Supply Chain Management Prashant Yadav, Professor of SCM, MIT-Zaragoza International Logistics Program

Tsukuba University, Jan 8-11, 2008

Why does inventory management get complicated in a disintegrated multi-agent supply chain ?

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 2

Number Numberof ofbabies babiesare areconstant! constant! How Howcome comethere thereis issuch suchaavariability variabilityin inthe thedemand demandfor forPampers? Pampers?

Order Size

Distributor Orders Retailer Orders

Customer Customer Demand Demand

Manufacturer’s Manufacturer’sOrders Orders

Time Source: Tom McGuffry, Electronic Commerce and Value Chain Management Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 3

This phenomenon of order variability amplification as you go upstream in the supply chain is commonly termed “bullwhip effect”

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 4

Examples: „ Procter & Gamble (P&G) and Diapers –

Reasonably stable market at consumer level

–

Substantial variability in orders that P&G placed on suppliers (such as 3M)

–

P&G coined the term “bullwhip effect”

„ Hewlett Packard (HP) and Printers

„

–

Some variability in sales

–

Bigger swings at the orders of resellers

–

Even bigger swings for orders from printer division to the IC division

Barilla and its distributors

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav

Order Variation

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Distributor Performance

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What causes the bullwhip effect ?

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 8

Demand Forecast Updating „ Orders as the only signals of product demand to upstream members „ Forecasting techniques rely heavily on recent demand observations

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav

Order Batching „ Economies of scale in ordering costs and manufacturing setups lead to

batching „ Periodic planning and ordering as part of MRP and periodic review

systems „ Economies of scale in transportation (full truckload rates) „ “Push” ordering motivated by short term financial performance measures

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav

Price Fluctuation and Trade Promotion „ Quantity discounts and advance purchases „ Variance of buying quantities bigger than variances in consumption

rate „ Hysteresis vs. Pantry Loading „ Marketing vs Supply Chain Management

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav

“Hysteresis” If you push on something, it will yield: when you release, does it spring back completely ? If not, it is exhibiting hysteresis

sales increase quickly as a result of promotion, then remain the same or decline slowly

Time Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav

Pantry Loading consumers buy in advance in response to a promotion, leading to post-decline in sales

Time Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav

Rationing and Shortage Gaming „ When demand exceeds manufacturing capacity, rationing of orders „ Customers exaggerate their real needs (“gaming”) „ Example, 1980’s DRAM chips „ When capacity constraints are removed, orders suddenly drop „ Example, HP and Laserjet III Printers

Motorola 1992, 1993 cellular phones

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav

Countering the bullwhip effect ?

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Countering the Bullwhip Effect ‹ ‹ ‹

Vendor Managed Inventory (VMI) Barilla’s JITD Continuous Replenishment Program (CRP) at Campbell Soup, Nestle, M&M, P&G, Scott Paper

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav

Countering the bullwhip effect with information sharing

‹

Sell-through data Point-of-Sale (POS) data

‹

Discount for Information Sharing ?

‹

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav

POS ? „ Kmart Workbench, Wal-Mart RetailLink, Target Partners-On-Line „ In 1985, Walton and his chief lieutenant, David Glass, began developing a

program called Retail Link. The software, and the hardware that went along with it, took years to perfect, eventually costing $4 billion. Wal-Mart shared this revolutionary software with suppliers at no cost, in order to help them meet the retailer's needs more efficiently „ Through Retail Link, suppliers can: ‹

Determine how many of their products were sold at Wal-Mart stores the previous day.

‹

Download purchase orders from Wal-Mart.

‹

Check the status of their invoices to Wal-Mart.

‹

Examine the effects of markdowns or returns on their inventory.

‹

Access reports on sales over a period of up to two years, as well as sales forecasts for their products for up to one year.

‹

Upload reports and updates for Wal-Mart.

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav

Dirty POS ? „ Cleaning POS „ Stock-outs and Unconstraining „ IRI, AC Nielsen survey data for weekly POS „ Other means of obtaining customer demand data directly ‹

Jewellery retail example

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav

Countering the bullwhip effect by reducing order batching ‹

Internet buying exchanges and Computerized Ordering

‹

Discount for Truck Load Assortment- Mixed SKUs

‹

Shipment Consolidation

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav

Countering the bullwhip effect by eliminating price fluctuation ‹

Everyday Low Price (EDLP)

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav

Thought Exercise „ Twolever is a large European food giant with strong brands in almost all food

product categories. „ Its products are distributed through major grocery chains in the UK and

