

B. Convert z into the order quantity that maximizes expected profit, Q: Q = μ


+z×σ
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
A PROCEDURE TO FIND THE ORDER QUANTITY THAT MAXIMIZES EXPECTED
PROFIT IN THE NEWSVENDOR MODEL

Overage cost, the loss incurred when a unit is ordered but not sold.

In other words, the overage cost is the per-unit cost of overordering. For the Hammer 3/2, we
have Co = 20.

Cu be the underage cost, the opportunity cost of not ordering a unit that could have been
sold.

Cu is the gain from selling a unit. In other words, the underage cost is the per-unit opportunity
cost of underordering. For the Hammer 3/2, Cu = 80

we need to choose Q to strike the balance between them that results in the maximum
expected profit.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
A PROCEDURE TO FIND THE ORDER QUANTITY THAT MAXIMIZES EXPECTED
PROFIT IN THE NEWSVENDOR MODEL

The expected gain from the first unit,


which equals the probability of selling
the first unit times the gain from the
first unit, is then very close to $80.

But since the probability we do not sell


that unit is quite small, the expected
loss on the first unit is nearly $0.

Given that the expected gain from the


first unit clearly exceeds the expected
loss, the profit from ordering that unit is
positive.
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
A PROCEDURE TO FIND THE ORDER QUANTITY THAT MAXIMIZES EXPECTED
PROFIT IN THE NEWSVENDOR MODEL

Now imagine we order the 6,400th


unit. The probability of selling that unit
is quite low, so the expected gain from
that unit is nearly zero.

In contrast, the probability of not


selling that unit is quite high, so the
expected loss is nearly $20 on that
unit. Clearly it makes no sense to order
the 6,400th unit.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
A PROCEDURE TO FIND THE ORDER QUANTITY THAT MAXIMIZES EXPECTED
PROFIT IN THE NEWSVENDOR MODEL

Now that we have defined the overage and underage costs, we need
to choose Q to strike the balance between them that results in the
maximum expected profit.
The expected loss on a unit is the cost of having the unit in inventory (the
overage cost) times the probability it is left in inventory.

For the Qth unit, that probability is F(Q): It is left in inventory if demand is less
than Q.

Therefore, the expected loss is Co × F(Q).

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
A PROCEDURE TO FIND THE ORDER QUANTITY THAT MAXIMIZES EXPECTED
PROFIT IN THE NEWSVENDOR MODEL

The expected gain on a unit is the benefit of selling a unit (the underage cost)
times the probability the unit is sold, which in this case occurs if demand is
greater than Q. The probability demand is greater than Q is (1 − F(Q)).

Therefore, the expected gain is Cu × (1 − F(Q)).

C ×F(Q)= C ×(1−F(Q))
o u

Cu
F (Q ) = *

Co + Cu

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
A PROCEDURE TO FIND THE ORDER QUANTITY THAT MAXIMIZES EXPECTED
PROFIT IN THE NEWSVENDOR MODEL

The order quantity that maximizes expected profit is the order quantity Q such
that demand is less than or equal to Q with probability C /(C + C ). u o u

That ratio with the underage and overage costs is called the critical ratio.

To choose the profit-maximizing order quantity, we need to find the


quantity such that demand will be less than that quantity with a
particular probability (the critical ratio)

We know for the Hammer 3/2 that C = 80 and C = 20, so the critical ratio is 0.80 u o

We need to find the order quantity Q such that there is an 80 percent probability
that demand is Q or lower.
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
A PROCEDURE TO FIND THE ORDER QUANTITY THAT MAXIMIZES EXPECTED
PROFIT IN THE NEWSVENDOR MODEL

The first is to use the Excel function, Normsinv(), and the second is to use the
Standard Normal Distribution Function Table.

Using EXCEL ; z = Normsinv(Critical ratio)

The critical ratio is 0.80 and Normsinv(0.80) returns 0.84. That means that there is an 80
percent chance the outcome of a standard normal will be 0.84 or lower.
It is normal with mean 3,192 and standard deviation 1,181. To convert our z into an order
quantity that makes sense for our actual demand forecast, we use the following equation:
Q = μ+z×σ

Hence, using our Excel method, the expected profit maximizing order quantity for the Hammer 3/2 is Q = 3,192 + 0.84 ×
1,181 = 4,184.
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
A PROCEDURE TO FIND THE ORDER QUANTITY THAT MAXIMIZES EXPECTED
PROFIT IN THE NEWSVENDOR MODEL

The second method to find Q is to use the Standard Normal Distribution


Function Table.

Again, we want to find the z such that the probability the standard normal is z or less is equal
to the critical ratio, which in this case is 0.80.

we see that Φ(0.84) = 0.7995 and Φ(0.85) = 0.8023, neither of which is exactly the 0.80
probability we are looking for: z = 0.84 yields a slightly lower probability (79.95 percent) and
z = 0.85 yields a slightly higher probability (80.23 percent). What should we do? The rule is
simple, which we will call the round-up rule:

Round-up rule. Whenever you are looking up a target value in a table and the target value
falls between two entries, choose the entry that leads to the larger order quantity.
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Hammer 3/2’s expected profit maximizing order quantity
• The critical ratio is 0.80
• Find the critical ratio inside the Standard Normal Distribution Function Table:

z 0.00 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09
0.5 0.6915 0.6950 0.6985 0.7019 0.7054 0.7088 0.7123 0.7157 0.7190 0.7224
0.6 0.7257 0.7291 0.7324 0.7357 0.7389 0.7422 0.7454 0.7486 0.7517 0.7549
0.7 0.7580 0.7611 0.7642 0.7673 0.7704 0.7734 0.7764 0.7794 0.7823 0.7852
0.8 0.7881 0.7910 0.7939 0.7967 0.7995 0.8023 0.8051 0.8078 0.8106 0.8133
0.9 0.8159 0.8186 0.8212 0.8238 0.8264 0.8289 0.8315 0.8340 0.8365 0.8389

If the critical ratio falls between two values in the table, choose the greater z-statistic …
this is called the round-up rule.
Choose z = 0.85

• Convert the z-statistic into an order quantity :


Q =  + z 
= 3192 + 0.85 1181 = 4196
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Performance Measures

165
Performance measures
This section shows us how to evaluate a number of relevant performance
measures, such as the

• expected leftover inventory (we don’t want too much of that),


• expected sales (we want more of that),
• expected lost sales (should be avoided),
• expected profit (hopefully maximized), and
• two measures of service, the in-stock probability and the stockout
probability,

which inform us about how likely it is for customers to be able to find the
product they want.
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Performance measurements
• For any order quantity the following performance measures needs to be
evaluated
• Expected profit
• In-stock probability
• Probability all demand is satisfied
• Stock-out probability
• Probability some demand is lost
• Expected lost sales
• The expected number of units by which demand will exceed the order quantity
• Expected sales
• The expected number of units sold.
• Expected left over inventory
• The expected number of units left over after demand (but before salvaging)
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Expected Leftover Inventory
The expected leftover inventory is the average (or expected) number of units still not sold at
the end of the selling season.

Demand can be more than our order quantity, in which case leftover inventory is zero, or
demand can be less then our order quantity, in which case there is some positive amount of
leftover inventory.

Expected leftover inventory is the average of all of those events (the cases with no leftover
inventory and all cases with positive leftover inventory) taking into account the likelihood of
each possible demand.

When demand is normally distributed, use the following equation:

Expected leftover inventory = σ × I(z)


Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Expected Leftover Inventory

σ = 1,181 but what is I(z)?

σ indicating Standard deviation of distribution representing demand

I (z) : It is the expected inventory if demand followed a standard normal distribution, and we ordered z units.

There are two methods to evaluate I(z), one using Excel and one using a table.

With either method, we first find the z-statistic that corresponds to our chosen order quantity, Q = 3,500:

The first method then uses the following Excel formula to evaluate the expected inventory if demand were a standard
normal distribution, I(z):

I(z) = Normdist(z,0,1,0) + z * Normsdist(z)


σ × I(z) = 1,181 × 0.5424 = 641 units leftover (i.e., remaining) in inventory at the end of the season.
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Expected Leftover Inventory Evaluation Procedure
If the demand forecast is a normal distribution with mean μ and standard deviation σ, then follow
steps A through D:

A. Evaluate the z-statistic for the order quantity Q: z =

B. Use the z-statistic to look up in the Standard Normal Inventory Function Table the expected
leftover inventory, I(z), with the standard normal distribution.