Europe „ The global supply chain manager at Twolever, Jeff (unfortunately) studied at

a business school in UK and took a course in supply chain management. „ He has mandated a company wide program to reduce the bullwhip effect. He

believes order batching and forward buying at the retailers is causing the demand fluctuations to get amplified before they reach the factories. He has also compiled some aggregate information on how much does additional variation in demand cost Twolever’s supply chain. „ He initiates a special bonus and career rewards program for the category

supply chain manager who achieves maximum reduction in bullwhip effect in his/her product category. Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 22

Thought Exercise „ They have also started obtaining Point of Sales data from a retail chain

which controls 30% of the market and very soon start obtaining it from the other big ones. „ He is confused on the right measure to base his bonus/rewards program

around. „ Jeff is amazed by your superior and more analytical knowledge of supply

chains and has engaged you as a consultant to help him.

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 23

Thought Exercise „ Twolever’s ice-cream division produces many different variants of a special

frozen treat with a shelf life of 7 days „ Twolever uses its own cold chain distribution network for distributing these

frozen treats. They are sold on a delivered cost basis to the retail chains’ distribution centers by Twolever's trucks. „ For this product the lead time from the factory to the retail distribution

centers is less than a day and large chains typically receive two deliveries per week „ There is a high storage cost for frozen treats ($2 per box of 1000 per day) for

Twolever. This cost is likely to be even higher for the retailers. „ The ice-cream SC manager argues that Jeff’s scheme does not make sense.

At least not for his category. „ As the unbiased external consultant what would be your recommendations Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 24

Traditionally: You call, we haul

Retailer ‹ monitors ‹ places

inventory levels

orders

Manufacturer ‹ manufactures

product

‹ routes

vehicles

‹ makes

deliveries

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 25

Vendor Managed Inventory : You rely, we supply Retailer ‹

lets the vendor to manage the inventory

Manufacturer ‹

monitors customers’ inventory

‹

controls inventory replenishment & decides – when to deliver – how much to deliver – how to deliver

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 26

VMI: more formally stated „ Supplier takes on the responsibility of managing the inventory at the

buyer’s site for the products it supplies, i.e., monitoring, planning, and directly replenishing the inventory at the buyer’s location(s) „ Supplier determines when stocks are to be replenished and in what

quantities, rather than it responding passively to orders placed by its buyers. „ Guided by a contract which specifies the financial terms, inventory

constraints, and/or performance targets such as service measures. „ VMI transfers inventory management (and in some cases ownership)

from the customer to the supplier „ Consignment is when supplier owns title of the goods

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 27

VMI in philosophy „ To produce things and to rear them,

but not to take possession of them, To act, but not to rely on one's own ability, This is called profound and secret virtue. ‹

Lao Tzu, The Way of Lao-Tzu Chinese philosopher (604 BC - 531 BC)

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VMI Benefits Buyer „ Relieved of the burden to specify, to place and to monitor purchase

orders, while enjoying guaranteed service levels „ Less resources for inventory management

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 29

VMI Benefits Supplier „ Significantly reduced forecast uncertainties, and hence safety

stocks „ Reduced logistics costs; better coordination of deliveries to

decrease transportation cost „ Freedom in when & how to manufacture product and make

deliveries - level production „ Better coordination of inventory levels at different customers

Both „ A renewed and reinforced link rises between the buyer and supplier

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 30

VMI Operational Implementation „ The supplier guarantees the continuity of a service level ,

usually a contracted service level agreement (SLA) „ The stock is stored in the buyer’s raw material inventory „ Raw materials are picked up daily, according to production

requirements or market demand, and paid to the supplier on the consumption, according to the agreement arranged „ The consumption trend information is constantly refreshed and

immediately transferred to the supplier

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 31

VMI Service Level Agreement ? Service level SL Fill rate FL stock level between a minimum level z and a maximum level Z Balanced scorecard attribute Time horizon to measure these and penalty clauses

Manufacturer-Retailer VMI vs. Supplier-Manufacturer VMI

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Issues in VMI coupled with Consignment „ One time inventory buy back by suppliers to start the Consignment

inventory program „ Handling Shrink „ Pharmaceutical supply chain example

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 33

VMI Essentials „ TRUST ‹

Accurate information provided on a timely basis

‹

Confidential information kept confidential

„ TECHNOLOGY ‹

Automated electronic messaging systems to exchange sales and demand data, shipping schedules, and invoicing

Source: Martin Savelsbergh, GA Tech

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 34

Power equation in the supply chain decides how easy or difficult it will be to implement vendor managed inventory or continuous replenishment programs So which direction is the power equation tilting ?