C. Expected leftover inventory = σ × I(z).

D. With Excel, expected leftover inventory can be evaluated with the following equation:

Expected leftover inventory = σ*(Normdist(z,0,1,0) + z*Normsdist(z)))

If the demand forecast is a discrete distribution function table, then expected leftover inventory
equals the inventory function for the chosen order quantity, I(Q).
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Expected Sales

Expected sales is the expected number of units sold given demand and the
order quantity.

the sum of sales and leftover inventory must equal the total number of
purchased units, Q:

Sales + Leftover inventory = Q

Expected sales = Q – Expected leftover inventory

Expected sales = 3,500 – 641 = 2,859


Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Expected Lost Sales
Expected lost sales is the expected number of units not sold because we ran
out of inventory.

Sales + Lost sales = Demand

Expected lost sales = μ − Expected sales

if O’Neill orders 3,500 Hammer 3/2s, then expected lost sales = 3,192 − 2,859 =
333.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Expected Lost Sales
When demand is normally distributed, we can use the following equation for
expected lost sales:

Expected lost sales = σ × L(z )

L(z) = Standard normal loss function

In mathematical optimization and decision theory, a loss function or cost function is a function that maps an event
or values of one or more variables into a real number intuitively representing some "cost" associated with the
event.

L(z ) = Normdist(z,0,1,0) − z * (1 − Normsdist(z)) in Excel

Second method through use of Standard Normal Loss Function Table


Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Expected Profit
We earn (Price − Cost) on each unit sold and we lose (Cost − Salvage) value on each unit we do
not sell, so our expected profit is

Expected profit = [(Price − Cost) × Expected sales] − [(Cost − Salvage value) ×


Expected leftover inventory]

With an order quantity of 3,500 units and a normal distribution demand forecast, the expected
profit for the Hammer 3/2 is

Expected profit = ($80 × 2,859) − ($20 × 641) = $215, 900

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
In-Stock Probability and Stockout Probability

A common measure of customer service is the in-stock probability.

The in-stock probability is the probability that the firm ends the
season having satisfied all demand. (Equivalently, the in-stock
probability is the probability that the firm has stock available for
every customer.)

That occurs if demand is less than or equal to the order quantity,


In-stock probability = F(Q)

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Stockout Probability

The stockout probability is the probability the firm stocks out for some
customer during the selling season (i.e., a lost sale occurs). Because the
firm stocks out if demand exceeds the order quantity,

Stockout probability = 1 − F(Q)

Stockout probability = 1 − In-stock probability

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Stockout Probability
The in-stock probability is not the only measure of customer service.

Another popular measure is the fill rate.

The fill rate is the probability a customer is able to purchase a unit (i.e., does not
experience a stockout).

This is not the same as the in-stock probability, which is the probability that all
demand is satisfied. For example, say we order Q = 100 and demand turns out to
be 101.

Most customers were able to purchase a unit (the fill rate is high) but the firm did
not satisfy all demand (in-stock is not satisfied)
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Expected lost sales of Hammer 3/2s with Q = 3000
• Suppose O’Neill orders 3000 Hammer 3/2s.
• How many sales will be lost on average?

• To find the answer:


• Step 1: normalize the order quantity to find its z-statistic.
Q −  3000 − 3192
z= = = −0.16
 1181
• Step 2: Look up in the Standard Normal Loss Function Table the expected lost sales for a standard normal
distribution with that z-statistic: L(-0.16)=0.4840
• or, in Excel
L( z ) = Normdist ( z ,0,1,0) − z * (1 − Normsdist ( z ))
• Step 3: Evaluate lost sales for the actual normal distribution:

Expected Lost Sales =   L( z ) = 1181 0.4840 = 572


Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Expected Profit
If they order 3000 Hammer 3/2s, then …
Expected sales = m - Expected lost sales = 3192 – 572 = 2620
Expected Left Over Inventory = Q - Expected Sales = 3000 – 2620 = 380

Expected Profit = (Price - Cost ) Expected Sales 


− (Cost - Salvage value ) Expected left over inventory 
= $80  2620 − $20  380
= $202,000

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
In-stock probability
In-stock probability: percentage of seasons without a stock out

For example consider 10 seasons:


1+1+ 0 +1+1+1+ 0 +1+ 0 +1
Instock Probability =
10
Write 0 if a season has stockout, 1 otherwise
Instock Probability = 0.7
Instock Probability = 0.7 = Probability that a single season has sufficient inventory
[Sufficient inventory] = [Demand during a season  Q]

InstockProbability = P(Demand ≤ Q)

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Evaluate the in-stock probability
• What is the in-stock probability if the order quantity is Q = 3000?
• Evaluate the z-statistic for the order quantity :
Q− 3000 − 3192
z= = = −0.16
 1181
• Look up F(z) in the Std. Normal Distribution Function Table:
• F(z)=F (-0.16) = 0.4364

• Answer :
• If 3000 units are orders, then there is a 43.64% chance all demand will be satisfied.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Other Measures of Service Performance
• The stock-out probability is the probability some demand is not satisfied:
➢Some demand is not satisfied if demand exceeds the order quantity, thus…
➢Stock-out probability = 1 – F(Q)
= 1 – In-stock probability
= 1 –0.4364 = 56.36%
• The fill rate is the fraction of demand that can purchase a unit:
➢The fill rate is also the probability a randomly chosen customer can purchase a unit.
➢The fill rate is not the same as the in-stock probability!

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Fill rate

Expected sales =  - Expected lost sales = 3192 – 572 = 2620

Expected sales Expected sales


Expected fill rate = =
Expected demand 
Expected lost sales 2858
= 1− =
 3192
= 82.08%

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Local store sells 1 paint bucket daily, 50 units
in stock, 1-day lead time

50 customers buy 1 bucket each - all satisfied


(units available)

Fill Rate and Additional customer (big house) wants 50


buckets, but stock is sold out
Service Level
Service Level: 98% (50 out of 51 customers’
orders fulfilled)

Fill Rate: 50% (50 units out of 100 units


fulfilled)
Numerical Problem
Dan McClure owns a thriving independent bookstore in artsy New
Hope, Pennsylvania. He must decide how many copies to order of a
new book, Power and Self-Destruction, an expose ́ on a famous
politician’s lurid affairs. Interest in the book will be intense at first
and then fizzle quickly as attention turns to other celebrities. The
book’s retail price is $20 and the wholesale price is $12. The
publisher will buy back the retailer’s leftover copies at a full refund,
but McClure Books incurs $4 in shipping and handling costs for each
book returned to the publisher. Dan believes his demand forecast can
be represented by a normal distribution with mean 200 and standard
deviation 80.
a. Dan will consider this book to be a blockbuster for him if it sells more than 400 units.
What is the probability Power and Self-Destruction will be a blockbuster?
b. Dan considers a book a “dog” if it sells less than 50 percent of his mean forecast. What is
the probability this expose ́ is a “dog”?
c. What is the probability demand for this book will be within 20 percent of the mean
forecast?
d. What order quantity maximizes Dan’s expected profit?
e. Dan prides himself on good customer service. In fact, his motto is “McClure’s got what
you want to read.” How many books should Dan order if he wants to achieve a 95 percent
in-stock probability?
f. If Dan orders the quantity chosen in part e to achieve a 95 percent In-stock probability,
then what is the probability that “Dan won’t have what some customer wants to read” (i.e.,
what is the probability some customer won’t be able to purchase a copy of the book)?
[14.4]
g. Suppose Dan orders 300 copies of the book. What would Dan’s expected profit be in this
case?
Distribution, Inventory, and Loss Function Tables
Distribution, Inventory, and Loss Function Tables
Distribution, Inventory, and Loss Function Tables
Distribution, Inventory, and Loss Function Tables
Distribution, Inventory, and Loss Function Tables
Solution
Solution
Solution
Practice Problem
Flextrola, Inc., an electronics systems integrator, is planning to design a key
component for their next-generation product with Solectrics. Flextrola will integrate
the component with some software and then sell it to consumers. Given the short life
cycles of such products and the long lead times quoted by Solectrics, Flextrola only
has one opportunity to place an order with Solectrics prior to the beginning of its
selling season. Flextrola’s demand during the season is normally distributed with a
mean of 1,000 and a standard deviation of 600. Solectrics’ production cost for the
component is $52 per unit and it plans to sell the component for $72 per unit to
Flextrola. Flextrola incurs essentially no cost associated with the software integration
and handling of each unit. Flextrola sells these units to consumers for $121 each.
Flextrola can sell unsold inventory at the end of the season in a secondary electronics
market for $50 each. The existing contract specifies that once Flextrola places the
order, no changes are allowed to it. Also, Solectrics does not accept any returns of
unsold inventory, so Flextrola must dispose of excess inventory in the secondary
market.
Practice Problem
a) What is the probability that Flextrola’s demand will be within 25 percent of its forecast?
b) What is the probability that Flextrola’s demand will be more than 40 percent greater than
its forecast?
c) Under this contract, how many units should Flextrola order to maximize its expected
profit?
For parts d through i, assume Flextrola orders 1,200 units.
d. What are Flextrola’s expected sales?
e. How many units of inventory can Flextrola expect to sell in the secondary electronics
market?
f. What is Flextrola’s expected profit?
Solution
Solution
Solution
Solution
Solution
Practice Problem
Fashionables is a franchisee of The Limited, a well-known retailer of fashionable clothing. Prior
to the winter season, The Limited offers Fashionables the choice of five different colors of a
particular sweater design. The sweaters are knit overseas by hand, and because of the lead times
involved, Fashionables will need to order its assortment in advance of the selling season. As per
the contracting terms offered by The Limited, Fashionables also will not be able to cancel,
modify, or reorder sweaters during the selling season. Demand for each color during the season
is normally distributed with a mean of 500 and a standard deviation of 200. Further, you may
assume that the demands for each sweater are independent of those for a different color. The
Limited offers the sweaters to Fashionables at the wholesale price of $40 per sweater, and
Fashionables plans to sell each sweater at the retail price of $70 per unit. The Limited delivers
orders placed by Fashionables in truckloads at a cost of $2,000 per truckload. The transportation
cost of $2,000 is borne by Fashionables. Assume, unless otherwise specified, that all the
sweaters ordered by Fashionables will fit into one truckload. Also, assume that all other
associated costs, such as unpacking and handling, are negligible, The Limited does not accept
any returns of unsold inventory. However, Fashionables can sell all of the unsold sweaters at the
end of the season at the fire-sale price of $20 each.
a) How many units of each sweater type should
Fashionables order to maximize its expected profit?
b) If Fashionables wishes to ensure a 97.5 percent in-
stock probability, what should its order quantity be
for each type of sweater?
c) For parts c and d, assume Fashionables orders 725
Practice of each sweater. What is Fashionables’ expected
profit?
Problem d) What is the stockout probability for each sweater?
e) Now, suppose that The Limited announces that the
unit truckload capacity is 2,500 total units of
sweaters. If Fashionables orders more than 2,500
units (from 2,501 to 5,000 units in total), it will
have to pay for two truckloads. What now is
Fashionables’ optimal order quantity for each
sweater?
Solution
Solution
Solution
Product Pooling
Product pooling is the process of addressing
demand for different items by creating a
single "universal" product that can meet the
needs of all consumers.
Product
Pooling:
Hammer 3/2 for the surf market, however Universa
O'Neill also offers a Hammer 3/2 for the l Design
recreational dive market.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Product Pooling: Universal Design
Two Hammer 3/2 wetsuits are available from O'Neill, both of which are
indistinguishable from one another save for the silk-screened logo.