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 35

Retail power

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Category Captainship „ The big dog not only eats first but also decides who will get the

plate scraps „ The limiting case of VMI is Retailers only sell shelf space to

manufacturers „ Slotting allowances

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 37

Multi-level inventory management and stock positioning

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 38

Typical Structure Central DC

Regional DC

Regional DC

Retailer

Retailer

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Complexity „ Demand at central DC is dependent upon the demand and the stocking

decisions at the branch DCs „ Demand at branch DC is dependent upon the demand and the stocking

decisions at the retail locations

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 40

Pertinent questions ? „ Should inventory stocking and replenishments decisions be made centrally or

in a decentralized fashion ? „ Should inventory be held at central warehouses or in regional warehouses ?

How much ? „ Where should inventory be deployed ? Should it be held at a central location or

should it be pushed forward closer to the retailer ? „ If there is a shortage of stock how should it be allocated ?

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 41

Central vs. Decentralized Inventory Planning Centralized „ Takes an overall cost view and hence may result in optimal stock positioning „ Harder to implement and makes decision making less responsive „ Multi-party supply chains are the de facto standard in most industries – stages

are owned by different entities Decentralized „ Does not take a global view of costs involved in making individual stage

decisions

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 42

“From a very early age , we are taught to break apart problems , to fragment the world. This apparently makes complex tasks……more manageable , but we pay a hidden , enormous price. We can no longer see the consequences of our actions , we lose our intrinsic sense of connection to a larger whole. When we try to ‘see the big picture’, we try to reassemble the fragments in our minds, to list and organize all the pieces….the task is futile…..after a while we give up trying to see the whole altogether.” Peter Senge The Fifth Discipline

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 43

Complexity in multi stage inventory management „ Each stage does not realize the implications of inventory holding and shortages

at stages downstream and upstream to it. „ “If I do not hold the appropriate amount of inventory, my downstream stages

may have to hold even more” ‹

Pooling effects

„ Upstream responsibility

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 44

Risk Pooling „ Consider these two systems:

Warehouse 1

Market 1

Warehouse 2

Market 2

Supplier

Market 1 Supplier

Centralized Warehouse Market 2

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 45

Sums of random variables „ normal distribution X ‹

standard deviation σX

„ normal distribution Y ‹

standard deviation σY

• assuming X and Y independent ‹

variance σ2 for X+Y = σx2 + σY2

„ Simple simulation experiment

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 46

Supply chain implications if demand at n retailers have standard deviations σ1, σ2, …, σn demand at centralized warehouse that serves them has standard deviation and if demand at different retailers is independent

σ = σ 1 + σ 2 + ... + σ n 2

2

2

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Safety stock location „

goal: 95% demand filled from stock

„

total SS requirement if SS kept at retailers as compared to SS requirement if SS kept at centralized warehouse is

1.

more

2.

less

3.

the same

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 48

Safety stock location „

SS kept at retailers ‹

„

kσ1 + kσ2 +…+ kσn

SS kept at centralized warehouse?

k σ 12 + σ 2 2 + ... + σ n 2

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 49

Safety stock location „

Assume all retailers have same demand variance ‹

„

SS kept at retailers ‹

„

σ1 = σ2 =…= σn = σ kσ1 + kσ2 +…+ kσn = n kσ

SS kept at centralized warehouse

k σ + σ 2 + ... + σ n = k nσ = nkσ 2 1

2

2

2

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 50

Risk Pooling „ For the same service level, which system will require more

inventory? „ For the same total inventory level, which system will have

better service? „ What factors affect these answers?

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 51

Aside on Stock Positioning „ Two types of demand correlation to be considered:

Auto-correlation: That is the correlation of the demand with itself in a time period. Example: You are less likely to buy a car tomorrow if you bought one today.

Inter-correlation(or cross-correlation): That is the correlation of demands that are realized by different retailers. Example:If you buy your car from one retailer, that means you won’t buy from another one in close future assuming you want to but only one car. Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 52

Risk Pooling ‹

Centralizing inventory reduces both safety stock and average inventory level for the same service level

‹

This works best for – High coefficient of variation, which reduces required safety

stock – Negatively correlated demand. Why?