Hammer 3/2 Surf Hammer 3/2 Dive

O'Neill might streamline its product line by adopting a single Hammer 3/2 suit, or
"Universal Hammer," instead of two separate designs.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Product Pooling
• Demand for the Surf Hammer is Normally distributed with mean 3192 and standard deviation
1181.

• Demand for the Dive Hammer has the same distribution as the Surf Hammer.

• Surf and Dive demands are independent


• then the Universal Hammer’s demand has mean 2 x 3192 = 6384 and std deviation =
sqrt(2) x 1181 = 1670.

• Price, cost and salvage value for the Universal Hammer are the same as for the other two:
• Hence, Co is 110 – 90 = 20, Cu = 180-110 = 70
• Same critical ratio = 70 /(20 + 70) = 0.7778
• Same optimal z statistic, 0.77
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Product Pooling
• The underage cost for the universal Hammer is still Cu = 190 − 110 = 80 and the
overage cost is still Co = 110 − 90 = 20. Hence, the critical ratio has not
changed:

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Product Pooling

Pooling the surf and dive Hammers together can potentially


increase profit by 4.4 percent [(463,920 −
444,560)/444,560].

This profit increase is 1.4 percent of the expected revenue


when O’Neill sells two wetsuits.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Product Pooling

• Reduced demand variability is the key to product pooling's


potential advantage for O'Neill.

• Since O'Neill is using two Hammer wetsuits, the coefficient of


variation is approximately 0.37 for each suit. The coefficient
of variation for a universal Hammer is approximately
1,670/6,384 = 0.26.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Product Pooling
20 20

Correlation refers to how one random 18


16
18
16
variable’s outcome tends to be related to 14
12
14

another random variable’s outcome. 10


12
10
8
8
6 6
Random demand for two products 4
4
2
2
(x-axis is product 1, y-axis is product 2). 0
0
0 5 10 15 20
0 5 10 15 20

• In scenario 1 (upper right graph) the correlation is 0.


20

• In scenario 2 (upper left graph) the correlation is - 18


16
0.9 14
12

• In scenario 3 (the lower graph) the correlation is 10


8
0.90. 6
4
In all scenarios, demand is normally distributed for 2
0
each product with a mean of 10 and a standard 0 5 10 15 20

deviation of 3.
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Standard Deviation and Coefficient of Variation for
pooled demand

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Demand Correlation

𝜌=0 (Independent demands) ; CV pooled= CV(Individual)/√2

𝜌= 1 (total positive correlation) ; CV pooled= CV(Individual)

𝜌= -1 (total negative correlation) ; CV pooled= 0

Product pooling is most effective if CV of universal product


is less than CV of individual products.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Order Up to Model: Medtronic’s Supply Chain for
Pacemakers:

Medtronic’s Supply Chain Order-up-to Model


for Pacemakers: Overview:
Medtronic Inc. manufactures pacemakers, a The order-up-to model is utilized for
technologically sophisticated product. inventory management.
Supply chain involves various stages from It involves maintaining inventory levels by
production to distribution to healthcare replenishing up to a specified threshold when
facilities.
a stock falls below a certain point.
Ensuring pacemaker availability is critical due
to its life-saving nature.
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Medtronic Pacemaker Options

Micra leadless pacemakers for Azure pacemaker Advisa MRI pacemaker Attesta pacemaker
bradycardia (slow heart rate)
Model numbers: Model numbers: ADDR01, Model numbers:
A2DR01, A3SR01 ADDR03, ADDR06, ATDR01, ATDRS1,
ADDRL1, ADDRS1 ATDRL1, ATSR01
Medtronic
Product
Portfolio
Their product line also includes
Medtronic is a renowned medical
treatments for cardiovascular
technology company known for its
diseases, surgery, diabetes,
cardiac rhythm products like
neurological diseases, spinal surgery,
pacemakers.
and eye/nose/throat diseases.

Medtronic's supply chain comprises In the US, a single distribution center


three levels of inventory: in Mounds View, Minnesota, focuses
Medtronic’s manufacturing facilities, distribution
centers (DCs), and field locations.
on cardiac rhythm product
distribution.

Supply
Chain
This distribution center serves Medtronic's DCs prioritize
around 500 sales representatives, maintaining high inventory
each with their designated availability for sales representatives
territories. in the field.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
The majority of finished goods inventory is held in the field by
sales representatives.

Field inventory is divided into two categories: consignment


inventory and trunk inventory.

Consignment inventory is owned by Medtronic and stored at a

Medtronic’s customer's location, typically in hospital closets.

Trunk inventory refers to inventory stored in the trunk of a sales

Supply Chain representative's vehicle.

Sales representatives have easy access to both consignment and


trunk inventory, making them essentially a single pool of inventory.
Focusing on a specific distribution center (DC) in Mounds View,
Minnesota, a sales representative named Susan Magnotto
operates in Madison, Wisconsin.

Susan Magnotto's territory includes major medical facilities.

The specific product under consideration is the InSync ICD Model


7272 pacemaker.
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Difference between Consignment Inventory and Trunk
Inventory

Aspect Consignment Inventory Trunk Inventory

Goods remain property of the Owned by the retailer or


Ownership
supplier (consignor) distributor

Typically stored at consignee's Retailer's or distributor's own


Storage Location
premises or agreed location warehouses/storage

Consignee doesn't pay until items Retailer/distributor purchases


Financial Implications
are sold inventory upfront

Consignor bears risk of


Retailer/distributor bears full risk
Risk Sharing obsolescence or damage until
of inventory
sold
Medtronic’s Supply Chain