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 53

Tradeoff „ centralization ‹

lower inventories

‹

operating efficiency

„ lower responsiveness

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 54

Stock Positioning Where to position safety stock ? Downstream Closer to customer Typically downstream units are the most expensive places to hold stock Pooling and aggregation of uncertainty effects are lost Upstream Farther from the customer May not provide the desired service level The inventory manager’s job is to create a fine balance

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 55

Safety Stock Positioning „ Autocorrelation of demands brings a tendency to hold stock at downstream

levels „ Intercorrelation of demands brings a tendency to hold SS at upper levels. „ An optimization approach for jointly correlated demands needs to be

introduced „ Unfortunately, your ERP systems don’t solve this problem „ Some vendors have started product offerings: ‹

Optiant

‹

Smart Ops

‹

ToolsGroup

„ The question of optimally positioning stock is however a very context and

company specific issue. It requires specific models Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 56

Revenue Sharing as a tool to align incentives

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 57

Thought Experiment „ You are a retailer. You buy a widget at a wholesale price of $3.00 from a

supplier and sell it for $ 4.00. „ It costs your supplier $2.00 to make that widget „ Unsold widgets are marked down and sold at $1.50 „ Demand is uncertain and uniformly distributed between 5 and 10 „ It is equally likely that demand is 5,6,7,8,9 or 10 units

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 58

Quiz: Understocked vs. Overstocked supply chains „ Stockout for the manufacturer is not a stockout for the retailer. If

the customer does not find Coke he is willing to settle for Pepsi „ Manufacturer is offering quantity discounts and huge seasonal

promotions „ Retailer has small margins „ Retailer has to take huge markdown when the product does not sell „ Manufacturer is keen to meet analyst expectations and is pushing

product into the channel

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 59

The channel as a whole Marginal Revenue/Costs

c

Qint

Q

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 60

The channel as a whole Marginal Revenue/Costs

c

Qint

Q

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 61

Traditional setting Marginal Revenue/Costs

w

c

Qd

Qint

Q

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 62

With revenue sharing Marginal Revenue/Costs

w

c

w = λc

Qd

Qint

Q

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 63

Non Linear pricing motivation Marginal Revenue/Costs

c

Qint

Q

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 64

Order Minimums

To illustrate typical structure only. A detailed ordering matrix can be obtained from Rentrak website for each studio

Source: Rentrak Website

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 65

Terms Vary

••$$0.00 0.00upfront upfrontfees fees •• 65/35% 65/35%split split(you (youkeep keep65%) 65%)vs vs$1.05 $1.05minimum minimumtransaction transactionfee feefor forfull fullterm term

••Sell Sellon on29th 29thday day(VHS (VHScost cost= =$2.00 $2.00vs vs35% 35%//DVD DVDcost cost= =$3.50 $3.50vs vs35% 35%––can cansell sell50%) 50%) (VHS/DVD) (VHS/DVD) ••66month want purchase monthlease leaseterm term (cost (cost= =$0.50) $0.50)ififyou wantto to •you $0.00 up-front fee purchase • $0.00 up-front fee

••$$3.75 3.75upfront upfrontfees fees •• 44/56% 44/56%split split(you (youkeep keep56%) 56%)vs vs$1.15 $1.15minimum minimumtransaction transactionfee feefor forfull fullterm term

••Sell Sellon on41st 41stday day(VHS (VHScost cost= =$2.40 $2.40can cansell sellall allbut butone) one) ••66month monthlease leaseterm term (cost (cost= =$1.20) $1.20)ififyou youwant wantto topurchase purchase

Source: Rentrak Website

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 66

Terms Vary

••$$0.00 0.00upfront upfrontfees fees •• 61/39% 61/39%split split(you (youkeep keep61%) 61%)vs vs$1.15 $1.15minimum minimumtransaction transactionfee feefor forfull fullterm term

••Sell Sellon on28th 28thday day(VHS (VHScost cost= =$2.00 $2.00vs vs39% 39%//DVD DVDcost cost= =$3.00 $3.00vs vs39%) 39%) (VHS/DVD) (VHS/DVD) ••66month want purchase monthlease leaseterm term (cost (cost= =$1.50) $1.50)ififyou wantto to •you $0.00 up-front fee purchase • $0.00 up-front fee

••$$1.25 1.25upfront upfrontfees fees •• 58/42% 58/42%split split(you (youkeep keep58%) 58%)vs vs$1.25 $1.25minimum minimumtransaction transactionfee feefor forfull fullterm term

••Sell Sellon on31st 31stday day(VHS (VHScost cost= =$1.70 $1.70DVD DVDCost Cost= =$$3.35) 3.35) ••66month monthlease leaseterm term (cost (cost= =$1.75) $1.75)ififyou youwant wantto topurchase purchase

Source: Rentrak Website

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 67

Revenue Sharing vs. Fixed Price A titles

B titles

C titles

Source: Mortimer 2002, Working Paper

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 68

Please feel free to send questions, comments, critique, war-stories etc. to pyadav＠zlc.edu.es pyadav ＠ mit.edu

Yadav –Supply Chain Management-Tsukuba Univ. © 2007 Prashant Yadav 69