• Surgeons anticipate the need for pacemakers during surgery but don't know the
specific model until the operation.
• Susan attends each surgery to ensure she has the required pacemaker models
available.
• Susan carries various pacemaker models to cater to different patient needs.
• After surgery, Susan replenishes her inventory by contacting Medtronic's Customer
Service.
• Medtronic's Customer Service forwards Susan's order to Mounds View, DC.
• If the requested model is in stock at the DC, it is sent to Susan via overnight carrier.
• Typically, Susan receives the ordered unit within one day, rarely exceeding two days.
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Medtronic’s Supply Chain
• Mounds View DC requests weekly replenishments from production facilities.
• There’s currently a three-week lead time for receiving each order of the InSync
pacemaker.
• Figure 1 displays one year's data on monthly shipments and end-of-month inventory at
the Mounds View DC for the InSync pacemaker.
• Figure 2 provides data on monthly implants (demand) and inventory for the InSync
pacemaker in Susan's territory over the same year.
• Significant variation exists in the number of units demanded at the DC and particularly in
Susan's territory.
• Increased demand in Susan's territory during the summer months isn't reflected in
aggregate shipments through the DC.
• The observed "pattern" in Susan's demand data may not be real, akin to how random
events may sometimes appear as patterns, similar to a splotch of ink on a piece of paper.
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Monthly shipments and end-of-month inventory

FIGURE 1 FIGURE 2
Monthly Shipments (Bar) and End-of-Month Inventory (line) for the Insync Pacemaker at Monthly Implants (bar) and End-of- Month Inventory (line) for the InSync Pacemaker in
the Mounds View Distribution Center Susan’s Territory
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
End-of-month inventory refers to
the quantity of goods or products
End-of- that a business has on hand at the
conclusion of a specific month.
Month It represents the remaining stock
Inventory available after all sales and
transactions have been accounted
for during that month.
Medtronic’s Supply Chain

• Susan's primary role as a sales representative is to promote Medtronic's


products among physicians in her territory.
• A significant portion of Susan's yearly income comes from bonuses linked to
meeting ambitious sales targets.
• Encouraging proactive sales efforts is crucial for Susan to meet these targets.
• Susan tends to prefer maintaining extra inventory if given the decision-making
authority on inventory investment.
• Several reasons support Susan's preference for holding a considerable
amount of inventory:
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Medtronic’s Supply Chain

Susan is motivated by
the sales incentive Medtronic’s products
Medtronic’s products
system to avoid have a long shelf life,
are generally quite
missing sales due to minimizing spoilage
small, so it is possible
inventory shortages. concerns. However,
to hold a considerable
Patients and surgeons failure to adhere to a
amount of inventory
won’t wait for back- “first-in-first-out”
in a relatively small
ordered inventory, regime could lead to
space (e.g., the trunk
leading to potential spoilage concerns
of a vehicle).
sales losses to over time.
competitors.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Medtronic’s Supply Chain

• Susan can be quickly replenished from the DC if inventory is available.


• However, she may not always have time to place an order immediately after an
implant.
• Maintaining an inventory buffer gives Susan flexibility in timing her replenishment
requests.
• Production facilities strive to prevent DCs from running out of stock, but occasional
shortages can still happen due to production issues.
• Factors such as lower production yield or capacity constraints with suppliers can lead
to product unavailability for weeks or months.
• Maintaining extra inventory safeguards Susan from these shortages, offering a
buffer against unexpected disruptions.
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Medtronic’s Supply Chain

Each sales The par level indicates


Once inventory reaches
representative is the maximum number Par levels are adjusted
the par level, no
assigned a par level for of units a quarterly based on
additional units can be
each product to representative can have previous sales and
ordered until one is
maintain a reasonable on order or on hand at anticipated demand.
implanted.
inventory. any given time.

Medtronic aims to strike a While Medtronic doesn't grant full


Sales representatives can
balance between avoiding autonomy over inventory to sales
request adjustments to
excessive inventory and representatives, it also aims to
par levels if they believe a
ensuring adequate stock to avoid operating with overly lean
higher level is justified.
meet demand. inventory levels.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
• The newsvendor and the order-up-to-inventory models are tools
for deciding how much inventory to put at a single location to
serve demand. An equally important decision, and one that we
have ignored so far, is how many different locations the firm
should store inventory to serve demand.
Location Pooling

Currently, there is a single distribution center serving the entire U.S. market.

The question arises: Should each sales representative have their own inventory
stockpile, or should multiple territories be served from a centralized location?

Similarly, should the U.S. market demand be managed by a single distribution


center, or should it be divided among multiple centers?

These questions prompt exploration through the concept of Location Pooling.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Location Pooling
• Representatives in adjacent territories could pool their
inventory at a centrally located space, such as a rented
area in a convenient location.

• Sharing inventory means representatives only carry what's


immediately needed, with trunk and consignment
inventory moved to the shared location.

• Control of pooled inventory would be managed by an


automatic replenishment system based on the order-up-to
model.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Location Pooling
• Average daily demand for Medtronic's InSync pacemaker in Susan
Magnotto's Madison, Wisconsin, territory follows a Poisson distribution
with a mean of 0.29 units per day.
• Suppose there are adjacent territories, each with a single sales representative,
with the same average daily demand of 0.29 units.
• Instead of individual inventory management, representatives now share a
common pool of inventory, creating a pooled territory and pooled
inventory.
• We now need to assess the performance of the system with pooled
territories, examining the impact of location pooling.
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Location Pooling
• The order-up-to model is employed to manage
inventory at the pooled territory.
• A target in-stock probability of 99.9 percent is
maintained, consistent with individual
territories.
• The lead time to replenish the pooled territory
remains at one day, with no anticipated
difference from individual territories.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Location Pooling
• Combining demand from different territories with
Poisson distributions results in a combined demand
distribution with a mean equal to the sum of their
individual means.
• If Susan shares inventory with two nearby
representatives, each with a mean demand of 0.29 units
per day, the total demand across the three territories
equals 3 times 0.29, which is 0.87 units per day.
• The order-up-to model can then be applied to the
pooled territory, assuming a lead time of one day and a
mean demand of 0.87 units.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Location Pooling

An alternative approach to comparing pooled territories and individual


territories involves evaluating inventory relative to the demand it serves.

This method calculates expected inventory in days of demand rather than


units.

Expected inventory in days-of-demand equals the expected inventory in


units divided by the expected daily demand.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Location Pooling
In contrast, inventory at
Inventory at individual
Table 1 includes the three pooled territories
territories equals 3.4 units
measure of expected equals 5.3 units divided by
divided by 0.29 daily
inventory in days of 0.87 daily demand,
demand, resulting in 11.7
demand. resulting in 6.1 days of
days of demand.
demand.

Pooling three territories


leads to a 48 percent
reduction in inventory
investment, consistent with
the reduction calculated
using units.
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Location Pooling

Pooling two or three territories significantly reduces inventory, as shown in


Table 1.

However, there are diminishing marginal returns to pooling territories,


meaning each new territory added to the pool brings a smaller reduction in
inventory compared to the previous one.

For instance, adding two more territories to a pool of six has minimal
impact on inventory investment, while adding two more territories to a pool
of one results in a dramatic inventory reduction.

Most of the benefit from pooling territories comes from combining the first
couple of territories, suggesting little value in combining many territories
together.
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Location Pooling
Location pooling generally reduces inventory, as evidenced by Table 1.

However, adding the seventh location to the pool slightly increases inventory.

This is because the order-up-to level must be an integer quantity, potentially


leading to a higher in-stock probability than the target.
For instance, the in-stock probability with six pooled territories is 99.90 percent,
while it increases to 99.97 percent with seven pooled territories.
Despite this issue, the general trend of location pooling reducing inventory remains
valid.
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Table 1. The Impact on InSync Pacemaker Inventory from Pooling
Sales Representatives’ Territories

Demand at each territory is Poisson with an average daily demand of 0.29 units, the target in-stock probability is 99.9
percent, and the lead time is one day.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Location Pooling

The Coefficient of Variation (CV) of a


Poisson distribution is calculated as the
standard deviation divided by the mean.
Since the standard deviation of a Poisson
distribution equals the square root of its
mean.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Figure 1. The Relationship between Expected Inventory (circles) and the
Coefficient of Variation (squares) as Territories Are Pooled

Demand in each territory is Poisson with mean 0.29 unit


per day, the target in-stock probability is 99.9 percent, and
the lead time is one day.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Location Pooling

Figure 1 illustrates the


Location pooling reduces
relationship between inventory
expected inventory in days-of- However, location pooling has
and the coefficient of variation
demand, mirroring the no effect on pipeline inventory
using data from Table 1,
decreasing trend in the in terms of days of demand.
showing a decreasing pattern in
coefficient of variation.
both.

Little's Law governs pipeline


inventory, and it relies on
averages rather than variability,
explaining the lack of impact
from location pooling on
pipeline inventory.
Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.
Table 2 Using Location Pooling to Raise the In-Stock Probability
While Maintaining the Same Inventory Investment

Demand at each territory is Poisson with average daily demand of 0.29 unit, and the lead time is one day.

Source: Matching Supply with Demand: An Introduction to Operations Management, by Cachon and Terweish, McGraw Hill Education.

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